As unusual as this investment is, it can be priced relatively easily: figure out life expectancy and payments, take present values, and voila, you have a price.
To the purchaser, the contract is essentially a bet that that the insured will die earlier than expected. If the person lives longer, then not only does the buyer have to make more payments, but the present value of the payoff is reduced. So at best such a contract makes one party wish for fewer birthday parties.
To the seller, it is a way to get some money upfront prior to death.
Life Partners is the largest player in this market and the Wall Street Journal has done an investigation and (not surprisingly) reports that people are living longer than Life Partners is forecasting. The WSJ article:
Odds Skew Against Investors in Bets on Strangers' Lives - WSJ.com:
"Life Partners, a fast-growing company in Waco, Texas, has made large fees from its life-insurance transactions while often significantly underestimating the life expectancies of people whose policies its customers invest in, a Wall Street Journal investigation found.....
According to the WSJ a startling 81% of the people investigated are living longer than expected. While this is great news for the people who sold the contract (they are alive), it is not good news for the buyers. For instance:
" Jacqueline Keller of Colorado Springs, Colo., said she is still paying premiums on pieces of two policies she bought in 1996 on AIDS patients. She said she had invested, in part, thinking this would help the original owners in their final months, but now, "every time I get a bill in the mail, I get ticked off."
Pretty interesting stuff. Now the cause of this health elixir is unknown. Is it overly optimistic (i.e. pessimistic) forecasts by the Life Partners, a lack of diligence by the buyers of teh contracts 9maybe a behaivoral story here as well), or wather knowing people are betting your death makes the person work oin health more) is unclear.r
Fascinating on many levels. For instance, consider the potentiallymessed up incentives are also worth mentioning (imagine for a second you find out that your doctor just bought a one of these on you!), the significant information asymmetry problems that arise (the seller will say in poor health to get more money), and the potential of changed behaviors brought about by knowing someone is betting you die(I am going to live longer than expected just to show those betting against me).
Interesting stuff! BTW this article was pointed out to me by RJ, who just successfully finished my Behavioral Finance class.