It’s a given that most of us want to extend our lives as long as possible. But our ever increasing lifespans can create problems for pension funds and others that depend on us dying to keep their books balanced.
 
Pension funds face severe longevity risk.  If pensioners live longer than expected, payouts from the funds could exceed the estimated cost of keeping the funds solvent. Worldwide, $17 trillion of pension funds – $23 trillion in assets – is exposed to longevity risk.

But the big banks—including Goldman Sachs, JPMorgan Chase, and Deustsche Bank—are coming to the rescue by packaging that longevity risk and selling it to investors.

They’re counting on investors being interested in gambling on your death.

The pension funds want to insure themselves against their longevity risk, so the banks are packaging that risk into longevity bonds, or in the pejorative, “death bonds,” and selling them to investors eager take on some of that risk. It’s a practice akin to the pre-financial crisis practice of packaging subprime mortgages into mortgage backed securities and selling them to investors.

Investors profit by taking “premiums,” a portion of the pension funds’ assets. In exchange, investors promise to make good on any losses experienced by pension funds if life expectancies deviate higher than their expected levels.

There are significant challenges for purveyors of longevity bonds. The primary challenge is that payout on the bet only happens when someone dies, and that can take 20 years or longer. Investors are looking for short-term performance, and the uncertainty of longevity bonds can keep them away. There’s also the counterparty risk inherent in a contract that can last 20 years or more. Pension funds must be able count on investors, and the banks, to remain solvent over the entire life of the contract.

The final challenge for death bonds is public perception. Although these death bonds, or “death derivatives,” fill a niche needed on Wall Street, they turn many stomachs on Main Street.

The Concerns Over Death Bonds

The stark reality of death bonds: Investors profit when insureds die. The drama of death bonds has pushed

 

them onto the mainstream consciousness, with The Wall Street Journal and The New York Times running multiple articles on the topic over the past few years.

BusinessWeekcalled death bonds “Wall Street's most macabre investment scheme yet.”

Concerns about gambling on the lives of strangers aren’t anything new. In the eighteenth century, gambling on lives using life insurance was a fairly common practice in England, where it took on an atmosphere akin to modern sports betting. In response, Parliament passed the Life Assurance Act, which is the forerunner of the modern insurable interest requirement.

The insurable interest requirement is intended to keep people from purchasing insurance on the lives of strangers. After all, an investor in a life insurance policy only profits when the insured dies. Strangers then have an incentive to hasten their return on investment. (See our recent article for AdvisorOne on a California court ruling on stranger-owned life insurance, or STOLI.)

Under the insurable interest requirement, only people with a nominal vested interest in seeing an insured survive are allowed to purchase a policy on the insured life. Generally, life insurance can only be purchased on the lives of close family members and anyone with a substantial economic interest in seeing the insured survive.

Although Goldman Sachs or investors who buy their death bonds aren’t likely to send out hit men to improve their profits, the idea of gambling on the lives of others is still generally repugnant to the public at large. 

 

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See also The Law Professor's blog at AdvisorFYI.