Death Bonds

Death bonds (aka life settlement-backed securities, longevity derivatives, mortality bonds) are asset-backed securities, a derivative based on the securitization of life insurance policies purchased from the elderly or the terminally ill. These securities were mainly sold in Europe.

Death bonds are a type of asset-backed security that originated from viatical settlements (aka life settlements) in the 1980's and 90's. This was the time when AIDS was rampant and incurable, and many sufferers needed or wanted cash, so they sold their life insurance policies to certain companies or investors that were offering to pay cash for the policy. The company or investor would continue making payments until the insured died. However, as AIDS victims lived longer, viatical settlements were not profitable, and with rampant fraud in the 1990's, they fell into disfavor.

The way they worked was that the seller, usually older than 70, went to a viatical broker to find buyers for the seller's policy. The broker usually got 3 bids for a policy from life settlement providers, who are mostly small firms, and bids may range from about 20% to 80% of the policy's value, depending on how long the insured is expected to live. The buyers take over the payment of premiums — otherwise the seller may stop paying, thereby terminating the policy — and collect when the seller dies.

People turned to viatical settlements because they needed the money or don't want to continue paying premiums, and they receive more money than surrendering the policy to the insurance company for cash.

Brokers generally receive commissions of 5-6% which are paid by seller. There is much fraud in this area, and only some states require viatical brokers to get a license.

Most of the buyers are viatical settlement companies, who then resell the policies to hedge funds or investment banks, who then securitizes them into asset-backed securities backed by a pool of about 200 policies. The anticipated buyers of these securities were mainly institutional investors, such as pension funds.

Death bonds can exist because of 2 characteristics of life insurance:

  1. The beneficiary does not need to have an insurable interest in the insured.
  2. The life insurance can't be canceled by the insurance company after about 1 or 2 years unless the premium isn't paid.

The main benefit besides the yield is that death bonds have no correlation to other investments. However, the yield depends on how long the people live — if long enough, then not only will there be no yield, but some, or all, of the principal may be lost. The yield = the payout amount minus the payment to the insured minus the premiums that need to be paid, and, of course, the costs of effecting the transaction.

Yield

Much of the fraud in this area was from overly optimistic (for the investor) projections of the yield based on inaccurate life expectancies. Every premium paid reduces the yield.

The disadvantages and risks of investing in death bonds include:

A big risk for these securities is that the insured may be disqualified for the insurance before death, such as may occur if the insured failed to disclose a pre-existing illness.