Last Updated Sep 7, 2009 8:08 AM EDT
Friday, the New York Times reported that bankers are seeking to buy life insurance packages from holders who sell them at a deep discount (around 40% of the settlement value). The banks will then bundle the packages, securitize them into bonds, and sell them off to clients such as pension funds, who receive the remainder of the settlement proceeds when people with the insurance die.
Naturally, due to the fact that this is essentially a gamble on life expectancy, the sooner the policyholders die, the bigger the payout. Despite being in just the planning stages, investment-grade raters say that "phones have been ringing off the hook" with enquiries. One investment banker puts it more succinctly: "We're hoping to get a herd stampeding after the first offering."
The juice for investment banks of course is in the fees they earn from the securitization process, regardless of the net asset value of the finished product. If this all sounds a little mortgage-backed security-ish, that's because fundamentally it is. One market watcher, writing at CafeSentido.com, explains:
Like mortgage-backed derivatives, life-insurance derivatives deal with a finite pool of money whose value will not increase over time: at some point, one of the gambling investors will find there is not enough money to cover initial investment plus interest.That's a pretty succinct explanation of the potential end-game in securitizing life insurance policies. There's another similarity between these life insurance securities and mortgage-backed ones: both policies depend upon cash-strapped consumers to exist. Why, after all, would anyone sell their life insurance policy for lower than its settlement value unless they badly needed cash today?
... This is the definition of a pyramid scheme: there is only the money people are putting in, and eventually, when one after another investor takes their payout, there is nothing left for those who stay in the game too long.
In Asia, the circumstances are somewhat different. Securitizing life insurance policies is not even an option: most consumers don't have one at all. That's precisely what investors are betting will create big returns in the future.
As a result, a spate of life insurance IPO's is now in the pipeline for the near future. Kicking off with AIG's Asia unit AIA, Shanghai-listed China Pacific Insurance is expected to raise $3.5 billion shortly after in Hong Kong (early 2010). Another three companies will file swiftly thereafter.
As with the western securities, banks are bullish about investor demand: According to Rob Jesudason, Asia head of the financial institutions group at Credit Suisse, "there's going to be very strong demand." [Reuters]
Notably, banks will benefit from the IPO's when they take their underwriting fees. But while the Asian life insurers will prosper from increased capital bases they derive from the listings, in the case of the American life insurers, they will probably lose out. That's because of the increased number of settlements they may be forced to pay out in fairly short order to the investors in the securitized policies.
With the life insurance sector in the U.S. not exactly on fire right now, this double-whammy of negatives may significantly weaken large American multi-nationals, which will find themselves struggling financially just as their Asian competitors gobble up market share.