An article in today's New York Times describes the booming third party trade in life insurance policies (termed SPeculator INduced LIFE insurace, spin-life). Normally, life insurance works as follows, I buy a life insurance policy from an insurance company pay an annual premium until I decide to cancel the policy or die, at which time the insurance company would pay out to my heirs. It seems as though some elderly are cashing out their policies by selling them to third party investors. These investors are willing to pay a lump sum for the right to pay the annual premium and eventually receive the policy payout when the insuree dies. The insuree goes from A) paying an annual premium for a certain payment upon death to B) receiving a certain payment now.
This situation is confusing to me. Normally, I think of insurance as being actuarily unfair to the insuree. That is, on average, the insuree pays in more than he or she takes out. Otherwise, insurance companies wouldn't be profitable (See for instance this article in the LA Times) . Insurees take part in the transaction because they are unwilling to bear the risk. In return for decreasing their risk, they are willing to accept a lower expected payoff. Yet, now think of the situation described in the NYT article. Investors are willing to pay to to become the insuree! Are these third party investors telling us that life insurance is under priced? That, the expected pay out of a life insurance policy is higher than the expected cost? Are they risk seeking?
What are the implications of spin-life? Who benefits? Who loses? Insurance companies will be checking their calculations to make sure they aren't under-pricing their policies. It seems that as expected payouts from the life insurance policies go down due to lack of cancellations, the prices of life insurance are likely to rise. The biggest potential losers, in my view, are the regular consumers of life insurance, who are likely to face higher prices. Is there a need for government intervention? Are there other costs associated with strangers benefiting from the deaths of the elderly? I certainly have little sympathy for the insurance companies who claim they are being
taken advantage of. They are in the business of taking advantage. This time, it seems as though some others are just one step ahead of them.