Their proponents say they could represent a multibillion-dollar business for investment banks. Their opponents say they are risky, poorly understood investments that place bets on human lives. And Canada's biggest credit rating agency has found itself caught in the middle of the debate.
They're called “death bonds” – or, more formally, life settlement securitizations – a burgeoning class of financial products that have caught the eye of financial innovators at some of Wall Street's biggest banks, which are eager to find new ways to make money after the popping of the mortgage bubble. The bonds are created by intermediaries that buy up life-insurance policies from policy holders – typically seniors looking to cash out their policies – bundling them together, and selling off small slices to investors. The profit comes when the policy holders die and the investment funds, as the designated beneficiaries, collect the payouts.
It may sound macabre, but the products have become increasingly popular in private investment transactions this decade – and have suddenly caught the attention of U.S. lawmakers. They are worried that Wall Street is preparing to repeat the same mistakes it made with subprime mortgages, and that bond rating agencies will be willing to put their stamp of approval on dubious offerings, just as they did during the credit boom earlier this decade.
I was a little surprised that all of the concern wasn't about life settlement companies buying and selling policies, but about the possibility that they would be securitized. — Dan Curry, DBRS Inc. president
Toronto-based credit rating agency DBRS Ltd. provides an interesting case in point.
Still trying to live down its willingness to rate the asset-backed commercial paper products that turned into a near-disaster for Canada's financial community during the credit meltdown, DBRS was called to the mat by a U.S. congressional committee last month to answer questions about life-settlement securitizations, after The New York Times ran a prominent story about the potential growth of the products.
Last year, DBRS became the first mainstream credit agency to lay out criteria for rating death bonds, placing it at the vanguard for eventually issuing ratings on life-settlement securities – a move that would open them up to a much broader investment base.
Never mind that DBRS has never given a rating to death bonds, that industry insiders say that they may never be more than a minor sideline for Wall Street firms, and that some of the biggest names rumoured to be considering issuing securities (such as Goldman Sachs and Credit Suisse) say they're aren't pursuing public death-bond issues. Washington is nervous – not so much about poor seniors selling their policies to the highest bidder, but about voters becoming exposed to another risky Wall Street scheme.
The most obvious attraction of life settlement investments is their certainty: insured people will eventually die. But perhaps even more compelling is their lack of correlation with other financial asset classes.
“I was a little surprised that all of the concern wasn't about life settlement companies buying and selling policies, but about the possibility that they would be securitized,” said Dan Curry, president of DBRS Inc., the U.S. arm of the Toronto company, who testified before the House financial services subcommittee on capital markets. “This is not another mortgage-backed securities market.”
The most obvious attraction of life settlement investments is their certainty: insured people will eventually die. But perhaps even more compelling is their lack of correlation with other financial asset classes.
What happens in the stock market or bond market has little, if any, bearing on whether and when an insured life will end. The appetite for uncorrelated investment assets, particularly among hedge funds, has become more acute in the wake of last year's financial market collapse, which buried virtually every traditional asset class in its path – even ones that had historically moved in opposite directions.
