Should Be Treated Like Insurance?

By Will Ourand

Table of Contents I. Introduction ...... 3

II. Longevity Insurance: In Theory and In Practice...... 5 A. /RQJHYLW\,QVXUDQFHDV'LVFXVVHGLQWKH$FDGHP\'U0LOHYVN\¶V$/'$ ...... 5 B. Longevity Insurance in the Marketplace...... 6

III. When Does the Law T reat Financial Products Like Insurance? ...... 7 A. What is Insurance? ...... 7 B. How Courts and Academics Have Handled Various Transactions Under the McCarran-Ferguson Act ...... 8 1. Risk Transfer ...... 9 2. Spreading the Risk ...... 10 3. Risk Insurability ...... 10 4. The Relative Importance of the Risk ...... 11 C. A Summary and Critique of the Legal Frameworks Focusing on the Type and Role of Risk for Determining When Financial Products are Treated Like Insurance ...... 11

I V. How Law and Economics Can Provide Additional Analysis for Answering the 4XHVWLRQ³:KDWLV,QVXUDQFH"´ ...... 12 A. The Basics ...... 12 1. Transaction Costs ...... 12 2. Moral Hazard ...... 13 3. Adverse Selection and Information Asymmetry...... 14 B. $0RUH'HWDLOHG$QVZHUWRWKH4XHVWLRQRI³:KDWLV,QVXUDQFH"´: The Economic Substance and Concerns of Traditional Insurance Policies ...... 15 1. Disputes as to Whether the Specified Risk Actually Occured ...... 16 2. Moral Hazard ...... 17 3. Adverse Selection ...... 15 4. Insurer Solvency ...... 18 C. Summary ...... 18

V. Longevity Insurance Should Not Be T reated Like Insurance ...... 19 A. Longevity Insurance: A Comparative Analysis of a Hypothetical Alternative Arrangement to Current Market Options ...... 19 B. Looking Beyond the Form of the Longevity Insurance Transaction: A Comparative Analysis ...... 22 1. Transaction Costs ...... 22 2. There Should Not be Disputes as to Whether the Risk Occured ...... 25 3. Adverse Selection ...... 26 4. Moral +D]DUG/RQJHYLW\,QVXUDQFH¶V,QFHQWLYHWR/LYH/RQJHr ...... 24 5. Solvency Concerns...... 27 C. Summary: A New Perspective on Longevity Insurance ...... 28

V I. Conclusion ...... 29

2

I. Introduction

Jon Matthews was given a of months after being diagnosed with Mesothlioma in 2006.1 By 2009, he had won two £10,000 pound bets that he would still be alive.2 Reflecting on KLVZLQQLQJV0U0DWWKHZVVWDWHG³,WKLQN,¶PWKHILUVWSHUVRQLQ WKH ZRUOG WR EHW RQ P\ RZQ OLIH´3 One could understand his sentiment. The thought of betting that you would survive longer than expected is not the first that would pop into the minds of most when confronted with a terminal illness. However, Mr. Matthews was incorrect in his assumption. Recently, a new financial product has been marketed to people who are worried about outliving their life savings. Metlife began to sell the ³/RQJHYLW\ ,QFRPH *XDUDQWHH´ LQ 4 This product is essentially a means for people to purchase income security beginning at a specified age.5 The mechanics of it are relatively simple, with customers typically paying a single premium in return for an annuity income beginning at a triggering age, such as 85.6 Metlife describes the product with the language of the insurance industry, calling it protection against ³WKHULVNRI OLYLQJORQJHUWKDQ H[SHFWHGLQ UHWLUHPHQW´7 In fact, this product KDVFRPHWREHNQRZQPRUHJHQHUDOO\DV³ORQJHYLW\LQVXUDQFH´8 So, Mr. Matthews was not correct in thinking that he was the first person to bet on his own life. Metlife had been providing a product that allowed people to do just that for a full two years before he was even diagnosed with Mesothelioma. 0HWOLIH¶V product, however, is not caOOHG ³JDPEOLQJ´ EXW Uather bears the more prestigious label of ³DQQXLW\´  At this point the famous question challenging the importance of the name given to a rose posed by William Shakespeare is likely to be sounding in the

1 BBC News, Dying Man Wins Bet He Would Live, available at: http://news.bbc.co.uk/2/hi/uk_news/england/beds/bucks/herts/8075288.stm (last accessed: March 5, 2010). This article was originally inspired by the blog SRVWLQJGLVFXVVLQJ0U0DWWKHZ¶VJDPEOHDVDW\SHRI³$QWL-/LIH,QVXUDQFH´ Martin F. Grace, Anti-, blog posting dated June 3, 2009, available at: http://riskprof.typepad.com/tort/2009/06/anti-life-insurance.html (last accessed March 25, 2010). 2 BBC News, Dying Man Wins Bet He Would Live. 3 Id. 4 2007 Press Releases at MetLife, Metlife Broadens Distribution of Deferred Income Annuity Through Metlife Investors; Renames Product, available at: http://www.metlife.com/about/press-room/us-press- releases/2007/index.html?compID=476 (last accessed: March 5, 2010). 5 Id. 6 Id. 7 Id. 8 W. Thomas Cooner, Conference on Life Insurance Company Products Current SEC, FINRA, Insurance, Tax, and ERISA Regulatory and Compliance Issues, ALI-ABA Course of Study Materials (2007). 3

UHDGHU¶V KHDG VR WKH DXWKRU ZLOO VSDUH the reader the tedium of once again utilizing that over-referenced line. Still, one must wonder, when it comes to the legal treatment of innovative financial products such as the prestigious-VRXQGLQJ ³/LIHWLPH ,QVXUDQFH *XDUDQWHH´ RIIHUHG E\ 0HWOLIH ZK\ VKRXOG ZH WUeat it DQ\GLIIHUHQWO\WKDQWKHPHUH³wager´PDGHE\0U0DWWKHZV" Simply pointing out the similarity between gambling and insurance, or between gambling and any other type of financial product for that matter, would not serve as a very original or helpful discussion. This article will instead try to discuss what types of factors should be looked at when determining how to treat different types of financial products. The specific argument advanced is that often the law is looking towards the form of a transaction when determining its legal treatment, and that instead it should be looking towards the substantive concerns which underlie that transaction. The method of analysis for looking at the substantive concerns will incorporate various Law and Economics concepts, including transaction costs, moral hazard, and adverse selection. In order to make this argument, it will be necessary to provide the reader with some foundational information necessary for a full appreciation of the issue. Part II will examine the various ways that longevity insurance has already been discussed by the academy and marketed by insurance companies. The goal of providing this information will be to provide a framework for understanding how this product has been thought of outside of practical and legal constraints, and then to show how it has been implemented by companies having to deal with those constraints. Part III will then provide an example of how courts have determined whether or not to treat various innovative financial products like insurance in the context of the McCarran-Ferguson Act. In particular, the discussion in this Part will highlight the emphasis that courts have placed on the form of the transaction. Following this overview will be a critical summary and assessment of the flaws of this type of form-based analysis. Part IV will then introduce concepts from the Law and Economics movement, including transaction costs, moral hazard, and adverse selection. These concepts will then be discussed as they relate to traditional types of insurance in order to provide the reader with a more detailed understanding of what types of concerns society should have regarding traditional insurance policies. This discussion will endeavor to provide a greater understanding of when financial products should be treated like insurance by looking beyond the form and towards the substantive concerns that underlie traditional insurance policies.

4

Part V will take all of the foundational building blocks presented in the preceding sections and finally reach the task at hand in attempting to answer the question regarding whether longevity insurance should be treated like insurance. In so doing, there will first be a brief analysis and critique of how the current legal tests would treat this product. Following that there will be a comparative analysis of longevity insurance and traditional insurance policies which will reflect the principles from Law and Economics discussed in Part IV. This analysis will show that many substantive concerns that society should have regarding traditional insurance policies are not present in the longevity insurance. Part VI will conclude the article.

