We’re All Gonna Die, Might As Well Make Some Money Off It

Imagine that you, your spouse, or a beloved relative is terminally ill. A man approaches you and asks whether your family would be interested in a little proposition. Your relative would need to provide their name, Social Security number, and a signature or two. In return, they would receive a few thousand dollars. Sounds like an identity theft scheme, doesn’t it? Only it was all perfectly legal. No families were swindled, no fake credit cards were opened. The lawyer behind this scheme was taking advantage of a loophole in the rules of a specific type of life insurance product, variable annuities. Investors used a system intended to protect a large nest egg for future generations to profit without having to die.

You can learn about this scheme and the loophole savant who invented it, Joe Caramadre, over at ProPublica. (“This American Life” told most of the story on public radio this weekend, if you’d like it in a form you can listen to while commuting.)

In normal life insurance, you pay a relatively small premiums either for the rest of your life (whole life insurance) or a fixed period of time (term life insurance.) This scheme took advantage of the flaws in a product that debuted a few decades ago, variable annuities. For these, a person hands over a certain amount of money to an insurance company, and that company extracts fees and invests it for them in a variety of places (government bonds, mutual funds, etc.) If the investment increases in value, the profit belongs to the investor. Well, to his or her heirs. If the investment’s value falls, the investor’s heirs are guaranteed to receive back at least the same amount that was invested in the first place. That’s called the “death benefit.” The system is designed for the investor and the annuitant to be the same person. Insurance companies didn’t anticipate that someone would invest in a variable annuity and seek out a dying stranger to serve as the annuitant.

There are three parties involved in a variable annuity: the investor, the person who puts up the money. There’s the beneficiary, the person who will receive the money at the end of the scheme. Then there’s the annuitant or the “measuring life,” the person whose death will end the investment.

The combination of the short timeframe and guaranteed death benefit meant that investors could choose the most aggressive investments available.

The insurance companies were not pleased with this scheme, but it wasn’t illegal. Is it unethical? Everyone seems to have a different opinion on that. Caramadre’s scheme appalls people because of its sheer size and lack of subtlety. He distributed flyers. He advertised in local Catholic newspapers.

Death Takes a Policy: How a Lawyer Exploited the Fine Print and Found Himself Facing Federal Charges [ProPublica]
Loopholes [This American Life]