Investing in death: Your savings might not survive
I’m a big fan of niche financial markets as well as learning about how NOT to invest. This leads me this week to the “life settlements” industry, and a subset of that business known as “viaticals.”
For those of us who had to Google the definition of “viaticals,” it basically allows you to invest in death.
Living owners of life insurance policies sometimes seek to sell their policies on the secondary market before they die to receive a lump sum of money as well as to relieve themselves of the obligation of keeping up expensive life insurance premiums. The investor pays the lump sum, maintains the policy premiums, and then collect the death benefit when the original policy owner dies.
Let’s say you have terminal cancer and a $100,000 policy that costs $500 a month: a life settlement investor would give you $50,000 to enjoy before you die, pay the monthly premiums until then and collect the full kitty after you pass.
Ideally, for the investor, you die quickly and before the premium costs eat up returns.
While regulated and considered legal transactions in 42 states, there’s an obvious ick-factor to life settlements, as investors essentially bet on, and benefit from, your early death. The faster you die, the greater their profits.
A life insurance policy for someone who beats the odds and lives a long time will end up costing the investor, who pays too much in premiums for too long to make a profit. Viaticals, a subset of life settlements, refers specifically to investing in policies of terminally ill patients, who have less than two years to live, or the chronically ill, who aren’t able to perform two “activities of daily living” like eating, bathing or dressing oneself.
For the policy purchaser, you can see how a life insurance policy of a terminally ill person on death’s door is worth a lot more than the life insurance policy of someone who’s chronically ill.
The legitimate financial cases for buying a secondary life insurance policy are twofold. First, terminally ill or elderly folks may need access to their cash today for end-of-life care. The industry first grew up as a response to the crisis of relatively young men with AIDS in the 1980s. They needed money right away and worried less about heirs or estate-planning.
Those earliest pools of viaticals, dedicated to purchasing AIDS policies, blew up catastrophically for investors in the mid 1990s, when a miracle cocktail combining protease inhibitors and two other drugs transformed HIV from a death sentence to a chronic illness. The insured survived, and investors lost everything.
The second major category of sellers today are often older high net-worth folks who purchased life insurance as an estateplanning tool, but who later find their estate-planning needs have changed, and they no longer want to maintain their policy.
The ick factor associated with viaticals is not the main reason why I’d urge you to avoid this business opportunity, should it ever come your way. Rather, I’d avoid life settlements because the industry seems to attract both fraud and financial blowups.
The fraud probably happens because life settlements and viaticals are just niche-y and opaque enough to attract a certain type of scheme-promoter who knows how to appeal to risk-taking investors. Those risk-taking investors, in turn, usually think they’ve found a relatively hidden, low-risk, highreturn way to invest.
Fraud in the industry has been perpetuated in a variety of clever ways.
My friend Michael Stern, a successful industry veteran of the life settlements industry, described to me a few of the classic scams.
In Texas, one of the industry’s most notorious operators, Life Partners Inc., filed for bankruptcy in 2015 following $46.9 million in court-imposed fines against the company and its main executives for fraud and insider trading. The Wall Street Journal reports Life Partners depended upon a physician — working on commission — who assigned shortened life-expectancies to policyholders where independent estimates would have been much longer. Those short-life estimates juiced the price at which the operators could sell life insurance policies to relatively unsophisticated investors.
Following that, maintaining the policies sometimes got too expensive for those investors, so the Life Partners executives repurchased policies from their customers to the financial benefit of insiders, leading to insider trading fines. The executives seem to have avoided jail time, and the business exited bankruptcy in December 2016, to be liquidated for the benefit of investors.
Stern says that because policies are expensive for existing investors to maintain, some operators have used the illegal practice of paying off old investors with new incoming investors, the classic definition of a Ponzi scheme.
As a side note, I decided long ago that when I write my first novel — a financial thriller obviously — the main plotline will involve a hedge fund dedicated to viaticals. Think Robin Cook’s “Coma” meets Michael Lewis’ “The Big Short.”
While viaticals make a brilliant premise for a creepy novel, my advice is to leave this investment opportunity to the professionals, partly for the ick factor, and partly because they are best equipped to navigate the fraud and blowups that seem to follow this industry niche.
Michael Taylor is a columnist for the San Antonio Express-News. michael@michaelthesmartmoney.com