Death Bonds

Profile of Steve Carlson

“Psssst, buddy! Want to buy a death bond? They’re the most exciting, new investment on the street today. Get ’em while they’re hot.” Hardly, at least in Canada, but I saw them pop-up in an article in The Globe and Mail last month. Death bonds are the catchy name for life settlement securitizations that are bundled life insurance policies sold, in this case, as bonds. Profits to investors come from the death benefits paid by the life insurance companies. Death can’t come too soon to maximize returns.

The article quoted life insurers’ ethical reactions to death bonds. Frank Zinatelli, Vice-President of legal services at the Canadian Life and Health Insurance Association that represents most of the life insurers in Canada said, “From an ethical context, you’re betting that someone will die. It doesn’t have the right smell.”

Interesting, but from an ethical context, death has always been the bet for life insurance’s existence. Death bonds are only another variation of the bet. As to the “right smell”? Surely, that has to be in the noses of those sniffing.

Steve Finch, an Executive VP of John Hancock Financial, part of Manulife Financial Corp. had this to say, “It’s not good public policy for investors’ returns to be driven by the early demise of a policy holder.” I’m assuming he’s referring to a public policy that he and his company would like to see everybody accept.

But I can’t help but think that policy owners should be advocating what they think would be a good public policy in this matter, too. Maybe one that’s based on the attitude: “We paid for our policies for years. Now our circumstances have changed. We’ve talked it over with our financial advisors and concluded that we no longer have the need for the death benefits that we once had. Our circumstances are such that it is advantageous to sell our policies to (or through) life settlement intermediaries who will use them to create death bonds or some other investment vehicle. There’s nothing sacred about our insurance policies, they are just another part of our portfolios. They are contracts that simply agree to pay a lump sum or face amount of money when we die. Now that vehicles like death bonds give these contracts an equity value, we would like to use the money from their sale to pursue other personal and financial goals that are now taking priority.”

Since this is Canada, there are bound to be government obstacles to these policy sales. As The Globe article points out, “In Canada, third-party purchases of life insurance policies are banned in six provinces and all three territories.” Privacy issues may create overwhelming problems for some insureds. And disgruntled ex-beneficiaries can always sue. Personally, my biggest concern would be how the Canada Revenue Agency will treat the money I receive through a life settlement intermediary. Is it taxable? If so, how? After all, the face amounts of my personal policies are paid to my beneficiaries tax-free.

Should you ever consider selling your life insurance policy, remember this. If your reason for selling is to free-up some cash because you have a terminal illness, then talk to your advisor first. It’s not well-known, but in Canada most life insurance companies will pay you part of the face amount while you’re still alive if you prove to their satisfaction that you are terminal and death is imminent, i.e. generally, likely to occur within six months. That amount may be enough to tide you over. (I have heard that the size of advanced payments in Canada range from 25% of the face amount and up.) The unpaid balance of the face amount less the interest on the advanced payment will eventually be paid to your beneficiary at your death. The sum of these two amounts is more money than any life settlement intermediary is likely to provide.

Copyright © by Marketing Options Inc. 2009.

One thought on “Death Bonds”

  1. Regulatory constraints aside, there are two issues that give rise to the concept of selling your life policy, one pro and one con. On one hand, the “smell test” argument put forth by the insurance industry lost its luster when they twisted life insurance from a protection vehicle for premature death to a “queasy” investment vehicle with the advent of Universal Life. Life policies are now rightfully considered an asset with a variable equity value depending on the point of measure, with all the rights of any asset ownership, including disposition. The fact that law and regulation hasn’t caught up with the current state of affairs is mute in the realm of ethics. Stated positions from the insurance industry would lend more credibility if they used actuarial and pricing arguments as a vote against. Under current pricing practices, if everyone kept their policy to the end, the pricing would be inadequate. This is exactly what would happen with Death Bonds.

    On the other hand, because of its very nature, life insurance is a complex, intangible instrument as a contract document and its application as a financial tool. Life insurance, on the surface, its simple, you die and the insurance pays a benefit. Similarly a mortgage most people understand. Bank lends you money, charges you a price and you pay it back over time. Then mortgages were bundled into mortgaged backed securities [MBS]. It became a complex financial instrument, which few understood with any clarity, but MBS promised returns too good to pass up. As the demand for MBS increased, the shenanigans for creating more mortgages to create MBS began in earnest. The rest is history.

    The temptation to play the same game with death bonds is no less. The sweater the return the more creative the usury tactics become in fulfilling and delivering on the demand. The sellers, in positions of perhaps weakness, agree to dispense, when upon sound reflection, may not do so. The “bundeler” of the death bond, might be tempted to over state or even fabricate performance / return, as has been seen in the viatical industry in the US. What can easily happen is two victims can emerge with death bonds; the seller of the risk and the investor. The Seller is not equipped to properly measure the value of the asset he is about to sell and the investor doesn’t have the tools to independently measure the risk he is buying. Hence, the need for a regulatory framework. is, in my opinion, in the public interest. Remember there were some very sophisticated and intelligent people that were “duped’ by Bernie Madoff.

Leave a Reply