Securitizing death

Warning: the content in this article is long, boring and oftentimes both.

During a meeting with company management for a project I recently worked on, I happened to have an interesting discussion with the CFO regarding the current liquidity in the global capital markets. He was an interesting chap and had quite a bit of his mind to offer under the topic of “Wall Street.”

One of the topics we touched on was asset securitization, a corner of structured finance (which is in turn, a corner of corporate finance) that no sane person would ever enter in the normal course of their living lives. He wasn’t particularly impressed with investment bankers, and called them, for instance, heartless. Who else, he asked, would ever think of profiting from the death of a fellow human being?

Let me explain.


Securitization is a way of creating liquidity based on otherwise illiquid assets. For instance, let us say I lend you $10,000 (not that I have that kind of cash, but it’s easy to type extra zeroes than make some). Anyways, I lend you $10,000, charging let’s say, a 20% interest rate (since you don’t have to actually pay, you wouldn’t mind the atrocious interest rate). So $10,000 for you at a flat 20% per annum for let’s say, 10 years.

Now, in the normal course of our relationship, I get $2,000 every year from you for the next 10 years as well as the principal amount of $10,000 at the end of ten years. You pay me a coupla’ grand every year, I buy a new server class Dell system with dual Nvidia SLI graphics cards every year and we are both happy.

This expected cash flow of $2,000 per year is, from my point of view, an asset, though I can’t sell it to anyone as is. If I trust that you are a good Samaritan and will repay fully, and on time, I have no risk on that cash flow. The loan I’ve made is free of default risk. This kind of future cash flow can be made into a product and sold to someone else.

I can, for instance, call up Barren Wuffet (a purely fictional investor who likes to gamble in the financial markets) and tell him “Gee, Wuffet, by God, I’ve got something here you might like. I have a guaranteed $2,000 cash flow every year for the next 10 years with a repayment of $10,000 in year 10. It’s yours for $15,000. Take it, my dear fella, and be a baron instead of a Barren.”

Now, depending on Mr. Wuffet’s outlook on a variety of financial parameters, he might find my proposition attractive. (The most notable parameter that changes his view about my offer is the market capitalization rate or the discounting rate. Of course, there are other factors like the risk of default, but let’s assume that you are a good boy and will pay back on time.)

The capitalization rate is nothing but the rate used to calculate the future value of a present sum. If let’s say a bond pays $100 in a year’s time, and it is available in the market and you can buy it for $90, the capitalization rate could be calculated as 11.11% (which is (100-90)/90). In other words, $90 compounded at 11.11% for a year will reach $100.

My valuation of the cash flow would in turn, depend on my world-view and if I use a rate of 15%, for instance, I would value the loan at around $12,500. Mr. Wuffet might use 8%, valuing the loan at $18,000 and if so, he’d find my proposition attractive since he’s getting something that according to him is worth $18,000 for $3,000 cheaper.

Irrespective of whether you understand the nuances of market capitalization rate or not, it should be evident that I can sell the loan that I made to you, as a package, to Mr. Wuffet. Mr. Wuffet can buy the loan and whatever you’d pay to me normally would go to Mr. Wuffet, since he is now the owner of the loan. Nothing changes for you, the borrower, but I get back my $10,000 I loaned to you and a neat $5,000 extra. In doing so, I remove the loan from my books and place it in someone else’s. Your indebtedness does not, however, change.

Notice what I’ve done here: I’ve created a security based on the loan I gave you that can be traded between two consenting parties. Mr. Wuffet can sell the loan to someone else and so on and so forth. He could even collect a hundred such loans (of similar nature) and sell them as a pool to large banks. This is the basic idea behind asset securitization.

Life after death?

Once you get the basic gist, there is no stopping what you can use as the underlying asset on which to securitize, and that includes death policies or life insurance.

For example, people with terminal diseases who don’t expect to live more than say, 3 years, could sell their life insurance policies to different companies, who in turn could securitize them. The securitizing company has a monetary incentive, therefore, in the death of those people whose life insurance policies are being securitized. The more they live, lesser the value of the securitized instruments.

