If you know anyone who’s retired, you might want to share this article with him/her. This is about another funky investment product insurance companies have concocted: Investing in the death of others. This is called the DEATH BOND.
Let’s take a look at this *new* way of making money on the back of the graveyard.
You Die, I Make Money
Let’s pretend you are 80 years old and you have an existing life insurance policy. You don’t really need the insurance policy as your basic needs (debts, children’s education, etc) are already covered. However, since you have been paying your premiums for all those years, you don’t necessarily want to let your policy die and get nothing back in return. What if I come to you and offer to take over the premium charge of your insurance policy and give you a lump sum payment right away? You would not receive as much as the life insurance policy coverage, but you will be able to benefit from this money while you are alive on top of not having this premium to pay each month.
If you are American, you can now sell your life insurance policy as a death bond. The death bond concept is quite straightforward: insurance companies will buy an aging individual life insurance policy upon an actuarial calculation. Then, it turns around and packages the insurance into a death bond. Imagine if you buy a $100K life insurance policy of someone who’s 85 for $50K and the person passes away during the same year. You would be making almost 100% in investment return.
A Little Bit of Death Bond History
Death bonds have not risen (haha!) this year for Halloween’s sake. In fact, death bonds are resurrected in the investment world every few years… like a malediction!
The first appearance of this concept was due to the low life expectancy of people who have AIDS. For those who had a life insurance in good standing upon the diagnostic, they wanted to benefit from the money while they are still alive to either get better treatments or to simply live comfortably for the short time remaining.
Over the years, AIDS treatments have gotten better and the interest of death bonds has faded away. The return on investment wasn’t there anymore. But insurance companies are not known to leave a profitable product on the shelf for too long. This is why they turned their product to a different market with a better chance of dying sooner: the aging population.
Insurance Companies Don’t Like That… and so Does the IRS
Funny enough, while the investment firms and investment departments of life insurance companies are working on this product, the overall life insurance industry is worried about such products. The reason is quite simple: the life insurance pricing is made considering a specific % of abandoned policies. While people grow older and the need for insurance is not there anymore, they simply quit their policy leaving the life insurance company with a stack of money it will never have to pay back. If death bonds would become popular, the new policies will have to be priced accordingly.
The Internal Revenue Service (IRS) is not a fan of this product either. In order to dissuade investors, it taxes insurance profits as regular income instead of capital gains. Therefore, the investor is paying more taxes on his profit.
As for Canada, most provinces forbid the sale of a life insurance policy to a third party. Therefore, Canadian investors have no other choice but to consider US policies.
Are Death Bonds a Good Investment?
When you simply think about buying a life insurance policy of someone who’s about to die, you can get the heebie-jeebies. However, if you can overlook the fact that you will be making money because someone else dies, there are other risks tied up to death bonds.
There is an important risk of fraud. Since this kind of product is relatively exotic, some small investment firms may be interested in selling death bonds without the right prospectus. Also, people may not die as expected. What happens if an investment firm is left with 80% of his life insurance on people that haven’t died yet? If you expect someone to die at the age of 85 and lives until the age of 102, what do you think will happen?
In the end, I’m not really sure about death bonds as legitimate in one’s portfolio. It is an interesting product on paper. However, there are too many ways that this investment strategy could go sideways. If you are looking at investing in a life insurance product related, you might as well to look into an annuity, that’s a safer product ;-).