II. Longevity Insurance: In Theory and In Practice

A. Longevity Insurance as Discussed in the Academy: 'U0LOHYVN\¶V$/'$

Dr. Moshe A. Milevsky described what he called an ³$GYDQFHG-Life Delayed Annuit[y]´RU³$/'$´IRUVKRUWLQDQ article published in October 2005.9 The ALDA as described by 'U 0LOHYVN\ ZDV GHVLJQHG WR EH SDLG IRU WKURXJK ³VPDOO premiums paid over a long pHULRG RI WLPH´ DQG ZRXOG ³EHJLQ paying an inflation-adjusted life-contingent income only at the DGYDQFHGDJHRIRUHYHQ´10 Dr. Milevsky envisioned WKH $/'$ DV D ³FORVH UHODWLYH´ RI GHILQHG EHQHILWV plans, which have become less common.11 2QHXQLTXHIHDWXUHRI'U0LOHYVN\¶V$/'$LVKLVSODQWo confront the lack of popularity facing annuities in the marketplace, particularly amongst those in the middle class.12 Dr. Milevsky H[SODLQHG WKDW ³>Z@KDW LV QHHGHG LV WR DFFHSW WKDW D VXGGHQ LUUHYHUVLEOH WUDQVDFWLRQ ZLOO QHYHU EH SRSXODU´ DQG DFFRUGLQJO\ SURSRVHG DQ DOWHUQDWLYH DV EHLQJ ³VORZ DQQXLtization over a very long period of time or the gradual purchase of longevity insurance that start providing income only at any DGYDQFHGDJH´13 The ALDA would also have no forfeiture benefits, meaning that it would not have a cash value, survival or estate benefits, and it could not be commuted for cash.14 The lack of forfeiture benefits would serve as a double-edged sword; while it would help

9 Moshe A. Milevsky, Real Longevity Insurance with a : Introduction to Advanced-Life Delayed Annuities (ALDA), 9 N. AM. ACTURIAL J. 109 (2005). 10 Id. 11 Id. at 109, 121. 12 Id. at 112-13. 13 Id. 14 Id. at 109. 5 keep premium SULFHVWR³PHUHFHQWVRQWKHGROODU´'U0LOHYVN\ hypothesized that a policy without such benefits ³PLJKW EH LPSRVVLEOHWRDWWDLQJLYHQWKHFXUUHQWUHJXODWRU\HQYLURQPHQW´15 Dr. Milevsky even proposed the ALDA to a Canadian LQVXUDQFH FRPSDQ\ ZKLFK DSSURDFKHG WKH SURGXFW ZLWK ³PXFK H[FLWHPHQW´16 The company even went so far as to have its actuaries produce a pricing table.17 Unfortunately, the product QHYHU PDGH LW WR PDUNHW GXH WR ³D QXPEHU RI LQVWLWXWLRQDO DQG UHJXODWRU\REVWDFOHV´18 Many of the reasons for not bringing the product to market provided by the insurance company had to do with administrative difficulties.19 However, there was at least one legal concern regarding the lack of a death benefit.20 While there were no specific legal barriers to prevent a product such as this from not KDYLQJDGHDWKEHQHILW'U0LOHYVN\FODLPVWKDW³>P@RVWLQVurance companies do not feel comfortable from a public relations (a.k.a. legal or possibly fiduciary) perspective offering such a product´21 The reason for this discomfort is that offering such a policy without a death benefit could result in premium payments being made for a total of up to 50 years with nothing to show for it if the policyholder dies before the specified age.22

B. Longevity Insurance in the Marketplace

As previously noted, Metlife has been marketing longevity insurance since 2004.23 They are not the only ones with such a product. In addition to Metlife, The Hartford24 and New York Life25 also sell longevity insurance. The specific mechanics of each product differ. For instance, while the New York Life

15 Id. 16 Id. at 118-19. 17 Id. 18 Id. at 119. 19 Id. 20 Id. 21 Id. (emphasis added). 22 Id. 23 2007 Press Releases at MetLife, Metlife Broadens Distribution of Deferred Income Annuity Through Metlife Investors; Renames Product, available at: http://www.metlife.com/about/press-room/us-press- releases/2007/index.html?compID=476 (last accessed: March 5, 2010). 24 The Hartford, 7KH+DUWIRUG¶V86:HDOWK0DQDJHPHQW*URXS(OHYDWHV7KUHH Executives, The Hartford Investor Relations, available at: http://ir.thehartford.com/releasedetail.cfm?ReleaseID=209249 (last accessed: March 5, 2010). 25 New York Life, New York Life Introduces New Variable Annuity That Offers Growth Potential and Longevity Insurance, available at: http://www.newyorklife.com/nyl/v/index.jsp?vgnextoid=0eed1219a49d2210a2b 3019d221024301cacRCRD (last accessed: March 5, 2010). 6 product only comes with a death benefit,26 0HWOLIH¶VSURGXFW FDQ be customized to either have or not have a death benefit.27 Many of these products DUHYHU\VLPLODUWR'U0LOHYVN\¶V proposal.28 However, there is one significant difference; namely, the products are being designed for those who are approaching retirement age.29 7KLV LV FRQWUDU\ WR 'U 0LOHYVN\¶V YLVLRQ RI people paying small premiums beginning as young as age 35.30 The lack of policies with payment occurring on a long-term weekly or monthly premium schedule is interesting, especially in light of the fact that this is the regulatory issue that had worried the Canadian insurance company Dr. Milevsky had approached.31 One commentator writing on behalf of the ALI-ABA noted that there was uncertainty regarding how state insurance commissioners would treat such polices without death benefits or cash values.32 The commentator theorized that there could be concerns regarding ³SRWHQWLDOSXEOLFEDFNODVKDJDLQVWDQDQQXLW\FRQWUDFWXQGHUZKLFK the owner could pay premiums for many years but receive nothing in return if he or she dies before the advanced age specified in the contraFW´33 )LQDOO\ WKH DXWKRU K\SRWKHVL]HG WKDW ³>V@WDWH insurance regulator concerns may have been a factor in the range RISURGXFWW\SHVWKDWKDYHEHHQEURXJKWWRPDUNHW´34

III. When Does the Law T reat Financial Products Like Insurance?

A. What is Insurance?

The normative goal of this article is to provide a better framework for determining what types of transactions should be treated like insurance. In order to do so it is initially important to understand what is meant by the term ³insurance.´ %ODFN¶V /DZ 'LFWLRQDU\ GHILQHV Lnsurance as a contract ZKHUH ³RQH SDUW\ WKH insurer) undertakes to indemnify another party (the insured) against risk of loss, damage, or liability arising from the occurrence of some specified contingency, and usu[ally]

26 Id. 27 2007 Press Releases at MetLife, Metlife Broadens Distribution of Deferred Income Annuity Through Metlife Investors; Renames Product, available at: http://www.metlife.com/about/press-room/us-press- releases/2007/index.html?compID=476 (last accessed: March 5, 2010). 28 Cooner, supra note 8 at 11. 29 Id. 30 Milevsky, supra note 9 at 113. 31 Milevsky, supra note 9 at 119. 32 Cooner, supra note 8 at 13. 33 Id. 34 Id. 7 to defend the insured or to pay for a defense regardless of whether WKHLQVXUHGLVXOWLPDWHO\IRXQGOLDEOH´35 It defines an annuity as ³[a]n obligation to pay a stated sum, usu[ally] monthly or annually, WR D VWDWHG UHFLSLHQW´ ZKLFK ³WHUPLQDWH>V@ XSRQ WKH GHDWK RI WKH designated beneficiDU\´36 These definitions do not solve all ambiguity present in various financial transactions. For instance, they simply do not provide enough details to understand what would make one transaction an investment and another transaction an . One must turn to the courts for a more specific description of the boundaries separating insurance from other transactions.