In the 1990s, people with AIDS used to do this. But with the advent of new drugs that helped combat AIDS, the attractiveness of the securitized pool went down and companies steered clear of the AIDS bunch, because, well, they didn’t die soon enough. Now they’re looking at senior citizens who are settling into the latter parts of their lives.

This is what the CFO alluded to. Investment bankers (or their kindred) will talk about life-extension risk, the risk that the people whose life policies they’ve securitized will actually live more than they expected. Stochastic calculus will be used with abandon and various numbers plugged into Excel sheets to find out if those people will live for longer than the “optimal” age so that Wall Street can make a pile of money.

We speak of life after death. Never in our dreams do we usually think of an after-life of this kind.

Of heartlessness and how it is achieved

Investment bankers are sometimes called ruthless and heartless, among other things. The former attribute is a pre-requisite in the profession and the latter a consequence (as you can see easily, by now).

Being in the midst of this madness, I can explain why. It is easy, oh so easy, to lose track of the bricks, mortar and human beings behind the 20-sheet Excel workbook you’ve meticulously developed. After a couple of weeks of digging through cash flow statements, doggedly gathering industry data and tweaking your earnings model, you begin to believe that even the Myers-Briggs personality of the CEO can be modeled into a string of neatly formatted “Accounting” cells in Excel.

Let me use a personal anecdote to throw light into at least some part of this–especially, the heartless part.

Once upon a time… oh whee, let’s cut the crap.

A little more than a year back, I was a little cog in the bulge bracket wheel that is Limen Siblings (named changed). One of the desks that I worked in was called High Yield Fixed Income, and my story largely revolves around this mysterious sounding piece of furniture. (Note: anyone who is not a Wall Street pro would call it junk bonds.)

High yield debt or junk bonds (as opposed to high grade debt) are bonds that are known to be highly risky. And since they are risky, they automatically offer higher returns. (To the 1% of the population who have heard of Moody’s or Standard & Poor’s, high yield debt is classified around BB/Ba or less.)

Anyway, my job was to basically assess whether the firm should invest in some high yield debt that was floating around in the market. I was handed over the ticker symbols of five companies who had market-traded bonds and asked to get to work. “Getting to work” meant digging up information about the industry, mulling through every line of published financial information about the company, dirtying your hand at charting with historical data, talking to the company management (CEO, CFO, IR etc.) and then incorporating all of this information into a detailed financial model that would magically prognosticate all kinds of vital statistics for the company for the next 10 years.

In short, all I had to do was to predict the future. How could it be any simpler?

At the end of the ritual, senior vice presidents or managing directors would ask me questions like “How does the PER stand against comparables?” or “What did management have to say about their capex guidance in their newly entered sector?” or “What do you make of EV/EBITDA?”; and if I uttered the right syllables in sequence, everyone would be happy, the junk bond would remain junk and I could sleep in the night.

It was all very well if you ate cash flow for breakfast and slept on balance sheets. Heh. Unfortunately for me, I didn’t particularly do any of these activities very well. So when I found out a particular company had their annual reports only in Taiwanese and the only person who could translate it for me on the team was on vacation, it made me quite empty in the stomach. All I knew was that I had to somehow figure it out (don’t ask me how), because in an investment bank, deadlines are taken surprisingly literally.

To make things even more interesting, I usually worked on 3, if not 4, assignments, simultaneously reporting to 2 different managers. Each had its own deadlines, its own pitfalls and its own diction and way of unreality. For instance, one of my duties every day (over and above the 3-4 formal assignments I had to work on) was to check out bond prices and update a database that tracks various parameters of the bonds over the months and years. This was done by a secretary usually, but spotting a neophyte in their midst, I guess my boss couldn’t resist the temptation.

Well, well. It took nothing less than 2-3 hours to pester traders for prices of bonds, calculate and enter yields, spreads and other such whatnots into an especially boring looking Excel workbook. Being a geek by up-bringing and too tied up for time to waste 3 precious hours every day, I tried to automate it. The team didn’t mind it–they’d stare wide-eyed at me when I showed them the basics of the API and my Excel file that would dynamically create and update reports saving a ton of work every day. The secretary was especially thankful: what used to take 2.5 hours of manual data entry and calculation every afternoon was now a matter of 2 minutes of punching a bunch of numbers into Excel.

