Death Trap Ahead

When I started seeing articles last summer about something called death bonds, it took me back to the '90s when I was a personal finance columnist in Tampa, Florida, witnessing the tail end of the viatical settlement movement. Viaticals were contracts calling for an investor to pay part of a seller's life insurance policy upfront and wait to collect the full amount when that person died. Viaticals originally catered to AIDS patients but were later marketed to all sorts of terminally ill folks. The viatical business worked in theory, but in practice, it attracted shady characters and enough fraudulent behavior to keep a personal finance columnist busy for years.

With death bonds, it seems the viatical settlement industry has matured and drunk the Wall Street Kool-Aid. Life settlement-backed securities are essentially spiffed-up viaticals. But this time, companies are bundling them up, dividing them into bonds and selling them mostly to institutional investors. Providers market them as good investments because they're not correlated with traditional investments—undoubtedly true—and because they can generate returns of 8 percent a year or better. The return figures might not be exaggerated, though history tells me to keep a hand on my wallet when listening to claims made by the people who dream these things up. As long as Wall Streeters are bundling the bonds for sale to hedge, pension and mutual funds, I've got no complaints. But don't be surprised to hear a sales pitch arguing that sophisticated individual investors could use some death bond diversification, too.

A couple of simple online searches tell me what I need to know for now: Many of the same characters from the old viatical business are now working the life settlement trade, which is to say that securities regulators are beginning to unearth scams. In some cases, promoters have attempted to persuade people (who aren't terminally ill) to take out life insurance strictly for the purpose of selling it. In others, they've inflated the expected returns based on the life expectancies of insurance holders. It's no wonder the National Association of Securities Dealers recently issued a warning about abusive practices in the industry.

So unless or until the industry gets absorbed by the mainstream investment community and sheds its sketchy past, steer clear.

—By Scott Bernard Nelson, a newspaper editor and freelance writer in Portland, Oregon

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