B. How Courts and Academics Have Handled Various Transactions Under the McCarran-Ferguson Act

The McCarran-Ferguson Act of 1945 gave the states the power to regulate WKH ³EXVLQHVV RI insurance.´37 Since then the litigation surrounding the McCarran-Ferguson Act has been a ripe place for the judicial and academic development of the boundaries VHSDUDWLQJZKDWFRQVWLWXWHVWKH³EXVLQHVVRILQVXUDQFH´IURPRWKHU financial transactions.38 This article now turns towards a brief analysis of some of the key points which have been important up until now in determining ZKDW FRQVWLWXWHV WKH ³business of insurance´ for determining regulatory authority. In so doing this article will ride on the coattails of the research performed by another commentator in looking towards four elements that courts have held to be important in this analysis.39 These four elements all relate to the risk-related aspects of the transaction, requiring that the risk: 1) is transferred from holder to provider; 2) is spread amongst the insureG   LV ³LQVXUDEOH´ DQG   LV sufficiently important in relation to the entire transaction in that it is either the main purpose of the transaction or that it necessitates the expertise of state insurance regulators in order to be regulated effectively.40

35 BLACK¶S LAW DICTIONARY (8th ed. 2004) (emphasis in original). 36 BLACK¶S LAW DICTIONARY (8th ed. 2004). 37 15 U.S.C. § 1011 (2006). I will continuously refer to the states as having the SRZHUWRUHJXODWHWKH³EXVLQHVVRILQVXUDQFH´UDWKHUWKDQVLPSO\XVLQJWKHWHUP ³LQVXUDQFH´EHFDXVHWKHUHDUHLPSRUWDQWFRQFHSWXDODQGDQDO\WLFDOGLVWLQFWLRQV EHWZHHQ WKH WHUP ³EXVLQHVV RI LQVXUDQFH´ DQG VLPSO\ ³LQVXUDQFH´  See, e.g. Steven J. Williams, 'LVWLQJXLVKLQJ ³,QVXUDQFH´ )URP ,QYHVWPHQW 3URGXFWV Under the McCarran-Ferguson Act: Crafting a Rule of Decision, 98 Colum. L. Rev. 1996, 1997 (1998) (discussing how McCarran-Ferguson left the question of ZKDWFRQVWLWXWHVWKH³EXVLQHVVRILQVXUDQFH´RSHQ  38 See generally Williams, supra note 37 (discussing case law under the McCarran-Feguson Act and proposing a new test to separate insurance from investment contracts). 39 Id. at 2022. 40 Id. 8

1. Risk Transfer

The risk transfer element is said to be the LQVXUHG¶V PDLQ purpose for entering the insurance transaction, with insurance HVVHQWLDOO\EHLQJ³DGHYLFHIRUWUDQVIHUULQJWRDQRWKHUSDUW\WKHULVN WKDW VRPH XQFHUWDLQ HYHQW ZLOO UHVXOW LQ ILQDQFLDO ORVV´41 The insured is said to receive two benefits from such transfer, which include being placed in a more similar economic position to where he or she was before the occurrence of such event, and mental security in the absence of the event occurring.42 The failure to provide the requisite risk-transfer resulted in variable annuities being found to not fall under the McCarran- Ferguson Act in SEC v. Variable Annuity Life Insurance Company of America.43 The variable annuities at issue had two different features from traditional annuities, namely: 1) premiums that were more heavily invested in equities; and 2) payment of benefits that was dependent upon how the investments performed.44 This &RXUW¶VGLVFXVVLRQZDVSDUWLFXODUO\LQWHUHVWLQJEHFDXVHLWZHQWLQWR a comparison of the risk-bearing aspects of fixed and variable annuities.45 7KH &RXUW DFNQRZOHGJHG WKDW ³DFWXDULDOO\ ERWK WKH fixed-dollar annuity and the variable annuity are calculated by LGHQWLFDOSULQFLSOHV´46 with the mortality risk born by the issuer in both instances.47 7KH &RXUW UHFRJQL]HG WKDW ³OLIH LQVXUDQFH LV DQ LQYROYLQJ LQVWLWXWLRQ´DQGH[SUHVVHGDGHVLUHWRQRW³IUHH]HWKHFRQFHSWVRI µLQVXUDQFH¶ RU µDQQXLW\¶ LQWR WKH PROG WKH\ ILWWHG ZKHQ WKHVH )HGHUDO$FWVZHUHSDVVHG´48 However, the Court VWDWHGWKDW³WKDW WKHFRQFHSWRIµLQVXUDQFH¶LQYROYHVVRPHLQYHVWPHQWULVN-taking on WKHSDUWRIWKHFRPSDQ\´49 and that the mortality risk presented in the variable annuities was not sufficient to meet this requirement.50 The Court said that the mortality risk did not effectuate the requisite risk transfer in the variable annuities because they lacked ³VRPHJXDUDQWHHRIIL[HGLQFRPH´51 Elaborating on this point, the Court stated that ³WKH YDULDEOH DQQXLW\ SODFHV DOO WKH LQYHVWPHQW

41 Id. at 2014. 42 Id. 43 SEC v. Variable Annuity Life Ins. Co. of America, 359 U.S. 65, 71-72 (1959). 44 Id. at 70. 45 Id. at 70-71. 46 Id. at 70. 47 Id. 48 Id. at 71. 49 Id. 50 Id. 51 Id. 9 risks on the annuitant, none on the company,´52 ZLWK³>W@KHKROGHU get[ting] only a share of what the portfolio of equity interests reflects-ZKLFKPD\EHDORWDOLWWOHRUQRWKLQJ´53

2. Spreading the Risk

In addition to risk transfer, courts and commentators have also discussed the importance of risk spreading.54 One commentator even picked up on the important conceptual divide between risk transfer and risk spreading as ³GLVWLQFWDQGVHSDUDWH element[s].´55 The distinction would really matter in situations where the risk transfer element was present, but the risk spreading element was not.56 These VLWXDWLRQV RFFXU ZKHUH FRXUWV PXVW ³GHWHUPLQH whether an activity of a non-insurance company should be inFOXGHGXQGHUWKHKHDGLQJRIµLQVXUDQFH¶´57 in which the ³FRXUW must take the further step of distinguishing that activity from all WKHRWKHUVRUWVRIDFWLYLWLHVWKDWLQYROYHULVNµVKLIWLQJ¶´58

3. Risk Insurability

The risk insurability requirement is based upon a distinction separating insurance risks from investment risks.59 Generally, the difference between insurance risks and investment risks is that LQVXUDQFHULVNVGHDOZLWKRQO\D³FKDQFHRIORVVRUQR ORVV´60 ZKLOHLQYHVWPHQWULVNVGHDOZLWK³WKHSRVVLELOLW\RIHLWKHU JDLQRUORVV´61 To help differentiate between these two types of risks, one can compare and contrast the situation of purchasing fire insurance for a house as opposed to purchasing stock.62 The holder of the fire insurance policy will either get paid the amount of compensation specified in the contract if there is a fire or will not in the absence of a fire; in no situations will the holder have an opportunity to realize a capital gain simply as a result of holding

52 Id. 70. 53 Id. at 70-71. 54 See Williams, supra note 37 at 2015-16 (discussing how various courts have utilized tests involving either risk transfer and risk spreading). 55 Id. at 2015. 56 Id. at 2016. 57 Id. 58 Id. 59 Williams, supra note 37 at 2017 (citing Helvering v. Le Gierse, 312 U.S. 531, 539-42). 60 Williams, supra note 37 at 2017-18. 61 Id. at 2018. 62 Id. 10 the policy.63 Contrarily, the holder of the stock could either watch the investment lose value or share in profits that the company produces.64

