The Wall Street Journal


June 22, 2005













The Liberation of Life Insurance
June 22, 2005; Page A11

When we last looked into the startling new business of buying and selling "used" life insurance policies, the back-pocket pioneers were already phasing themselves out. Wall Street, we predicted, would soon be running a lustful eye over a multibillion-dollar opportunity. Gentrification was just around the corner.

That was four years ago. Eliot Spitzer has been a blessing to newshounds in many ways, including by unearthing, as part of his AIG investigation, a handwritten note from the honcho himself, Hank Greenberg, dated just a month after our column. He fretted about the "risk of adverse PR" consequences from the company's then-secret dabbling in a market whose original participants were even then being sized up for handcuffs. "I am uneasy about this."

AIG can now add to its troubles accusations that it accounted for $927 million in purchased life insurance policies in improper fashion (at least pending an accounting rule change, now in the works, that would put AIG back on the right side of the accounting mavens).

In such a deal, the buyer of the unwanted insurance policies (AIG, in this case) keeps up the premiums until the seller dies, then collects the death benefit. AIG most probably doesn't yet know whether its toe-dabbing in these waters has been profitable. That's because the original policyholders are almost certainly still alive. A rule of thumb is that the target audience consists of individual "insureds" who are 65 or older, in declining health, with an expected life expectancy of six to 12 years.

For those who care about such things, the Spitzer revelations did confirm long-standing industry scuttlebutt: AIG, as rumored, had been the deep pockets behind Coventry First, a small Pennsylvania firm that emerged overnight as the "life settlements" industry's biggest player, climbing over the wreckage of the previous "viatical" industry, which had briefly thrived by brokering sales of life insurance policies from dying AIDS victims, then fell into disrepute thanks to fraud and the miracle drugs that kept many of the sellers alive longer than expected.

What's striking is how quickly the industry has gone from respectable to disgraceful and back again. General Re, the insurance unit of Warren Buffett's Berkshire Hathaway, reportedly has invested $800 million in buying up used polices. German investors -- because of favorable tax laws, not because of any national trait -- have also been big buyers of American death benefits, led by HVB Group, the country's second biggest bank. On the London Stock Exchange now trades a fund devoted exclusively to these investments.

Four years ago, self-appointed industry consciences were decrying this emerging secondary market because it gave buyers a rooting interest in the seller's early demise. Such scruples were destined to go by the boards for good reason: Americans over 65 hold life insurance with a face value of $500 billion, at least $100 billion of which is deemed ripe for resale. The biggest beneficiaries, of course, are the policyholders themselves, who suddenly find they're in possession of a valuable asset.

Ghoulish or not, liquefying this store of illiquid capital is now recognized as a legitimate business opportunity.

Which brings us to Steve Keller, founder of the firm Kelco, whom we held out last time as an example of an industry pioneer not likely to enjoy the success that he helped start. His firm had just been raided by the FBI, although he argued his only sin was to have screwed up the insurance industry's business model, which relied on high lapse rates and casual underwriting.

At his trial two years ago, a parade of government witnesses, many of them HIV victims who appeared as part of their own plea bargains, testified that Kelco had knowingly bought policies from people who lied to insurers about their medical condition. Kelco's lawyers argued, in essence, that selling policies to sick people was the insurance industry's problem, which it could fix by cleaning up its underwriting act. It wasn't Kelco's problem. Kelco employees "viewed the insurance industry as the competitor and they were proud of what they did," declared defense lawyer Robert Tarun.

This argument fared no better in Mr. Keller's case than it did in many other cases of "viatical fraud" around the country. He was convicted and sentenced to 14 years, although the judge, who said he saw grounds for a successful appeal, set him and two other executives free on bail -- in gratitude for which Mr. Keller promptly spirited himself and his family to Panama, where he was later rearrested.

But credit him and the industry's other pioneers with having done good too. Gone are the days when insurance companies were the sole market for policyholders who wanted something to show for decades of paying premiums without having to die first.

Once, these policies might have been allowed to lapse or returned to the company for a minuscule "surrender" payment. But -- here's the peculiar calculation -- where the covered person has suffered a health reverse that reduces his or her life expectancy, the real economic value of the death benefit may be far greater than the surrender value, even after the premiums that would have to be paid until he or she finally dies.

Now that institutional investors are buying and selling hundreds of policies at a time, vanished is the specter of an investor seeking to hasten his payoff with a blunt object. Pricing will improve too, as securitization takes advantage of the law of large numbers to remove much of the risk from mortality estimates.

The new securities are expected to appeal particularly to pension funds, always looking for ways to match the maturities of their investments with the timing of their payouts. Thus the recycling of life insurance by older Americans will become, twice over, a way for them to finance their own retirements.