Oh HECM, someone drank my STOLI!

You've never heard of either of these, I assume.

HECM is the FHA program called Home Equity Conversion Mortgage. In common parlance, this is a reverse mortgage. I don't know why they call it a reverse mortgage because that's confusing. I'd call it a factoring forward sale or something that that, but then again that isn't any easier to understand. HECM allows a home owner (typically elderly) to receive current cash payments that look like monthly loan payments, where the collateral for the loan is their home. The "trick" is that they don't have to pay back the loan until they die, and the home is sold.

Another way to describe this transaction is converting your house into a "residential annuity" (you get to live there until you die) plus a cash annuity.

From the lender's perspective, this is a mortgage combined with life expectancy risk. Their loan may be good, but they aren't sure, probably, until the borrower dies. (Or, to be precise, sells the house, moves into a nursing home, etc.)

So here is the Government supporting a loan program that depends on old people dying. In the popular press, they call this "death pool" investing, or worse.

That brings me to STOLI. Stranger Owned Life Insurance. This is a rather obscure part of the life insurance world, that got an especially bad reputation in the early '90s. Suppose you own a life insurance policy on yourself, and no longer want to make the payments. Someone else might. You could sell the policy to another person. They continue to pay premiums, they get the death benefit when you die. (Viaticals were the early transactions involving AIDs patients who sold policies on terrible terms. The ONLY solace, I suppose, is that HIV cocktails bankrupted most of these early buyers.)

The thing is, in the popular press, this is called "death pool" investing, or worse. Oh, and state governments are outlawing these types of transactions left and right. Often at the behest of the life insurers who monopolize the market via incredibly low "surrender values" of policies, that do not reflect the potential embedded value of mortality risk. In polite company, these are called "life settlements."

Why might there be embedded value in life settlements? This isn't going to sound very nice, but here goes an extreme example...You bought a $1 million policy as a healthy 60 year old. Ten years later, you have a massive heart attack, and survive. You are now a 70 year old who just had a massive heart attack. Your life expectancy is now much shorter than a 70 year old who didn't, (at least for a while.) The policy you own was priced based on the average 60 year old. You are now not the average 70 year old from that pool of 60 year olds. Thus, your life insurance policy has an expected value much greater than the average when it was written. Someone will buy it from you. It's a perfectly good investment.

Preying on the elderly is not a virtuous activity. However, both of these transactions serve a purpose. Both provide payments to (presumably) consenting adults. They both depend on the fact that "insurable interest" , (that is, an individual's ability to obtain life insurance, and thus transact in the security that pays off in the state of the world in which they die,) has value. This insurable interest has significant value, and individuals ought to be able to access that value.

A competitive market in HECM would allow lenders to differentiate based on health not just age. This would be better for the elderly. And, STOLI significantly benefits the elderly.