Debate sought on death investment

This Perspective column was first published in today’s edition of Fund Strategy.

Many people’s reaction to discovering the existence of a secondary market in life insurance is likely to resemble finding a dead cat on the pavement: “yuk”.

Somehow it seems to such critics undignified for an investor to buy a life insurance policy from its original owner. It means the insurance is no longer fulfilling its proper purpose of financially providing for someone’s dependents in the event of the policyholder’s death. Even worse it means the investor will financially benefit from the original policyholder’s demise.

Of course the investor is extremely unlikely to do anything to hasten the seller’s death. That would be illegal in any case. But such transactions appear to many people somehow unseemly.

In response to such objections the life settlements industry has strong counter-arguments. For a start policyholders sell their policies voluntarily. It is the free choice of a consenting adult.

Moreover the seller is likely to benefit from the transaction. For example, a 70-year-old woman may no longer need life insurance as she may no longer have any dependents. Her children may have grown up and become financially secure. Selling the insurance policy could allow her to pay for anything from medical expenses to a round-the-world cruise.

From a market perspective both sides of the transaction are likely to benefit. The seller has access to extra cash before her death and the investor is likely to make a significant profit. There is room to debate the appropriate price to be paid for such policies but that is not a fundamental moral question.

I first touched on this question in an earlier column (June 6) after watching Michael Sandel, a professor of philosophy at Harvard, discuss the topic on television. Having read his recent book, What Money Can’t Buy (Allen Lane), it is possible to take the debate further.

Viaticals (from the Latin word for “voyage”) were the immediate predecessor of life settlements. These earlier products emerged in response to the AIDS epidemic of the 1980s and 1990s. Those diagnosed with what in the early days was a terminal illness often welcomed the opportunity to sell their life policies at a discount.

However, the advent of effective treatments for AIDS posed a problem for the viatical industry. Many of those diagnosed with the disease suddenly enjoyed the prospect of many more years of life. Excellent news for them but a problem for investors.

After that the investment industry diversified to life insurance in general. In what became know as life settlements those who no longer needed their policies, generally the relatively elderly, simply sold them to investors. Investment returns would then depended on how long the seller lived for. The investor had an interest in the seller dying young as it meant returns would be higher.

More recently such policies have been securitised. Second hand life policies have been pooled together as funds. Such pools provide a steady income stream to those who invest in them.

Sandel likens such pooled investments in some respects to websites such as stiffs.com – “the home of the celebrity dead pool” – where users can bet on when celebrities are likely to die. Only, unlike with life settlements policies, such sites can claim no socially useful purpose.

In some respects the moral issues raised by life settlements policies are not new. For instance, anyone who takes out a life insurance policy is in essence making a bet that they will die over a certain period. They do this not because they want to die but, on the contrary, they want to protect their dependents in the event of their death.

Only in the primary life insurance market the interests of the individual and the insurance company are aligned. Neither wants the policyholder to die.

If anything the analogy with life settlements is closer with annuities and pensions. The product provider in both cases has an interest in their client dying. But such investments are normally contained in such large pools that they are arguably anonymous for practical purposes.

There are strong arguments on both sides over whether life settlements and associated products are morally desirable. On one side, is what could be called the market-based or utilitarian case. From this perspective it is not up to society as a whole to make moral judgments. Individuals should be free to choose what to do with their own life insurance policies. The market simply provides a mechanism for those who want to buy and sell to exercise their choices.

For critics of such policies there are various objections. The fairness argument contends that the choice being made is not as free as it seems. Someone facing financial hardship may be under pressure to sell their policy at a deep discount.

Another objection is what could be called the corruption argument. From this perspective allowing the buying and selling of life policies coarsens human life. It turns what should be a moral matter into a commercial transaction.

Sandel refuses to give his verdict on life settlements specifically but he raises a general objection to what he sees as the crowding out of morals by markets. First, he says allowing market values free rein leads to the widening of inequality as the rich benefit from the increased scope of market transactions.

Secondly, it is socially corrosive. Sandel refers to this as the “skyboxification” of American life but the reference is not to the satellite television channel. In America a “skybox” is the name given to corporate boxes at sports grounds. Sandel fears the emergence of a society where the rich will be increasingly separated from the rest thanks to their ability to buy access to privileges.

It is possible to come down on either side on the discussion but Sandel is surely right that it should be the subject for public debate. It should not be left to the market, or state functionaries, to decide such matters.