The Market for Used Life Insurance

I will admit that what got me to click on the article at the Wall Street Journal was the mug-shot-like picture of the sad middle-aged guy who could really use a shave.

Turns out, the picture is mug-shot-like because it is, in fact, a mug shot. The ennui filled subject is one Steven Brasner, a Florida life insurance salesman. He has the unmistakable look of a man who’s entire life has suddenly come crashing down around him.

I feel for the guy. It is not like the insurance thing was just a cover for some glamorously dangerous life of high-stakes crime. In that case you might expect an expression of I-knew-they’d-get-me-eventually resignation or perhaps an I’ll-beat-the-rap defiance. No, Brasner really sold insurance for a living.

His crime, and I will get to the details in a moment, was to fill in some false information on a few forms. Okay, more like a lot of false information on rather a lot of forms. But I am getting ahead of myself.

The WSJ headline reads “Regulators Rein In Murky Life Policies.” But the policies in question were not themselves the least bit murky. In fact, they were apparently garden variety term-life contracts which were only remarkable in that they had a tendency to be in amounts much larger than the person taking out the policy might reasonably need.

Brasner, it transpires, was involved in the peculiar business of Stranger Originated Life Insurance, or STOLI. Brasner would find appropriately older folks (not hard in Florida) sell them an insurance policy, and then broker the deal in which they resold the policy to an investor. The investor would pay the policy owner a tidy sum, 3% to 5% of the policy’s face value, which net of Brasner’s commission was almost pure profit, and agree to take care of all future premiums, in exchange for getting the insurance payout when the inevitable happened.

The WSJ article is quite informative in several areas. It tells us that Brasner had a 50 foot yacht called “STOLI on the Docks”, that “he decorated his office in a New York Yankees theme, including posters of old-timers, jerseys and autographed baseballs” and that he lived in “a $1 million Mediterranean-style villa.” It does not, however, explain how it is that this could be a profitable business. How could buying other people’s term insurance policies be a good investment, particularly after the person who took out the policy and the salesman get their cut?

The unexplained answer is that life insurance companies are not very good at what they do. Well, that is not quite fair. Life insurance companies, at least the successful ones, are quite good at sales and marketing, and if you are cynical enough to understand that as their primary function, then they are quite good at what they do. It is in the area of underwriting, the understanding of risk and the setting of premiums, where the companies lack talent.

Basically, Brasner’s investors had discovered that some policies were systematically underpriced. Conversely, since insurance companies are generally financially healthy, we can infer that other policies were equally overpriced. Charging one group of people too little and another too much is not much of a problem to a marketing focused firm, as long as it all balances out in the end.

Of course, the nightmare scenario is that it won’t balance out, that some bunch of sharp money types will get the people you aren’t charging enough to take out big policies so that they can buy them. Which is where the unfortunate Mr. Brasner comes in.

(This, by the way, is a completely different beast from so called “dead janitor” or “dead peasant” schemes, more properly known as company owned life insurance or COLI. In that maneuver a large employer takes out life insurance on thousands of its employees, generally without their knowledge, and names itself as the beneficiary. With enough employees involved, the amounts of money flowing out as premiums and flowing in as death benefits are relatively constant, and indeed nearly equal. But for arcane reasons this saves the employer money on taxes. Far from being objectionable to the insurance companies, these schemes are arranged and run by them.)

If you have ever taken out a substantial life insurance policy then you know that the issuing company will do some due diligence to confirm that you really have a need for the coverage you are buying. A retiree of modest means with no dependents who wants a $10 million policy is almost certainly up to no good. So the insurance company will ask about, among other things, the net worth of the customer and may go so far as to call references to check that the prospective insured is legit.

Of course, the older folks that Brasner helped to secure large (and marketable) insurance policies had no real need for the insurance. To cover this up, false answers were given on applications, principally to inflate wealth. As far as I can tell, none of the false information concerned the riskiness of the policy, that is, they told the truth about their age, health, etc. Brasner, allegedly, filled out these forms. But the would-be policyholders signed them.

There are four players in this story: Brasner, the retirees, the insurance companies, and the investors. The WSJ article characterizes them as, respectively, a greedy New Yorker who got rich via murky dealings, “aging retirees in need of money” duped by same, upstanding and efficient companies who have been the victims of sophisticated fraud, and “cash-flush hedge funds eager for offbeat investments.”

Brasner is certainly sleazy, and possibly occasionally criminal, but casting him as the sole bad actor is a bit much. Conversely, pretending that the sweet old things who took out the policies were innocent shills is beyond the pale. At best, they allowed Brasner to prepare an application on their behalf which they submitted without reading. And they received, or expected to receive, a six-figure check for their efforts.

