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Thursday, September 10, 2009

Life or Death Investing

I'd like to highlight an article that was published September 5th, 2009 in the New York Times titled Wall Street Pursues Profit in Bundles of Life Insurance. It is a wonderful tale on how the Wizards of Wall Street plan to create a new security for their hungry investors. Now, let it be known, I'm a bad, bad dinosaur. For example, one of my main goals in life is to bring down Good Dinosaur ... but the investing scheme they are pushing rubs even me the wrong way! Let me explain.

So we all remember the sub-prime debacle that led to the credit crisis, right? It featured consumers taking on far too much debt, corporate greed, rating agency bribery, and all that other nefarious stuff? Ok, good. Well the new plan is to take life insurance policies from individuals and securitize, or group, certain policies into bond-ish instruments. The benefits, let it be known, are wonderful! For the individual, he will receive a far larger payout (20 to 200 percent more) when compared to the expected surrender value an insurer would pay currently. Investors now have a new, wonderful derivative investment vehicle to pour money into. And big banks have a new revenue engine. Each will likely put out new ETFs, slapping some catchy name / ticker combination such as "GO LIVE (GLIV)" so the general public can take part in the capital markets casino. Here is a graphic of it all:

Now this looks eerily similar to the workflow that resulted in the sub-prime mess. While this resemblance could be a cause for concern, it really should not be. Securitization, when practiced intelligently, is a fabulous concept as it lessens risk. There will be the same vulnerabilities should we lose touch with reality again, but hopefully we will learn from our past mistakes and follies.

So what is my problem then? My issue is the following: In order for an investor in these proposed bond-funds to make money the underlying security (a person) that controls the value of the derivative product (the life insurance policy) must behave (die on time or earlier, preferably earlier). That is dark, my friends.

Here are a few choice quotes from those analyzing this proposal:

"There is another potential risk for investors: that some people could live far longer than expected."

[To lessen risk, ] a bond made up of life settlements would ideally have policies from people with a range of diseases — leukemia, lung cancer, heart disease, breast cancer, diabetes, Alzheimer's. That is because if too many people with leukemia are in the securitization portfolio, and a cure is developed, the value of the bond would plummet.

I'm all for making a buck, but you have to draw the line somewhere. When you are making money based on a cure to awful afflictions not being discovered or rooting for people to die prematurely, you have crossed that line. You are giving investors that hold these "death-to-you" bonds perverse incentives to withhold investment into companies that are looking to find cures and extend people's life expectancies! We should be investing to build, not tear down.

I do not want to see a prospectus for a bond ETF such as the following showing up in my mailbox any time soon:

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