Sunday, January 25, 2004

Dead Peasants

You know, something's been confusing me. We've had these stories about how companies have been taking out "dead peasant" life insurance policies on their workers and make money on their deaths. Now we have this story out of Texas where the state is proposing to take out such life insurance policies on retired teachers. This Does Not Make Any Sense. Somebody doesn't understand how insurance works.

Any life insurance policy should be actuarially fair - that is, the expected discounted value of the payout should be equal to the expected discounted lifetime premium payments. So, if you die the day after you take out the policy you'll be ahead of the game. If you live until you're 110 you'll probably have wasted your money. Life insurance isn't a get quick rich scheme for the estate, it's simply a way to remove individual risk by combining it with a large number of other policies making it, from the perspective of the company, a riskless endeavor - barring a plague or something.

The reason to have "dead peasant" insurance policies is because from the point of view of a business, if your workers die prematurely it's costly to replace them and train new workers. (update: as Wingnut correctly reminds us in comments, favorable tax treatment can also be a reason.)

However, I can't think of any reason why an actuarially fair insurance policy written for a pool of retired teachers would have any financial benefit for the state. Somebody's getting scammed. And who's doing the scamming?

Former U.S. Sen. Phil Gramm, now an executive at UBS Investment Bank of New York, is promoting the proposal. State officials stressed that they are only considering the idea. But they pointed out that the plan could raise millions of dollars for the financially strapped Texas Teacher Retirement System, one of the largest public pensions in the nation, while the state would assume little risk.