The Grim Reaper Charges 2 and 20

September 24, 2007 |

Cliché alert!  The only certain things in life are death and taxes.  I have to disagree to some extent with the taxes part until we get a verdict on how my carried interest is getting taxed.  The death part on the other hand seems more certain these days within the hedge fund ranks.  Without naming names, it seems the mortality rate amongst hedge fund managers has been on the rise lately.  Possibly correlated with the fact that there are simply more hedge fund managers, but also certainly due to other factors. 

Now in a couple of high profile cases, death was the result of participation in recreational activities (e.g., snowmobiling, motorcycle riding, etc.).  In these instances, it’s hard to fault the deceased for having fun and living life to its fullest. 

Heart attacks, on the other hand, should make us step back and wonder if maybe our managers are too serious, too stressed, and not taking the best care of themselves.  Now don’t get me wrong, I want my managers focused, but I also want them to live long, happy, and healthy lives.  Please folks, make time for friends, family, exercise, and recreation and eat a more healthy diet.

Since we’re on the topic of death, let’s talk mortality trades.  That’s right, long and short mortality.  How is this accomplished?  Life insurance related investment strategies.  There are a number of ways to play this trade. 

Long mortality (i.e., your return is greater the shorter the life span of the insured): here investors can buy another person’s life insurance policy in the open market, pay the premiums, and collect the benefit when the insured dies.  The policy will generally trade on a discounted basis with the primary factor being the expected life of the insured.  With that said, the shorter the life span, the quicker the pay off and the greater the return. 

Another related long mortality strategy is to make a loan to an insured at a high rate (often 10%+ per annum) with the loan collateralized by the life insurance policy.  Here you have a couple of paths: 1) the borrower makes their payments and you receive the interest; 2) The borrower defaults, you now own the policy and sell it in the open market, hopefully at a premium to the outstanding loan value; or 3) the borrower defaults, you now own the policy, and you hold the policy (and pay the premiums) awaiting the insured’s death for your payoff.

Short mortality trades, on the other hand, bet on the life extension of the insured or group of insured’s.  A typical strategy here is selling extreme mortality protection.  This strategy is basically re-insurance or taking some of the risk off of the books of the life insurers.  Here, you are collecting a nice annual premium from the insurers (generally 10 %+), but are at risk if mortality in a certain pool exceeds set parameters.  A large amount of deaths from natural disasters or disease outbreaks are really your risk here.  These trades are generally private and bespoke allowing the investor to structure the pool of insured’s’ and the triggers. 

A much more feel good strategy as you’re cheering for life, right?

Seems like some pretty sick and twisted shit, eh?  Well, it’s out there and it’s a multi billion dollar segment of the investment universe where a lot of reputable hedge funds are playing and the insured are willingly selling their policies or borrowing against them (this is a far cry from the sleazy viatical game that occurred years ago).  Most related strategies are on the lower end of the liquidity spectrum, but the non-correlated nature of the trade, along with healthy (pardon the pun) returns, makes the opportunity set attractive.
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