4. The Relative Importance of the Risk

The fourth aspect, the relative importance of the risk, is LPSRUWDQW EHFDXVH ³>T@XDOLWLHV RI µLQVXUDQFH¶ H[LVW DV DQFLOODU\ DFWLYLWLHV LQ D ZLGH UDQJH RI EXVLQHVVHV´65 Examples of such ancillary activities include auto warranties and lease repair provisions.66 However, it is not enough to look to see whether the risk- related aspect is merely ancillary to the contract as a whole. The risk-related aspect may be ancillary but still be important enough relative to the overall transaction that it should be treated as insurance if it would require the expertise of state insurance regulators.67

C. A Summary and Critique of the Legal Frameworks Focusing on the Type and Role of Risk for Determining When Financial Products are Treated Like Insurance

The discussion presented above provided a brief overview of how courts and commentators have approached the issue of whether to treat various financial products like insurance in the context of the McCarran-Ferguson Act. This analysis was necessitated by the problems discussed in the Introduction to this article, namely that many transactions appear to be quite similar depending upon the level of abstraction adopted. When such similarities arise, the issue becomes how to handle the distinctions and similarities for the purposes of legal treatment. The common theme of the analysis of the courts and commentators had to deal with how risk was involved in the transaction. Each stage of the analysis was basically a different mechanism for looking at the risk involved from different perspectives, namely: where the risk was transferred, whether the risk was spread, the type of the risk, and the relative importance of the risk to the transaction as a whole. It seems odd that in the entire discussion the only place that the need for the expertise of the state regulators appeared as a

63 Id. 64 Id. 65 Id. at 2019. 66 Id. 67 Id. at 2021-22. 11 controlling factor was in one circumstance: where a risk was ancillary to the transaction.68 If these tests are intended to be a means for determining the legal treatment of various financial transactions, then would it not make more sense for the entire analysis to revolve around the issue of the necessity of state insurance regulator expertise? By focusing so heavily on the various aspects of the risk involved in the transaction it may be possible to miss the ultimately more important issue of the actual substantive concerns that the law should be trying to address when dealing with innovative financial products. It may be that the discussion and resulting tests for the differing manifestations of risk have assumed that the nature of the risk serves as a proxy for the more important question of when state insurance regulator expertise is needed, but why utilize a proxy that is a product of superficial form rather than looking to the actual problems that such transactions may entail? It is one thing to lecture others as to their failure to place substance above form, but it is quite another matter to actually suggest a closer means for determining the substantive concerns that would require the expertise of state insurance regulators. Thankfully, others have already made great strides in understanding the types of concerns that are present in the economic transactions that exist in our legal society. By carefully applying their work to the task at hand, this article next aspires to provide a better means for understanding the substantive concerns that give rise to the need for the expertise of state insurance regulators.

I V. How Law and Economics Can Provide Additional Analysis for Answering WKH 4XHVWLRQ ³:KDW LV ,QVXUDQFH"´

A. The Basics

1. Transaction Costs

R.H. Coase wrote The Problem of Social Coast in order to paint a clearer picture of how the law could work better to confront the problem of transaction costs.69 Coase provided some examples of transaction costs, including finding people to make deals with, negotiating deals, enforcing the terms of the deal, and inspection to ensure compliance with the deal.70 The problem with such costs is WKDWWKH\³DUHRIWHQH[WUHPHO\FRVWO\VXIIiciently costly at any rate

68 Williams, supra note 37 at 2022. 69 R.H. Coase, The Problem of Social Cost, 3 J. L. & Econ. 1, 1 n.1 (1960). 70 Id. at 15 12 to prevent many transactions that would be carried out in a world LQZKLFKWKHSULFLQJV\VWHPZRUNHGZLWKRXWFRVW´71 There are a variety of means by which transaction costs can be dealt with, including forming a firm or through government regulation.72 Each solution to the transaction cost problem has its own unique benefits and costs, and accordingly each solution may or may not be appropriate depending upon the circumstances.73 Government regulation is a unique method to deal with transaction costs because it can do what the firm cannot.74 The JRYHUQPHQWFDQFKRRVH³WRDYRLGWKHPDUNHWDOWRJHWKHU´75 which would allow it to make D³GHFUHHWKDWIDFWRUVRISURGXFWLRQVKRXOG only be used in such-and-VXFKDZD\´UDWKHr than negotiating with the factory owners in the marketplace.76 Additionally, the government can use the power of law enforcement to implement regulations.77 With the unique abilities of the government to confront transaction costs come unique costs as well.78 For instance, UHJXODWLRQVFUHDWHGE\WKHJRYHUQPHQWPD\QRW³QHFHVVDULO\DOZD\V be those which increase the efficiency with which the economic V\VWHP RSHUDWHV´ JLYHQ WKDW WKH\ DUH ³PDGH E\ D IDOOLEOH administration subject to political pressures and operating without DQ\FRPSHWLWLYHFKHFN´79 Additionally, there is a problem in that ³JHQHUDOUHJXODWLRQVZKLFKPXVWDSSO\WRDZLGHYDULHW\RIFDVHV will be enforced in some cases in which they are clearly LQDSSURSULDWH´80

2. Moral Hazard

Moral hazard is ³WKH WHQGHQF\ RI LQVXUDQFH SURWHFWLRQ WR DOWHU DQ LQGLYLGXDO¶V PRWLYH WR SUHYHQW ORVV´81 Despite the judgmental-sounding name that it bears, moral hazard does not necessarily refer to some type of defect with morality.82 Rather, it could also be thought of as the result of skewed economic incentives.83 Or, in other words, the fact that an insured uses a

71 Id. 72 Id. at 16-18. 73 Id. 74 Id. at 17. 75 Id. 76 Id. 77 Id. 78 Id. at 18. 79 Id. 80 Id. 81 Steven Shavell, On Moral Hazard and Insurance, 83 Q. J. Econ. 541 (1979). 82 Mark Pauly, The Economics of Moral Hazard: Comment, 58 Am. Econ. Rev. 531, 535 (1968) [hereinafter Pauly, The Economics of Moral Hazard]. 83 Id. 13 service when insurance is present more ³WKDQ LQ LWV DEVHQFH LV D UHVXOWQRWRIPRUDOSHUILG\EXWRIUDWLRQDOHFRQRPLFEHKDYLRU´84 The reason for this LV WKDW ³>V@LQFH WKH FRVW RI WKH LQGLYLGXDO¶V excess usage is spread over all other purchasers of that insurance, the individual is not prompted to restrain his usage of [services covered by the policy]´85

3. Adverse Selection and Information Asymmetry

Adverse selection in the context of insurance is a problem that is caused by information asymmetry between insurers and those seeking insurance.86 More precisely, the asymmetry arises EHFDXVH³WKHLQVXUHUFDQQRWGHWHUPLQHVRPHFKDUDFWHULVWLFVRIWKH insured that are relevant to the determination of the probability of WKHIXWXUHVWDWHWRRFFXU´87 The information asymmetry gives way to an adverse selection problem when the person seeking insurance lies.88 As a result of this information asymmetry, one commentator has REVHUYHGWKDW³>V@RORQJDVVRPHSHRSOHOLHWKHLQVXUHUZLOOKDYH WRDVVXPHWKDWDQ\JLYHQLQVXUHGPD\OLH´89 The potential for lying inherent in information asymmetries has an impact upon the pricing and provision of products.90 Even where there ma\H[LVWSURYLGHUVRI³JRRGTXDOLW\SURGXFWV´LQDQ acceptable price range to potential consumers, the effect of those attempting to sell inferior products has to be taken into account.91 $VRQHFRPPHQWDWRUKDVSXWLW³>W@KHFRVWRIGLVKRQHVW\WKHUHIRUH lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate EXVLQHVVRXWRIH[LVWHQFH´92

