Daniel Indiviglio writes that Wall Street is designing a new derivative that would allow purchasers to hedge against longevity risk (or speculate on it) in his article entitled “Death Derivatives: Has Wall Street Finally Gone Too Far?” in the Atlantic.
As the title indicates, some of the article is devoted to whether the public might view “death derivatives” as obscene, but Indiviglio dismisses such concerns, concluding that such hedges could serve a valid business purpose and there are plenty of businesses that “profit from death” anyway (e.g., the funeral business).
Pension funds, for example, might sell such derivatives to hedge against potential unfunded liabilities that would occur if pensioners lived long enough to draw more funds than were available to pay out. In that case, the purchasers would end up funding the payouts (or at least part of them) with their premium payments.
Indiviglio also imagines that the pharmaceutical industry, for example, might have “sort of” an “insurable interest” in such a hedge ? as a purchaser. His logic goes like this: drugs generally prolong life. If a company’s drug is not successful ? does not work, does not get FDA approved, etc. ? the longevity of a random population sample should not increase. That makes a lot of unsubstantiated assumptions about a causal relationship between the success of a particular drug or even a while pharmaceutical company and longevity of a population.
Indiviglio also speculates that insider trading in death derivatives may arise from, for example, inside information about the success or failure of a drug. Again, that inside information would probably be tightly correlated with the stock of the company whose drug succeeds or fails, but would have only a loopy connection at best with the longevity of a random population sample.
Moral considerations (whether valid or not) will “not stop Wall Street and investors from trying to make these securities work. If there is a market for death derivatives and they can find mechanisms that create a robust, liquid market, then it could thrive,” writes Indiviglio.
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