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SEC targets investors who bet on death

Offshore hedge funds call it an investment maturing.

Human beings call it death.

And that's why the Securities and Exchange Commission is recommending Thursday far stricter regulation of life settlements. This macabre investment allows hedge funds and other investors, many of them offshore, to bet on when people will die. The investors pay a lump sum to a person with a life insurance policy. And then the investors effectively "own" the life insurance policy, paying the annual premium but collecting the payout when the insured person dies.

The calculation for investors is simple: Will the person selling the life insurance policy die soon enough so that the lump sum and annual premiums aren't greater than the ultimate payout?

For certain, the right to sell your life insurance policy is part of U.S. law (see 1911 Supreme Court decision Grigsby v. Russell.) Many point out that AIDS patients in the 1980s sold their life insurance policies to raise money to pay for treatment to make their lives more comfortable until the day they died. And there is any number of reasons to defend the right to sell your settlement. The market was $7 billion in 2009 and some have estimated it will grow 10-fold in the next decade.

But there's no doubt that this is an area ripe for abuse. Even CNN host Larry King apparently got snookered. The settlements are regulated in a very limited way at the federal level, and states have a range of conflicting statutes. Some states have none. That's why the SEC wants Congress to amend the federal securities laws to treat the settlements like securities--stocks and bonds--and inflict a rigorous regime of disclosure and business conduct standards to people who buy and sell them.

It's hard to see an argument against increased regulation, but it seems that the dark nature of this market might already be cramping the life settlement business. The market has already shrunk from a height of $12 billion several years ago. And key financial companies that had been involved in the business--including Goldman Sachs and Deutsche Bank--have either downsized their interest in the area or got out of it altogether.

* Read the SEC study on life settlements.

* Read a GAO study on life settlements.

Follow me on Twitter @Goldfarb.

By Zachary A. Goldfarb  |  July 22, 2010; 2:27 PM ET
Categories:  SEC  
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