What is a Death Bond?
A death bond is a bond backed by life insurance policies.
How Does a Death Bond Work?
Let's say Company XYZ is a life-settlement provider. A life-settlement provider purchases whole and universal life insurance policies from people who no longer need or want the coverage but want to recoup their investments in the policies. The sellers receive cash to use as they wish; the buyer begins making the premium payments on the seller's behalf. In this way, Company XYZ essentially has a policy on the life of the seller.
When the seller dies, Company XYZ receives the death benefits from the insurance policy. Company XYZ purchases many of these insurance policies and eventually has a large portfolio of them. Because the people covered by the policies will die at different times, Company XYZ will have a stream of cash flows (from the death benefits) coming to it over time. Additionally, the cash flows are not correlated to what is happening elsewhere in the markets.
Company XYZ can securitize this stream of cash flows by pooling the policies and issuing bonds to investors. The investors give Company XYZ cash for the bonds (which Company XYZ uses for business operations and to buy more policies), and Company XYZ gives the investors coupon payments over a period of time. These investments are called death bonds.
Why Does a Death Bond Matter?
Death bonds are macabre investments that are also very novel and controversial. On one hand, the insurance holders can receive much-needed cash to fund retirement or pay medical expenses while they are still alive. On the other hand, one of the many controversial aspects of death bonds is that the sooner the insured dies, the higher the returns are for the investors (after all, Company XYZ does not have to keep paying the insurance premiums for the person). From a financial perspective, there is certainty that payments will come -- after all, everybody eventually dies. The risk, therefore, is that Company XYZ will not pass through the payments as promised or that the insurer will withhold the death benefit.