Of course, none of them had ever programmed a computer before, so whatever I did with any piece of code was, in their eyes, pure magic. But I did not for a moment shatter their illusion. I let myself be proclaimed an Excel guru–a name that a few of us from the IIMs carry into Wall Street, and with good reason.

So when the vice president saw the report on her desk and the debt model in her inbox, she happily assumed that it was just another day at work because she didn’t have a clue that the Bloomberg API did not have the kind of functions I wanted to use to cull out the million data points needed and the cheerful if non-programmer tech support lady in New York left it to myself to build the macro in VBA, because she couldn’t quite comprehend it when I asked whether the function call was asynchronous. Such is life (whatever is left of it, rather) in an investment bank, though I have to say I didn’t mind the programming bit.

Once, seeing one of my senior vice presidents staring blankly at the model, I queried politely: “Anne (name changed), do you want to see the source code?” To which she raised her eyebrows and shot back, “The what?”

I said don’t bother.

As you can see, I had my moments, however rare they were compared to the ones my managers had in watching me trying to grapple with the intricate niceties of high finance I had never even dreamt of before.

What is my point?

I don’t think I will personally be comfortable handing securitized life insurance policies and/or trading them. It’s not the way I’m wired. I can’t do it. I can’t help but think about the people at the other end of the Excel sheet. What I’m trying to do here is to offer one possible (humorous, if I need to be explicit) reason why investment bankers are so insulated sometimes from the rest of humanity.

My point, as circumlocuitous as it is, is that when you’ve gone through a wringer of a time like this, your association with Excel transcends into an emotional affair. The numbers you punched and the punches you suffered are yours, and you take pride in both. After a while, each sheet in your workbook begins to symbolize a particular phase of your life, and any flaw in it would indirectly be taken as a flaw in your life. The cells dissolve into a magnificent Van Gogh and you pause in the middle of the day to admire your creation. So don’t expect me to take it lightly when you so much as raise your finger to point at my beautifully colored cells in a disrespectful manner.

No surprise then, that investment bankers don’t care if the numbers on those cells mean the profit margins of oil giants or the death of a human being–someone with dreams, aspirations, a family and a life full of fond memories.


  • I was having this discussion abt insurance securitization and reverse mortgages with Hari. Finally it boils down to the point that both parties benefit, and mutually agree to the transaction without anyone forcing them to. So it is a legitimate and, can I say, ethical transaction (?). The only bet that the ibank is making is on the life expectancy. Now should one make money out of betting on how long the other guy is gonna live sounds bad, but it is still benefiting the other guy today, right? What say?

  • Agreed, the benefits are mutual. But the question is not so much about utility as it is about morality. But, as far as I can read him, what prompted the CFO to comment thus was the fact that the securitized instruments could then be traded in the market freely. It is one thing to have a mutually agreed contract between two parties, but I guess it is a slightly different matter to quote a price for someone’s death and buy and sell it like a commodity. Heck if you have a hundred such contracts, you’re literally investing in a graveyard.

    It is similar to the question whether voluntary euthanasia is right or wrong.

  • I agree with Hari: the dead dude is getting his insurance no matter what. Its not like bought the parties want the chap to die :) One of them will have obviously makes a notional gain if the person in question lives. You can’t feel sorry for this chap.

    You can’t compare it with this guy in Bihar, who used to insure other people’s lives, without telling them and kill them and collect the benefits. That is pure evil. (I don’t know if this is true though, its just hearsay.)

    Anyway, your description of the i-banking profession is quite accurate ;) especially with the Magic of the Macro! :)

  • The Bihar racket if true is outrageous, no doubt.

    But coming back to our securitization of death, it seems to be that those of us in close proximity to the investment banking profession would tend to side with Wall Street–call it intertia if you will. It’d be interesting to see what “normal” people, if I may, would think of this. The CFO epitomizes the sentiment outside Wall Street.

    There is no question that both parties benefit: this question would not have arisen if we were talking about mortgage securitization. But when one talks of life and death, one cannot ignore the emotional repurcussions. That’s where the catch lies.

    (I like that: the Magic of the Macro. Hehe!)

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