Inside Money: Why death is a great diversifier

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Matt McCarten's offer to cash in his life insurance policy raises some interesting investment questions.

Potential investors - whether that's the issuing insurance company or other third-parties - would have to put a specific price on his chances of surviving a certain period of time. The numbers are tricky and depend on the nature of McCarten's policy as well as the current state of his health.

"It's a bit macabre in one sense but basically it is a way of helping people who are in a difficult position," Peter Neilson, head of the Investment Savings and Insurance Association, told the NZ Herald.

And while it's legal in New Zealand to sell your life policy short, according to my sources, it's not that common nowadays - probably because the old-style 'whole of life' insurance policies, which included an investment component, have been largely superseded by 'term life' products.

But there is a booming secondary market in life insurance policies in the US, which local investors have been able to participate in for several years.
Due to a few peculiarities of the US market, life insurance is much more investable asset class there than elsewhere.

For instance, US policies become 'non contestable' after being held for two years - ie the insurance company has to pay up the face value, no questions asked, when the insured person dies.

A number of companies buy out policy-holders looking to cash in their, usually million-dollar plus, policies (for whatever reason) at a discount to the face value in a market described as 'life settlements'. The policies are then bundled up into funds for investors whose return is enhanced when the underlying insured die earlier than actuarially calculated.

Death can be a great diversifier, as this 2010 press release from Russell Investments explains.

The Australian-based Life Settlements Fund, for instance, has raised a significant amount of money from NZ investors in a pool backed by about 120 US life insurance policies.

There are, of course, some delicate ethical issues to confront with life settlements investments. There's also some fascinating market distortions in the US discussed here, including a burgeoning trade in companies encouraging wealthy people to take out life insurance they didn't want in order to on-sell it to investors when it becomes non contestable.

None of this helps Matt McCarten, however. I can only hope he gets a good price for his policy, and wish him a speedy recovery.