Saturday 21 May 2011

'Death Derivatives': Now THAT'S Capitalism@Work

Technically speaking, a financial derivative, e.g. a contract-for-
difference, can be settled on any independently-determined numerical variable agreed upon by
the parties. Usually something like the price of oil of course; but it could be the number of pages in Saturday's copy of the FT, or the number of burgers sold at a particular branch of Macdonalds in a given week. A swap, as they say, is an exchange of cashflow between consenting adults.

Here's a great new idea: death derivatives. Nope, not Warren Buffett's 'financial weapons of mass destruction', but contracts settled on actuarial data relating to life expectancy - have a read of this. There are loads of companies that have major financial exposure to that particular variable, so in principle this might work really well.

From the very first systematic record-keeping on mortality rates in England in the 1660's, actuarial data were meant to be useful. I can't imagine why anyone considers there would be some kind of moral scruple about this. It's just a cracking idea.

Might even be a better hedge for Bad News than gold ...



Lord Blagger said...

Who wants the other side?

Barnacle Bill said...

It's a very interesting proposition, one that will probably be looked at very closely by some of the bigger pension funds who are trying to sort out the mess of future funding for our pensions.
However, with such large amounts involved I think it would be a magnet for corruption.
Say for example someone had inside information that a group of people on a certain drug were more likely to die earlier than those not on it?
But morally I've no problem with it.

Anonymous said...

"I can't imagine why anyone considers there would be some kind of moral scruple about this."

Stand by for Goldman or Citi death squads.

andrew said...

This is a well established area in the wholesale side.

Pension funds have been looking at this since about 2009 or earlier.

These people have a Life & Longevity Markets Association

These bets are typically made on the basis of swapping your assets (fixed-term gilts or equities) for an income stream that matches the lifetime of your membership.

On the retail side it is called life insurance.

Both these things have big markets, but the underlying facts of population future expected lifetimes do not change very quickly and they change in a fairly open and predictable manner.

Big changes in prices are driven by interest rates.

If the market was open to me I would go long on barclays bank pensioners and short on bus drivers.

Now, taking a bet either way on the life expectancy of a specific person who is not you has a number of moral issues...

Anonymous said...

I am Anon @ 09.31

Given that the banks have been quite prepared to destroy the economy of western civilization for a couple of million pound bonuses, and right now in the US the banks are evicting people whose houses they have no legal claim against - corporate death squads is not too great a leap, if it makes the companies money.

We are now in a post democratic, Fascist world.

Nick Drew said...

Who wants the other side, M'Lord ?

when you take insurance you are hoping the other guy thinks you won't die early

when you buy an annuity you are hoping he thinks you will die early

so (it seems to me) there is a fair degree of symmetry in position-taking within the industry

Mr Barnacle, anon - surely the whole pensions industry has always wanted people dead before their time - how does this change things ?

is your point that, so far, the capital markets haven't really had much of a stake in the insurance / pension markets, but that if they swung in via derivatives, they would have - and that they are nastier people ?

Andrew, those are 2 good points: it's often the way that there are proto-markets in things that eventually get caught up with & formalised in a derivative or exchange-traded product (e.g. there used to be informal ways of going short before shorting became readily available to the retail punter)

& (for obvious reasons of moral hazard) isn't it illegal in many circumstances to take out life insurance on a third party ?

Anonymous said...

"is your point that, so far, they would have - and that they are nastier people ?"

I guess yes. We are a different breed to the folks who ran the system in the '40s, '50's, 60's, '70's. They were largely governed in what was 'the right thing to do'(TM), by a discrete moral code which I propose no longer exists.

We can see what is going on in the USA, some of the activities of the large international banks is in my opinion criminal and morally despicable. You only have to read some of the court records and the judgments starting to trickle out to understand the degenerate behavior of the financial institutions.

Nick Drew said...

in my opinion criminal and morally despicable

- agreed

and, as a fully paid-up capitalist I'd also say: highly damaging to the capitalist system, take 'em out & bang 'em up

James Higham said...

A swap, as they say, is an exchange of cashflow between consenting adults.

What are OCDs then, Nick?

Laban said...

I've hedged my pension investment with term assurance up to age 72 - on the Sods-law basis that the more life insurance I have, the less likely I am to die - unless I annoy the wife.

I do think the moral hazard here is massive - and the modern financial services industry is proven not to be able to resist moral hazard. When you consider that this idea doesn't actually alter the sums of money to be paid out to pensioners (until that moral hazard kicks in, anyway), and would just be one set of actuaries gambling against another in a zero-sum game - I don't like it at all. If one set of actuaries wants to gamble against another they can start selling term assurance.

Imagine a 1917-style flu epidemic which breaks out, and which is making, or about to make, a fortune for some latter-day Marc Rich type. Then up pops a small biotech firm with a promising vaccine. The temptation to try to slow the implementation one way or another - with every week's delay bringing in another few billion - might be hard to resist. somehow

Laban said...

Indeed there might even be a temptation to CREATE a pathogen - obviously in an arms-length, deniable way. But we already know how clever people are at moving money off the accounts.

People will do anything for money - up to and including murder. There are many clever but amoral people in financial services who might in a different world be criminals - but who have realised that using their intelligence to rip people off is a much safer route to wealth and power than bank robbery.

Nick Drew said...

but as you say, these people already exist ! surely if you are up for murder you have been able to coin £££ since time immemorial ?

the recent history of *ahem* Russia ... no derivatives required

and I'd say you could trash (e.g.) an individual company by foul means (having shorted it etc) a lot easier than you could alter actuarial statistics, the mafia have been doing this forever

I don't doubt the moral hazard, I just don't see it moves us into any territory not already occupied long since

Laban said...

References for that, Demetrius? I'd have thought that would be criminal behaviour.

andrew said...

actually having mentioned how morally dodgy it is to take out a bet on another specific person's life, I now recall the french viager system - which does precisely that.

Nick Drew said...

Laban was responding to Demetrius, who had commented:

Nothing new here. XXXXXXX through its YYYYYYY subsidiary were taking on leveraged loans based on income streams from retirement leaseholds. These factored in the anticipated rate of mortality. This in fact could be managed because YYYYYYY also provided the security entry systems. It happened if the mortalities in a block were not up to the figures needed the security entry service simply stopped admitting paramedic's and ambulance crews.

Laban said...

I googled the aforementioned company, and while I found lots of bad things about them, I didn't find anyone accusing them of trying to kill their clients in any way other than financially.