In recent weeks, American International Group Inc. (AIG) has sought to rally support among investors and credit-ratings firms for a controversial deal: the sale of securities backed by insurance policies on the lives of older people.
There have been few offerings of these types of securities, which critics have called "death bonds," "blood pools" and "collateralized death obligations" because they pay off when the insured dies. And AIG's effort so far isn't panning out. Standard & Poor's recently declined to provide a rating, an essential step in selling such securities to most investors.
AIG's push highlights the giant insurer's outsize role as an investor in the market, known as life settlements—a role that has largely gone unnoticed.
With life settlements, investors buy older people's policies, betting the future death benefit will exceed the cash they pay both to buy the policy and for premiums when waiting for the person to die.
The giant insurer's life-settlements portfolio totals about $18 billion in anticipated death benefits, according to the company's financial filings—or well over a third of the estimated $45 billion that has changed hands since the market revved up about a decade ago.
"We are looking at this portfolio as we evaluate AIG going forward," an AIG spokesman said, declining to elaborate.
The activity on AIG's part provides a glimpse into the company's entrepreneurial culture and shows how the company, slimmed down over the past two years as it raised cash to repay its 2008 government bailout, still has little-known pockets of business.
In general, life insurers have said widespread ownership of their policies by investors—essentially betting on death—would be bad for the industry's reputation. Many insurers, including one of AIG's units, have gone to court asserting that buyers misled them about wanting policies for estate planning when the goal was to flip them to investors.
For investors, many life settlements have proved to be losing bets, as people have lived longer than expected and as credit dried up in 2008. Since then the market has remained depressed, in part because of the mounting litigation.
The new wrinkle of securitization arose in the market's boom years before the financial crisis. Just as Wall Street banks bundled mortgages to make mortgage bonds, financiers looked into bundling hundreds of life-insurance policies into bonds that they could then sell, with the bonds' income coming from the death benefits.
The industry's trade group, American Council of Life Insurers, has criticized the concept, saying the existence of a Wall Street pipeline that needs to be filled with policies could encourage fraud by commission-paid agents and others trying to get older people to purchase and sell policies.
Under AIG's recent proposal to sell securities based on part of its portfolio, a subsidiary of its Chartis property-casualty unit would collateralize notes worth $900 million with 1,157 policies acquired since 2001. AIG would sell $250 million to outside investors, according to its marketing materials.
"S&P has not published a rating" on the proposed AIG policy-backed notes, a spokesman for the firm said. As for why, he pointed to a March S&P report highlighting the "unique risks" of such securities. The report discusses issues including the difficulty of estimating life expectancies of insured individuals. The proposal and S&P's response were reported in the trade publication Life Settlements Report earlier this month.
The biggest successful such securitization was an effort by AIG in 2009. Rated by insurance specialist A.M. Best Co., the deal created investment-grade securities that AIG has been able to hold in the portfolios of its insurance units. The securitization involved 3,400 policies with $8.4 billion of death benefits.
AIG's life-settlement business is in its Chartis property-casualty division. In its marketing materials for the newest securitization, AIG said only 22 of the policies in its portfolio of thousands had been "disputed," and none of those were in the proposed transaction.
It is unlikely that any losses or gains in AIG's life-settlements portfolio would have a significant effect on the overall earnings of the company, which is preparing a stock offering next month as the U.S. government winds down its bailout.
Chartis also has been involved with life settlements in another way. It has sold "lender protection" insurance to a finance firm that lends to people to help them pay premiums on multimillion-dollar life policies, according to a prospectus for a stock offering by Imperial Holdings Inc. earlier this year.
Chartis sold the "lender protection" coverage to Imperial from 2008 through 2010. It came in handy for Imperial, because borrowers, who typically take out two-year loans, have defaulted on 490 of 513 loans covered by the insurance and so far maturing, according to another Imperial filing. If borrowers cannot sell their policies profitably in the secondary market, Imperial can turn to AIG.
As of Dec. 31, AIG had made good on 479 claims, paying more than $177.8 million and getting the policies in exchange, the filing shows. Imperial declined to comment.