Wednesday, September 10, 2014

Yuck Factor

Here is a Bloomberg article from last week on a unit of insurance giant AIG that is suing a life settlement company.  Life settlements are are described in the article:
In such deals, called life settlements, an investor buys insurance policies from individuals and pays the premiums until they die, when the investor collects the payout. The arrangement becomes less profitable for the investor the longer the person survives.
The division of AIG, Lavastone, hired a life settlement company, Coventry, to buy life insurance policies on its behalf.  The AIG unit is suing Coventry because it bought the life insurance policies cheaper than it knew AIG would pay for the policies and then sold the policies to AIG at a mark-up.

Let's look at this closer:  An insurance company, AIG, forms a division to buy life insurance policies cheap so it won't have to pay the full face amount of the insurance policy when the insured person dies.   "Let's pay $.20 now so we don't have to pay $1.00 later."   AIG had no moral problem buying insurance policies from old or sick people at deep discounts to avoid having to pay the full face value of the insurance, but it gets mad and sues when it found out it paid a deep discount plus a little more. The article didn't state whether Coventry was tasked to buy just AIG policies or could buy any available insurance policies, but I'm sure AIG wanted Coventry to buy AIG policies.  Either way, I don't have much sympathy for AIG.

Life settlement is not a pretty business.


Anonymous said...

One rather disturbing aspect of this arrangement is that it would seem to give the investor an incentive to ensure that the insured does not live any longer than necessary.

Rational Realist said...

That's called the Whack Factor. The reason why AIG is likely mad is because through its underwriting skill and enough policy purchases its strategy would work from an actuarial standpoint, with premature deaths crossing out extended lives. Ugly business investing in people dying.

Concrete Jungle said...

Whoa, you're not accurately portraying what is claimed in the suit here. According to the article, and the suit, AIG hired Coventry and paid them a fee to acquire policies (insurance companies do this all the time) and they both agreed that the policies would be transferred at COST to AIG (they paid Coventry a fee for this, the deal was not that Coventry got to mark them up). Coventry then created a shell company to hide a markup in the price.

This would be similar to you hiring a guy to go out and buy you the best tires that money can buy, and you agree to pay him $25 for the service and stipulate you do not want to pay a markup. The guy you hire goes and creates a fictitious company called Secret Tires LLC and buys the set of tires in town at $100 from a dealer, then has Secret Tires LLC sell them to you for $200.

Rational Realist said...

Concrete Jungle,
Thanks for the clarification. Coventry takes an ugly business and makes even uglier. Lawsuit makes sense. There are some wild investments surrounding these life settlements.