Is this subprime redux?

Thursday, Sept. 10, 2009 | 2:07 a.m.

Many Wall Street investment banks are on the verge of taking the plunge into another scheme that involves bundling and reselling what are thought to be sure-thing assets, just as bundled subprime mortgages were thought to be sure things.

The banks are planning to buy life insurance policies from senior citizens and make money by selling them to investors, who would cash in if the seniors soon died.

It would work, morbidly, like this: A senior citizen would be persuaded to sell his life insurance policy for instant cash. If the policy is for $500,000, the bank would pay, say, $250,000.

The bank would then take over the premiums, become the beneficiary and find an investor for that policy. If the senior citizen were to die two years later, the bank and investor would share a profit of $125,000 for each of those two years, minus the premiums paid.

Such “life settlements” have been around for decades but on a rather insignificant scale. Now the big banks, trying to recover from their subprime fiasco, are in serious talks about buying life settlements in massive quantity, bundling them into securities and selling them to national and international investors.

There are many financial risks, however, as pointed out in a story in Sunday’s edition of The New York Times. The most obvious is that of senior citizens living past their bank-calculated life expectancies. In those cases the yearly return for investors would be greatly diminished and years of extra premium payments would subtract from any profit. Losses could be incurred.

With the advent of new medicines and surgical techniques, life expectancy is increasing. Imagine what would happen to an economy shored up by bundled life settlements if new drugs or procedures allowed cancer and heart patients — who sold off their life insurance to pay for treatment — to live years longer than they are today.

Our view is that the Securities and Exchange Commission should ensure there are safeguards in this type of trading before it takes off and leads to another meltdown.