84 Id. 85 Id. 86 George A. Akerlof, 7KH0DUNHWIRU³/HPRQV´4XDOLW\8QFHUWDLQW\DQGWKH Market Mechanism, 84 Q. J. ECON. 488, 490-94 (1970). 87 Mark Pauly, Overinsurance and Public Provision of Insurance: The Roles of Moral Hazard and Adverse Selection, 88 Q. J. Econ 44, 44-45 (1974) [hereinafter Pauly, Overinsurance]. 88 Id. at 54. 89 Id. 90 Akerlof, supra note 86 at 495. 91 Id. 92 Id. 14

B. $ 0RUH 'HWDLOHG $QVZHU WR WKH 4XHVWLRQ RI ³:KDW LV ,QVXUDQFH"´: The Economic Substance and Concerns of Traditional Insurance Policies

Earlier, insurance was defined and discussed as it exists within the legal context.93 The discussion there focused on risk allocation, risk type, and the relative importance of the risk.94 There are other ways to look at insurance transactions. Why look towards what role we think that risk is playing within the transaction when we could instead look towards what type of concerns we have with the way that risk is involved in the transaction? This is where the Law and Economics perspective may provide unique advantages over the traditional legal discussion surrounding insurance. Applying the work of Law and Economics to the issue of insurance, we can better understand the fundamental issue that lurks under all of this discussion: what specific concerns should we have about insurance transactions as compared to other transactions? An insurance transaction, at its core, is an agreement between the insured and the insurer that the insurer will pay a specified amount to the insured if the risk were to occur. In a world without transaction costs, the insured would provide all relevant information to the insurer, and the insurer could and would pay the insured if the risk were to occur. Unfortunately, insurance transactions do not occur without transaction costs and other problems. What follows will be an attempt to provide an overview of some of the transaction cost, moral hazard, and adverse selection concerns involved in traditional insurance transactions.

1. Disputes as to Whether the Specified Risk Actually Occurred

Part of enforcing an insurance transaction involves determining whether or not the covered risk actually occurred. Recall from the previous discussion that enforcing the terms of the deal results in transaction costs.95 The insurer is obligated to pay when the risk occurs, but both parties do not always agree that the risk occurred.96

93 See supra part III. 94 Id. 95 See Part IV(A)(1). 96 See, e.g. Willy E. Rice, The Court of Appeals for the Fifth Circuit: A Review of 2007-2008 Insurance Decisions, 41 TEXAS TECH L. REV. 1013 (covering insurance based decisions for the fifth circuit, many of which involved disputes where the insurer did not pay benefits to the insured) 15

An infamous example of the types of disputes that can arise EHWZHHQ LQVXUHGV DQG LQVXUHUV LV WKH ³$QWL-&RQFXUUHQW &DXVH´ stipulations common in homeowners insurance policies.97 In situations like that presented by Hurricane Katrina, insureds and insurers may find themselves in a dispute as to what caused the damage.98 In the example from Hurricane Katrina, homeowner insurancH FRPSDQLHV FRXOG SUHYDLO DJDLQVW LQVXUHGV LI D ³UDWLRQDO jury could conclude, based on the testimony of [insurance FRPSDQ\@H[SHUWVWKDWWKH>LQVXUHG¶V@KRPHDQGSHUVRQDOSURSHUW\ ZHUHGHVWUR\HGE\ZDWHU´99 While the homeowners insurance policy may jump out as the most infamous example of disputes between insureds and insurers, these types of disputes arise in other types of insurance policies as well. For example, one can look at life insurance provisions disclaiming coverage if the insured commits suicide or is executed by the state.100

2. Moral Hazard

Another concern is how the insured will be affected by moral hazard. This is something that the insured will likely either not know, not disclose, or both.101 The effect of moral hazard regarding insurance has been well studied. For instance, one study showed that compulsory auto insurance had the moral hazard effect of increasing fatalities.102 Moral hazard also results in additional costs because the insured may have to begin observing the care taken by the insured regarding the insured risk.103 The timing of such observations would have different costs to the insurer EHFDXVH ³H[ DQWH observation requires that all policyholders are investigated, while ex post observation requires only that those who make claims are

97 Id. at 1044. 98 Id. 99 Id. at 1045 (quoting Broussard v. State Farm Fire & Cas. Co., 523 F.3d 618, 625 (citing Wall v. Swilley, 562 So. 2d 1252, 1256 (Miss. 1990)). 100 See, e.g., George Richards, Life Insurance-Suicide and Execution for Crime, 22 Yale L.J. 292 (arguing in favor of allowing life insurance companies to cover suicide and executions if they choose to). 101 The moral hazard concern can also be thought of as a problem of asymmetrical information, because the insured is going to have greater access to the information regarding the continuing level of risk. Pauly, Overinsurance, supra note 87 DW  ³0RUDO KD]DUd can be thought of as arising from an asymmetry of information: the insured knows his level of preventative activity, EXWWKHLQVXUHUGRHVQRW´ 102 Alma Cohen & Rajeev Dehejia, The Effect of Automobile Insurance and Accident Liability Laws on Traffic Fatalities, 47 J. L. & Econ. 357, 388 (2004). 103 See Shavell, supra note 81 (discussing various levels of observed care and the impact on moral hazard). 16

LQYHVWLJDWHG´104 Whether observations are made ex ante or ex post, they are likely to come with their own costs, and each may have different levels of quality.105 For instance, the costs of ensuring that the insured has actually utilized smoke detectors and is keeping their home free of fire hazards might make sense as an H[DQWHREVHUYDWLRQEHFDXVHWKH³>H@vidence of care . . . taken to prevent or reduce loss might itself be partially or completely GHVWUR\HGLQDILUH´106 Contrarily, an ex ante investigation of the iQVXUHG¶V GULYLQJ DELOLWLHV ZRXOG OLNHO\ QRW prove to be efficient because the insured could simply fake a different driving style during the test, whereas after an accident for which a claim is made the insurer could use witness reports and the police investigation to determine the observation of care.107

3. Adverse Selection

Another concern regarding the insured is adverse selection. The insurer would need to know all of the pertinent information about the insured in order to provide the most efficient price for the insurance policy in accordance to the deal struck.108 However, due to the aforementioned problems of asymmetrical information, the insured is not going to provide the insurer with all of the pertinent information required.109 This does not always have to be the result of a purposeful distortion on the part of the insured. There are some things that are either not known or not provable.110 It has been said that ³>W@KHSULQFLSOHRIµDGYHUVHVHOHFWLRQ¶ LV SRWHQWLDOO\ SUHVHQW LQ DOO OLQHV RI LQVXUDQFH´111 This concern arises in the context because, ³HUURU LQ PHGLFDO check-XSVGRFWRUV¶V\PSDWK\ZLWKROGHUSDWLHQWVDQGVRRQPDNH it much easier for the applicant to assess the risks involved than the LQVXUDQFHFRPSDQ\´112

104 Id. at 550. 105 Id. 106 Id. 107 Id. at 551. 108 See Akerloff, supra note 86 at 492 & 495 (discussing the tendency of the insured to not disclose all details known to the insured and the general costs of dishonesty on economic transactions). 109 Id. at 492. 110 Paul, Overinsurance, supra note 87 DW ³,WVKRXOGEHHPSKDVL]HGWKDWWKLV asymmetry need not be the result of mendacity on the part of the insured; if WKHUH DUH VRPH DVSHFWV RI WKH LQVXUHG¶V FRQGLWLRQ ZKLFK FDQQRW EH proved by objective evidence that the insurer will accept, it does not matter whether a SDUWLFXODULQVXUHGWHOOVWKHWUXWKRUQRW´  HPSKDVLVLQRULJLQDO  111 See Akerloff, supra note 86 at 493. 112 See Akerloff, supra note 86 at 492. 17

