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Should Longevity Insurance Be Treated Like Insurance? by Will Should Longevity Insurance 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 life expectancy 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-Life Insurance, 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
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