Saturday, February 6, 2010

Making Money When Others Die

Periodically, the financial press gets excited over the business of investors making money when other people die.  Do you own life insurance?  Does your employer provide life insurance? Do you own an annuity?  Then you make money, or have cheap insurance, because other people die.  There's nothing terribly wrong with this, and in other contexts people seem to agree.  Some deep seated discomfort with death seems to make people squeamish when we remove the veil around profits that depend on death.

Diversification drives the "value" of death.  Just like when you invest in a portfolio of stocks to diversify your risk and raise your returns, life insurance companies diversify their insureds to reduce prices to them, (and, of course, raise their profits.)  If MetLife wanted to provide you a life insurance policy that solely depended on your life, they'd charge you far more than they do because that would be risky.

In fact, you can have a life insurance policy that depends only on your life if you want it!  We'd call it a savings account! You contribute every year, and the benefits would build up naturally!  If you want giant death benefits compared to your premium, you need other people's lives on the line. That's why insurance companies exist: They pool risks, thereby reducing risks and costs to the underlying insureds.

Additionally, often your life insurance company sells annuities.  Annuity providers definitively make money when others die.  An annuity pays a small payment as long as the insured lives.  This makes your life insurance cheap.  Why?  annuities (almost) perfectly hedge life insurance.  Life insurance policies involve small payments from the insured to the company while the person lives, and a large payment from the company to the insureds estate when they die.  Annuities involve large payments to the insurance company at the start, and small payments from the company to the insured as long as they live.  The combination mkes the insurance company into a "moving" business, not a "storage" business! (You need to understand that post to understand many of my ideas, btw.)

Last point, for now: Of the two certainties in life, death and taxes, only one has value to you: death.  You cannot lose this asset against your will. Not even bankruptcy.  You can only realize the value of this asset in one of two ways: Buy life insurance, or allow someone else to buy it for you.  Preventing individuals from selling their insurable interest destroys the value of that asset for anyone who cannot afford or does not need life insurance.  That's just not fair.

No comments:

Post a Comment