4. Insurer Solvency

Another important part of enforcing the transaction is making sure that the insurer can actually pay if the risk does occur. Accordingly, insurer solvency has been a popular topic of discussion for economists.113 State insurance regulators deal with solvency in three main ways.114 First, they can exercise direct control through such means as setting minimal capital requirements and by placing limits on how insurers can invest.115 Secondly, they can monitor the insurers through such bodies as the National Association of Insurance Commissioners (NAIC).116 Third, they can and do establish a way to pay those insured by insolvent insurers through such means as guaranty funds.117

C. Summary

Let us return to where we started before the discussion of transaction costs as they apply to insurance. It was previously stated that insurance is an agreement between the insured and the insurer that the insurer will pay a specified amount to the insured if the risk were to occur. The legal tests discussed above for differentiating insurance from other types of financial products can help to further define this abstraction. However, those tests all did so by focusing on the nature and role of the risk. To this extent, such tests are ultimately superficial when viewed in light of their goal, which is to separate out which transaction are to be subjected to state insurance regulation. Their superficiality is a result of a focus strictly upon the form of the transaction; transactions that have certain types of risks involved in certain ways are to be subjected to state insurance regulation, whereas transactions that do not have those certain types of risks involved in those certain ways are not subjected to state insurance regulation. It was only in the case of a transaction involving an ancillary risk that the more substantive issue of whether the expertise of state insurance regulators would be necessary was included as a test.118 Being that the question posed is whether to treat a financial product like insurance, the issue of the necessity of state insurance regulator

113 FOUNDATIONS OF INSURANCE ECONOMICS: READINGS IN ECONOMICS AND FINANCE, 30-34 (George Dionne & Scott E. Harrington eds., Kluwer Academic Publishers 1992) [hereinafter FOUNDATINOS OF INSURANCE ECONOMICS]. 114 Id. at 31. 115 Id. 116 Id. 117 Id. 118 Part III(b)(4). 18 expertise should be the foundation of the analysis, not an ancillary concern. Having left Part III with this issue left open, what followed in this Part was a discussion of the types of concerns that society should have regarding insurance transactions. This discussion was conducted utilizing concepts from the Law and Economics movement and served to provide a more detailed analysis of the substantive concerns underlying insurance transactions. This analysis should prove helpful when determining what types of transactions involving risks may necessitate the expertise of state insurance regulators. It should also help to provide a more accurate depiction of innovative financial products that involve risk regarding the concerns society should have about those products. Finally, it should help to paint a more accurate picture as to the appropriate legal treatment of those products. With this new level of understanding of insurance WUDQVDFWLRQV IUHVK LQ WKH UHDGHU¶V PLQG LW LV WLPH WR WXUQ to the question that this article originally sought out to answer: Should longevity insurance be treated like insurance?

V. Longevity Insurance Should Not Be T reated Like Insurance

A. Longevity Insurance: A Comparative Analysis of a Hypothetical Alternative Arrangement to Current Market Options

In Part II there was a brief description of the theoretical proposals for longevity insurance, as well as some examples of real world products which serve similar purposes. All of the discussion involved products either designed for, or sold by, insurance companies. Dr. Milevsky approached an insurance company with his ALDA proposal.119 Longevity insurance has been marketed by three big life insurance companies.120 This makes intuitive sense from a pragmatic point of view. After all, insurance companies are used to dealing with transactions that involve risk. Yet is it possible that this type of activity could be conducted outside the confines of the insurance context? For instance, imagine that 100 people decided to get together and purchase a specified amount of 100 year bonds from Disney, with the non-transferrable right to recover a bond contingent upon

119 Part II(a). 120 Part II(b). 19

UHDFKLQJRQH¶Vth birthday.121 Would society benefit by forcing these 100 people to seek the approval of state insurance regulators? Some may contend that the way to answer this question is to look towards the mechanics of the transaction. This would be unfortunate for the 100 people (assuming that they want to avoid state insurance regulation), because the mechanics look very much like traditional types of insurance policies. This is so because the transaction engaged in by the 100 people is a means by which they can transfer and spread the financial risk associated with living past the age of 85. This LVD³SXUH´ type of risk; the 100 people are not seeking to obtain the upside of a speculative investment, but rather are seeking a pre-determined amount (a 100 year bond) to cover the costs of living past the age of 85. The risk is of sole importance in regards to entering into the transaction.122 That being said, should this type of analysis be controlling? Admittedly this analysis tells us much about what the transaction looks like, and even about what the transaction does. However, this type of inquiry does not by itself answer the ultimate question of whether and what types of concerns society should have regarding this transaction. It could be that the form and purpose serve as proxies for determining whether and what types of concerns society should have. Courts, legislatures, and regulators have their hands full in WKHLU GXWLHV DV VRFLHW\¶V UHIHUHHV  ,W LV XQGHUVWDQGDEOH WKDW WKHy want to use proxies as remotely abstracted as possible in order to expeditiously handle the vast amount of social interactions they are responsible for supervising. Yet those proxies should not be allowed to control where their application is inappropriate. Otherwise, the risk of allowing rules designed for transactions with similar forms and purposes to control transactions with substantively different economic concerns may actualize. Could that be what has happened in the case of longevity insurance? In other words, when determining what type of legal treatment should apply to individual transactions, the form may be useful in helping to think of what types of concerns may arise in transactions with similar forms. Yet, that should not conclude the analysis. At most, the analysis of the form should serve as a useful way-station to the endpoint of understanding what types of concerns society should have regarding that transaction. By failing to carry the analysis beyond the form of the transaction, the danger of allowing the form to control the substance becomes a reality.

121 This hypothetical was originally proposed by Dino Falaschetti Ph. D, MBA, CPA. 122 This is an application of the tests utilized by courts to determine whether transactions should be classified as insurance as described in Part III. 20

One can see an example of where form may have been allowed to control substance by looking at the comparison of the real world marketing of longevity insurance as opposed to Dr. MilHYVN\¶V $/'$  5HFDOO IURP WKH GLVFXVVLRQ DERYH WKDW 'U Milevsky viewed the long-term premium payment plan beginning at a relatively young age (such as 35) as being crucial to the $/'$¶V YLDELOLW\ IRU middle class people who typically do not invest in annuities.123 Yet, the longevity insurance plans offered on the market are currently targeted at people who are retiring.124 Remember also that it has been hypothesized that the ³SRWHQWLDO public backlash against an annuity contract under which the owner could pay premiums for many years but receive nothing in return if he or she dies before the advanced age specified in the contract,´ PD\KDYHFDXVHGWKLVGHYLDWLRQEHWZHHQ'U0LOHYVN\¶Vtheoretical ALDA and longevity insurance products introduced into the marketplace.125 Accordingly, it may be that state insurance regulation may ultimately be stifling longevity insurance from reaching its theoretical potential to serve as a viable income security tool for people in the middle class who are attempting to plan for their retirement early in their lives. One way to understand this may be to think of the process for determining the legal treatment of financial products like a FKLOGUHQ¶VVKDSH-matching block toy. To expand this metaphor to the current situation, imagine that the edges of shape holes are sharp. The sharp edges are a necessary accommodation for the shape-matching block toy as a metaphor for the process of regulatory classification, because there are only a finite amount of shapes, and various blocks of multiple shapes must be pushed through. It is the sharp edges which allow shapes without a matching hole to be fit into a hole designed for a different shape. Next, imagine that longevity insurance is rectangle. There are three holes to choose from; one is a triangle, one is a circle, and one is a square. A superficial form-based review indicates to the state insurance regulator that the square will be the closest fit for the longevity insurance rectangle. The problem is that while the square hole is not designed for a rectangle, the rectangle must go somewhere. Accordingly, the rectangle is forced through the square hole, and in the process the sharp edges cause part of the rectangle to be cut off; the parts that do not properly fit into the square hole are left as severed shavings helplessly cluttering the ground around the toy. The severed shavings are the aspects of longevity insurance that do not properly align with current perceptions of what insurance products with similar forms that

