AIG returns to spotlight with collateralized death obligations

a painting of the grim reaper

AIG's aim to securitize bets on death has been criticized by the life insurance industry as a potential avenue for fraud and abuse. Image: Flickr/markhillary CC-BY-SA

American International Group went belly-up in 2008 because of over-leveraged exposure to credit default swaps written against sub-prime mortgages. Now AIG, which was rescued with a $182 billion taxpayer bailout, wants to do the same thing with securities backed by life insurance settlements, otherwise known as “death bonds.” After securitizing the death bonds, AIG’s death bond scheme hit a major roadblock when Standard & Poor’s refused to rate the securities for investors.

AIG’s death bond business

A life settlement is the purchase of an older person’s life insurance policy for cash. The investor bets that death benefits will exceed the amount they paid for the policy and the premiums they pay while they wait for the insured party to die. Death bonds, also referred to as “collateralized death obligations” and “death pools,” became popular during the financial bubble. Wall Street banks that bundled sub-prime mortgages to sell as securities started doing the same thing with life settlements. Much like sub-prime mortgage securities, most collateralized death obligations became losing bets when credit dried up and people who sold their insurance policies lived longer than the investors had hoped. AIG’s death pool portfolio includes 4,000 life settlements totaling $2.58 billion in potential death benefits.

Why S&P declined to rate AIG death pool

Earlier this year AIG bundled more than $2 billion of its life settlement portfolio into death bonds, but so far no investors are biting. A Standard & Poor’s rating is a key requirement for selling securities. Citing the unique risks of death bonds, which include the difficulty of correctly estimating the life expectancies of the insured individuals, S&P declined to publish a rating for AIG’s death bonds. Insurers also look upon death bonds with distaste, saying that the mass-marketing of betting on death is bad for the industry’s reputation. The American Council of Life Insurers has said that the need to fill a Wall Street pipeline with death bonds would result in the same type of fraud by commission-paid mortgage brokers that triggered the housing crisis and financial meltdown.

The greedy prey on the needy

As many cash-strapped elderly people struggle to find ways to survive, brokers have found a growing market for investors who want to gain a financial interest in their deaths. Competition among life settlement brokers for individuals expected to live from two to 10 more years who would consider selling their life insurance policies is becoming intense. Many life settlement operations target seniors in poor health with aggressive sales tactics. Many insurers have taken life settlement brokers to court, claiming they were misled by brokers who said the policies were for estate planning purposes when they planned on flipping them to investors all along.


Wall Street Journal

Bloomberg Businessweek


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