A less charitable person (e.g. me) would cast the retirees as the principal fraudsters and Brasner as their accomplice and instructor. Not holding them responsible is to treat them as children, naive and unaware of what goes on around them, something I am sure that they would strongly object to in most other contexts.

And then we have the insurance companies. My sympathy for financial concerns that sell products for less than they are worth and then claim that they are being victimized by smarter people who take advantage of the bargain is nil. Less than nil. The way the system is supposed to work is that dumb companies are supposed to either get smart, i.e. figure out how to price insurance correctly, or go out of business.

Instead, the insurance companies have goaded state regulators and prosecutors into jailing people like Brasner. To be sure, Brasner lied and/or helped others lie in order to obtain insurance policies, and that is fraud. But what was lied about ought not to have mattered. The economics and risk of the policies were exactly what the issuing companies were told they were.

The deception covered only the intent, and in a sense the identity and sophistication, of the customer. The insurance companies are, essentially, asserting a right to do business only with those no more intelligent than they are. If only AIG had discovered the same legal principle in time.

[Photo – Palm Beach County Sheriff’s Office]

Insurance, Media | Frank Curmudgeon | June 28, 2010 11:59 am

317 Comments

By Adam, June 28, 2010 @ 12:14 pm

Great post! As an accountant for an insurance company (not life though, we’re in equipment breakdown insurance which is its own type of sham business), this sort of post fascinates me.
These insurance companies really need to learn how to better price their risk, and I agree with your assessment that they deserve zero sympathy unless they were flat out lied to about the age/healthy/etc. of the insured (which they were not).
The oldsters were not victims either, they knew what they were doing and at best ignorant of signing something without reading it just to get a fat check!
By jim, June 28, 2010 @ 6:21 pm

I have to agree that the individuals who the policy was taken out against are not innocent victims here. AT best they are naive people who took money for nothing and signed forms they didn’t read. If you’re getting money for nothing by signing a form then you have to be pretty ignorant to not suspect something fishy is going on. If they understood exactly what was going on then may have participated in the fraud.

Buying life insurance on someone else soley for the sake of speculating on financial gain when you have no relationship to the other person just seems slimy to me. You only make money if people die.
By Bob, June 29, 2010 @ 10:04 am

Hmm. I’m not sure you understand all the aspects here. STOLI policies (like viatical life settlements) can be a positive investment for the purchases because the acturial assessment of the insurance companies figure in a certain amount of lapsed policies. Not 100% of all term life (or any life) policies reach the end of the contract. One might say that this fact demonstrates folks are sold policies they don’t need (i.e. 30 year level term rather than 20 year term, or basically any cash value policy). But on the other hand that means regular folks who buy insurance for the proper purpose get life insurance cheaper than would be in a market where all the demand is created by STOLI buyers or turned into viatical settlements (i.e. never any lapses). A market dominated by STOLI and viatical settlements means the price per dollar of life insurance goes up, even for those just wanting to make sure their family will have enough to make due.
By Andrew Stevens, July 6, 2010 @ 6:11 pm

You have made the assumption that the life insurance companies don’t know what they’re doing and the investors do. This may be true, but it may also be false. There are some investors who paid a pretty penny for life insurance policies on AIDS victims back in the ’80s, when their life expectancy was measured in months, who are still paying premiums and waiting for the original owner to die decades later. This doesn’t have anything to do with whether the life insurance companies were right or wrong, since they sold the policy before the original owners came down with AIDS, but it does show that investors don’t always know what they’re doing. Predicting someone’s future life expectancy is a dicey business.

It is true, by the way, that life insurance companies misprice all the time. There are hundreds of different life insurers pricing thousands of different combinations of age and health and smoking status and whatnot and sometimes the pricing makes a mistake on a particular combination which doesn’t get caught until the product is in the field. As soon as they realize that they’re selling “too many” of that type of policy, they usually immediately step in and reprice to eliminate the error.

The idea that the old people were duped is obvious nonsense, of course. They were paid a large amount of money for basically doing nothing. I don’t know how it can be spun that they were “scammed.” Of course, they probably made themselves uninsurable in the process, but presumably they felt they have no future need for life insurance, so nothing lost. They were also cajoled into committing a crime which they may or may not have to answer for, but I fail to see how this turns them into victims.

Bob is quite right about the lapse assumption, by the way. And most life insurance companies that I’m aware of have conducted research into the risks involved if a substantial share of their block of business become life settlements. This usually entails slashing the lapse assumption to a much lower rate. This doesn’t always hurt profitability (early lapses before the company has received enough premiums to recover commissions are very bad for the company), but on net it usually does.
By Yael Diamond, July 7, 2010 @ 10:17 am

Great post! And I agree that the people who took out the policies should be held accountable in some way or another – no one is handing out money these days without a catch or a scam!
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