123 Part II(A). Milevsky, supra note 9 at 112-113. 124 Part II(B). 125 Cooner, supra note 8. 21 serve similar purposes should look like. In order to make it onto the market the rectangle had to go through one of the holes. In so doing, the rectangle had to shed whatever aspects it contained which did not properly conform to the available holes. This could explain why longevity insurance has not reached its full potential as envisioned by Dr. Milevsky. What follows will be an attempt to provide a different type of analysis by looking underneath of the form of the longevity insurance transaction. The tools employed in this analysis will be the previously discussed concepts from the Law and Economics movement. These concepts will be looked at as they relate to longevity insurance by conducting a comparative analysis of how they relate to traditional insurance policies. This analysis is advanced with the hopes of providing a better means for XQGHUVWDQGLQJZKDWZRXOGEHWKHEHVW³ILW´IRUWKHOHJDOWUHDWPHQW of longevity insurance. In so doing, it is also likely that this process could be later extended to other types of financial innovations.

B. Looking Beyond the Form of the Longevity Insurance Transaction: A Comparative Analysis

1. Transaction Costs

Recall from the discussion in Part IV that transaction costs include negotiating and enforcing agreements.126 Negotiating and enforcing insurance contracts involves a transfer of information between the insurer and the insured. Insurance companies require their clients to provide pertinent information concerning the insured risk through a variety of means. The insured will want to know pertinent information concerning the scope of the risk covered by the insurance contract. Accordingly, in order to create and enforce an insurance contract, there must be an exchange of this information. One significant example of this exchange includes insurance policy coverage forms. In light of the centrality of the information exchange in regards to the overall insurance transaction, one would expect that insurance regulators have a heavy hand in this process. This assumption would be correct.127

126 Part IV(A)(1). 127 See, e.g., Interstate Insurance Product Regulation Commission, Individual Life Insurance Application Standards, available at http://www.insurancecompact.org/rulemaking_records/090212_ind_life_applica tion.pdf (last accessed March 13, 2010) (articulating standards for individual life insurance regulation application forms). 22

This type of regulation makes sense in complex insurance transactions. In such situations, the insured may fail to ask the right questions and therefore enter into such agreements with false assumptions regarding the actual scope of coverage. There is a multitude of a ways that homes or cars can become damaged, only VRPHRIZKLFKZLOOEHFRYHUHGE\DKRPHRZQHU¶VSROLF\. There are many different ways to die, only some of which are covered by life insurance. The same does not hold true for longevity insurance. The longevity insurance transaction is relatively simple and straightforward when compared to traditional insurance policies. The only real necessary exchange of information would be some simple facts, such as: 1) the current age of the would-be insured; 2) the genealogy of the insured; 3) the current health status of the insured; and 4) the scope of coverage. The current age of the would-be insured could be readily verified through the presentation of a birth certificate. This would not necessitate the expertise of the state insurance regulators; birth certificates are already issued by state authorities such as the Department of Health. To the extent we are worried about the insured falsifying such documents there are already numerous laws against altering government documents. This type of fraud is likely to be best handled by the criminal justice system. The insurer may want to know the genealogy of the would- be insured. It would certainly be helpful to know if everyone in the would-EHLQVXUHG¶V IDPLO\KDVOLYHGWR WKH DJHRI 7KDW being said, there are already numerous genealogy companies in operation which could readily provide such information for a fee. Thus, it is unlikely that the need to exchange this type of information would require the expertise of state insurance regulators. The current health status of the insured could be readily ascertained through requiring the insured to have a physical performed. While this type of information exchange may trigger significant problems in other contexts,128 these problems are unlikely to arise in the context of longevity insurance. Specifically, these problems relate primarily to the issue of adverse selection which is not likely to be a significant problem in the context of longevity insurance. This will be further discussed in Part V(B)(4). The scope of coverage would also be incredibly straightforward. There will be a requirement for the insured to make payments of a specified amount, and in return the insured would get the right to whatever form of compensation was agreed

128 See Akerloff, supra note 86 (discussing the difficulty in obtaining accurate medical information in the health insurance context). 23 upon on the specified birthday of the insured. This is not a KRPHRZQHU¶V policy where wind damage is covered but water damage is not. This is not a life insurance policy where certain types of deaths are covered and others are not. With longevity insurance, either you are alive and kicking on your specified birthday or you are not. It does not seem that the expertise of state insurance regulators would be required to make sure that a fair agreement is occurring between the insured and the insurer as to which birthday is specified. It would hardly seem like a legitimate requirement that the forms display a disclaimer such as ³%,57+'$<6-84 ARE 127&29(5('%<7+,632/,&<´ One would think that the general public would be able to readily XQGHUVWDQG WKDW D SROLF\ WKDW SD\V RXW XSRQ UHDFKLQJ RQH¶V th birthday would pay out upon reaching that birthday and not upon reaching earlier birthdays. In sum, while transaction costs inherent in the necessary exchange of information may point towards the necessity of the expertise of state insurance regulators in traditional insurance policies, the need for such oversight in the context of longevity insurance is simply not present. The scope of coverage would be so incredibly straightforward that there would be little need for state insurance regulators to police the content and conveyance of such information between the insured and the insurer.

2. There Should Not be Disputes as to Whether the Risk Occurred

The problem of whether the risk actually occurred relates back to the issue of the information exchange between the insurer and the insured as it relates to the scope of coverage. It also exists in situations where the scope of coverage may be clear, but the causation of the claim asserted by the insured is not.129 This is the situation that was present in the wake of Hurricane Katrina where the courtrooms were flooded with debates as to whether wind or water caused the damage asserted in the claim.130 Longevity insurance does not present the types of problems that traditional types of insurance do in this regard. The insured either has reached the specified birthday as determined by the already-issued government birth-certificate, or they have not. True, there may be instances of fraud, but as previously stated this type of criminal activity is likely better handled by already existing criminal laws. Additionally, fraud would almost certainly constitute a ground for the insurer to seek a remedy through

129 See discussion supra Part IV(B)(3). 130 Id. 24 contract law, and the insurer would have both significant interest and resources in pursuing this remedy. This is simply not like the adversarial situation where both wind and water were involved in the damage and both parties are arguing that one and not the other was responsible for causation. The straightforward nature of the triggering event in longevity insurance would make it so that any disputes in this regard would be de minimis. Furthermore, they would also be more appropriately handled through other channels than state insurance regulation, such as criminal or contract law.

