Your money or your life?

I spent a good chunk of last week visiting with one of my old college friends who is someone who has strong opinions on a lot of subjects.  One of his targets last weekend was insurance markets which he thinks should be regulated like utilities (another of our friends is an actuary, so insurance tends to come up as a topic - we have more fun than it sounds like though, don't worry).  Another target was the market for a number of financial derivatives which he feels are immoral in that many of them are betting on failure and disasters.

These are things most of us outside Wall St. don't think about everyday, and he made some good arguments, but I generally played the devil's advocate and the "good free-market-economist" to most of his points, pointing out the value of insurance and in managing risk, etc.  This morning though,  I think I found a story that really puts the debate about insurance and derivative regulations in stark perspective:

James Vlahos of the NY Times reported on a financial instrument in which you basically sell your life insurance policy on the open market, so that when you die the buyer gets your benefits.  They pay you cash up front and take over your premiums in return.  This practice apparently became more common during the AIDS epidemic of the late 80's.  If you're envisioning some sort of bad, futuristic Keanu Reeves type movie where greedy investors are signing up the destitute and the homeless for lucrative life insurance policies and then arranging "accidents" to collect ... well ... so am I.  What do you think, legitimate investment opportunity and free market at work or post-apocolyptic ghoulish horror show?  

Two important points to highlight ... just like when home loans became toxic assets in the derivative market, this is a case in which the traditional insurance incentives are inverted, and there is potential for some fairly bad outcomes and unexpected behavior as a result. The problem with home loans was that those making the lending decisions weren't holding the loans, and thus the incentive to evaluate default risk was much less than in a traditional "It's a Wonderful Life" type neighborhood bank.  There are similar informational asymmetries and risk issues here as well.

Secondly, I'd be interested to see someone take a look at how likely more widespread sales of this type would be to affect prices and benefits for those who are the more "traditional" holders of life insurance policies (such as parents hoping to leave their children taken care of in case of an accident) if more single "life-entrepreneurs" were to start flooding the market and, for lack of a better term, selling their souls.  How this affects benefits packages for employers is another interesting question as a good chunk of the market is employer-based.  Food for thought, and discussion.

Source: NY Times
Via: Centives.net