The Japanese approach regulation very differently from the way Americans do. First, just about nothing is codified in writing. Lawyers are few and far between (by design, the bar exam is difficult to pass). If you try to get an opinion on whether a new idea will pass muster, you are certain not to get a crisp answer. One reason is the Japanese have somevery different fundamental ideas. The Anglo-Saxon construct is that something is permitted or it isn’t. The Japanese, by contrast, will tolerate new products that are provided by firms that are in their good graces if the activity stays at a low level. If it becomes significant, it becomes subject to official study, and that is often a death sentence.
This is not as nutty an idea as it may seem. Risky activities, if kept to a modest scale, can address needs of select customer groups, and if the purveyors have to operate the business on a contained basis, they will hopefully focus on the best quality customers, thus limiting the exposure of their firm (and by extension, the financial system). Consider subprime loans. Even though that product has fallen into disrepute, there was a portion of the market that was worth serving. In fact, FHA loans, which have 3% downpayments, were the original subprime and had a very good track record on defaults (the product that has shown big losses was a zero down payment offering that the FHA had asked to shut down).
Why the disparity in results? The FHA did borrower screening. The FHA lost market share to private sector subprime lenders because their process was faster and less demanding (and people who would have failed FHA standards did get credit). Similarly, not for profit mortgage lenders have seen default rates similar to those of prime borrowers, when they serve subprime customers.
Wall Street has its eyes on another potential hot new market, and appears likely again to screw up what was a good product for customers.
The life settlement business is one where investors buy life insurance policies from holders who need the dough, say someone sick or elderly, at a much better rate than what the insurance company offers as a cash settlement value. The investor then continues to make payments and is gambling that the insured party will die on or ahead of schedule (as determined by actuarial tables).
On a small scale, this is a useful service to people who are in a bind. But the ramp up that Wall Street intends, of marketing the idea more aggressively and securitizing the policies, is likely to put all life insurance customers at a disadvantage.
The big reason is that many policies lapse (as in the owner of the policy fails to make payments. Those lapses are included in current pricing models. Investors will not miss payments, which means insurance providers will pay out more often than in the past on life insurance policies, which in turn means their profits will deteriorate, which means they will raise rates on everyone.
A second concern is fraud, that some life settlement companies have gotten people to enter into insurance contracts for the sole purpose of on-selling them.
From the New York Times:
After the mortgage business imploded last year, Wall Street investment banks began searching for another big idea…
The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.
The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.
Either way, Wall Street would profit by pocketing sizable fees for creating the bonds, reselling them and subsequently trading them…..
The idea is still in the planning stages. But already “our phones have been ringing off the hook with inquiries,” says Kathleen Tillwitz, a senior vice president at DBRS, which gives risk ratings to investments and is reviewing nine proposals for life-insurance securitizations from private investors and financial firms, including Credit Suisse.
“We’re hoping to get a herd stampeding after the first offering,” said one investment banker not authorized to speak to the news media.