3. Moral Hazard: Longevity Insurance¶V Incentive to Live Longer

As discussed earlier, moral hazard rears its ugly head in traditional insurance policies in socially harmful ways.131 A prominent example of this is the increase in fatalities that follows mandatory auto insurance laws.132 It makes sense then that insurance policy coverage is the type of thing that society would want to keep a close eye on to the extent that is has the potential to increase socially harmful actions on the part of the insured. This logic does not extend to longevity insurance. Unlike auto insurance which causes the insured to be less careful in regards to the insured item, longevity insurance should have the effect of making the insured want to live longer. While moral hazard is typically a cause for concern, it is only a concern because in those situations the insurance is serving to encourage socially harmful actions. Unless we are willing to state that it is socially harmful to encourage people to live longer,133 then the potential moral hazard effects on the insured should not be a cause for concern. That being said, insurance has an effect on more than just the individual insured. For instance, one can watch a multitude of cable television shows discussing murder investigations and observe the effects of the incentive to murder that exists in many traditional life insurance policies. The incentive actually cuts the exact opposite way in longevity insurance policies which would RQO\SD\RXWXSRQWKHLQVXUHG¶VFRQWLQXLQJWROLYHUDWKHUWKDQWKH LQVXUHG¶VGHDWK.134

131 Part IV(B)(1). 132 Cohen, supra note 102. 133 The author does not doubt that there are utilitarian arguments supporting this notion. However, that dispute is best left for other intellectual battlefields. 134 For an interesting and brief discussion of the disparity between traditional life insurance policies and longevity insurance type situations, see Martin F. Grace, Anti-Life Insurance, blog posting date June 3, 2009, available at: http://riskprof.typepad.com/tort/2009/06/anti-life-insurance.html (discussing 25

4. Adverse Selection

The problem of adverse selection was previously discussed in the context of health insurance policies where the insured is able to conceal certain health issues from the insured.135 This problem is magnified in that context because of the difficulty in obtaining fully accurate information concerning the health of the insured.136 The problem of adverse selection in health insurance is a good example of the problem of adverse selection more generally in insurance. This is because the nature of the risk requires certain information that is easily possessed by the insured and difficult to acquire by the insurer.137 This is a manifestation of the classic problem of information asymmetry.138 Information asymmetries can only exist where one side can have more information than the other. With the example of health insurance discussed above, it makes sense that the insured has information regarding their present health status that the insurer cannot easily obtain. Contrarily, in longevity insurance the presence of information asymmetry between the insured and the insurer does not seem to make much intuitive sense. How many people are able to accurately predict the day of their death? Should an individual have such predictive capabilities, it would seem that such abilities would likely be employed to obtain wealth in other contexts where speculation could yield higher rewards. Another interesting aspect of adverse selection in this context is the disparity in the age of purchase of longevity LQVXUDQFHEHWZHHQ'U0LOHYVN\¶Vtheoretical ALDA and the real world products. While it is likely incredibly difficult, if not outright impossible, to predict the age that one will die, it would SUREDEO\JURZVOLJKWO\HDVLHUDVRQH¶VDJe progresses. This makes sense, because the older one becomes, the closer to death one inches. Someone who is completely healthy at the age of 65 has an information advantage in this regard in comparison to someone who is completely healthy at the age of 40. To this end, the current longevity insurance products being sold in the market place

KRZ0U0DWWKHZV¶VJDPEOHZDVDFWXDOO\DW\SHRI³WUXHOLIHLQVXUDQFH´ZLWK WUDGLWLRQDOOLIHLQVXUDQFHDFWXDOO\EHLQJ³GHDWKLQVXUDQFH´  ODVWDFFHVVHG0DUFK 25, 2010). While there may then be an incentive for the longevity insurers to kill their insured before their specified trigger birthday, this concern is likely best dealt with through traditional law enforcement mechanisms; state insurance regulators likely have little expertise in regards to preventing and investigating homicides that police departments do not have. 135 Part IV(B)(2). 136 Akerloff, supra note 86. 137 Id. 138 Id. 26 actually represent a greater concern regarding adverse selection than Dr. 0LOHYVN\¶V theoretical ALDA which would have been purchased as early as age 35.

5. Solvency Concerns

In order for the insurer to be able to carry out its end of the transaction it must be able to pay should the triggering event occur. This issue exists in any contractual situation where one party promises to pay another party. In the context of insurance this issue is known as solvency.139 Should the mere fact that longevity transactions involve both risk and solvency concerns be sufficient to mandate state insurance regulation? In answering this inquiry it may be helpful to look at excess and surplus lines insurance. Excess and surplus lines insurers are SURYLGHUV ZKR ZLOO FRYHU ULVNV WKDW WKH ³VWDQGDUG´ LQVXUDQFH market does not cover.140 They enjoy less regulation than traditional insurance providers in that they are not subject to rate and form regulations.141 However, states still require them to meet certain capital requirements.142 The reader might wonder at this point why people looking to either provide longevity insurance or to enter into agreements such as the 100 people purchasing 100 year bonds would not simply try to go the route of excess and surplus lines insurance. Unfortunately, this option would likely be foreclosed by state insurance regulators because excess and surplus lines insurers ³cannot write insurance that is typically available in the admitted market´DQG³may only write a policy if it has been rejected by 3 different admitted carriers´143 Due to the current longevity insurance products existing in the marketplace previously described it is incredibly unlikely that an excess and surplus lines insurer would be able to provide this product. The above point does not represent an end to the utility of the discussion of excess and surplus lines insurance as it relates to longevity insurance. It is important to note that up to this point, the only substantive concern that longevity insurance shares with traditional insurance policies is the solvency aspect. The discussion of excess and surplus lines insurance is important because it shows that not all types of insurance policies need the

139 See discussion supra part IV(B)(4). 140 American Association of Managing General Agents, An Introduction to the Background and Strength of the Excess & Surplus Lines Insurance Marketplace at 2 [hereinafter AAMGA, An Introduction]. 141 Id. at 11. 142 Id. at 13. 143 American Association of Managing General Agents, FAQs, AAMGA.org, available at: http://www.aamga.org/faqs (last visited March 25, 2010). 27 full oversight of state insurance regulators to function. Excess and surplus lines insurance is responsible for a considerable amount of insurance coverage available in the marketplace. For instance, at the time of this writing, members of the American Association of Managing General Agents (AAMGA) provide $23.9 billion worth of coverage.144 This means that it is possible for insurance coverage to be provided by carriers who are solvent without being subjected to the fully battery of state insurance regulator oversight.

C. Summary: A New Perspective on Longevity Insurance

The discussion from Section B was geared towards providing a more comprehensive understanding of longevity insurance that extends beyond the mere form and purpose of the transaction. The purpose was to show that while the form of longevity insurance may appear to be quite similar to traditional insurance policies, the substance of longevity insurance is different in almost every significant way. It is admitted that longevity insurance is essentially a means by which one can transfer and spread the pure risk of insurance and that the risk-aspect of the transaction is the sole purpose of engaging in the arrangement. However, looking beneath these superficial considerations revealed a much different perspective on the comparison between longevity insurance and traditional insurance. Longevity insurance is a relatively straightforward transaction with very little information that needs to be exchanged. There would likely be de minimis concerns regarding whether the alleged triggering event actually occurred, and to the extent that there is a potential for discrepancies in this regard, there are more effective mechanisms already established by basic principles of criminal and contract law that would work to deal with these problems. The moral hazard effect is not socially harmful. The possibility of adverse selection is minimal, and to the extent that it is possible, the current market place as governed by the oversight of state insurance regulators actually increases the possibility in comparison to the theoretical ALDA proposed by Dr. Milevsky. Finally, the one similar economic concern between longevity insurance and traditional insurance policies is solvency, and as evidenced by the excess and surplus lines insurance market, the full oversight of state insurance regulators is not necessary to ensure that this concern is adequately dealt with.

144 AAMGA, An Introduction at 17. 28

V I. Conclusion

This paper began by discussing a FDQFHUSDWLHQW¶VJDPEOH that he would outlive his prognosis. It then proceeded to discuss annuity products currently provided that essentially allow people to make this same gamble through life insurance providers. These products are referred to as longevity insurance. Yet, despite the name provided it is important to dig deeper and really ask the most basic question regarding this product: should longevity insurance be treated like insurance? When choosing the legal treatment for longevity insurance it would make sense to look at its substantive concerns rather than its superficial form. By looking solely to the superficial form, society runs the risk that the form will control the substance. This may have happened with the current array of longevity insurance products on the market. Important components of the theoretical product may be left lying on the floor should they not be able to fit the shape of traditional insurance transactions that happen to have similar forms and purposes. It is these important components that society loses out on when innovative products such as longevity insurance are shoved into holes where they simply do not fit.

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