When the earnest scoldy public-interest journalists at ProPublica take it upon themselves to defend a financial scam artist who tricked terminally ill people into signing documents that they didn’t understand,* you have to figure there’s a pretty good story behind it. Oh God is there. I challenge you to find a better story about mispriced derivatives in the last week of August than ProPublica’s story this weekend about Joseph Caramadre.

The scam – and I say that with some affection – is this: life insurers offered products (call them variable annuities or death-put bonds, but you can abstract them to just one-period investments) that allowed you to invest your money in stuff and then, when a “reference life” or “annuitant” – a person, normally but not necessarily you – died, you got back the greater of (1) your original investment (plus interest sometimes!) and (2) the value of the stuff. So if the stuff went up, you profited; if it went down, you broke even (or did a little better). In exchange for this guarantee you paid a tiny fee every month, and I guess actuarially those fees were supposed to add up to the fair price of the put that the insurer was selling you.

But the trick comes when you decide, as amazingly you can, to make the annuitant not you but rather someone you found in an AIDS hospice and then bamboozled into signing up for the scheme by giving him a $2,000 payment that you told him was a charitable donation so he didn’t have to report it to the IRS. Then you end up paying almost nothing – well, $2,000 and change – for that put that the insurer is selling you, meaning that you get it for way under its fair value. And if you have a free put, you might as well combine it with the most volatile thing you can find. And our guy did. Actually he did a little better than that:

With decent gains locked in, he would take flyers on the riskiest investments possible. Sometimes, he would invest his clients’ money in two variable annuities, one that paid out if the market went up and the other if it declined. It didn’t matter. When the annuitant died, Caramadre’s client, at the very least, would get both principals back plus the gains from whichever fund paid out.

AAHAAHAAH THAT IS AMAZING. I think I love this guy even more than ProPublica obviously does. I mean, not the scamming dying people. But the scamming insurance companies! It’s so … efficient.

Anyway, the story goes on: the insurers figured it out, they sued him repeatedly, they lost every time because this was obviously allowed by their documents, they revised their products, and ultimately the FBI decided this was pretty shitty – to the dying annuitants, they say, though you might cynically read it as “to the insurers” – and so they’re accusing the guy of criminal fraud, basically because he tricked these dying reference-life people into signing the documents.

Which, yeah, if the prosecution is even half-right, he wasn’t exactly nice to those people, though be careful about exactly how they were harmed – they got $2,000 for signing a piece of paper, and it’s not like that signature lost them or their survivors any other benefits. Forging a variable-annuity signature isn’t like forging, say, a mortgage signature: no one owed any money or damaged their credit or anything by signing these documents. They just felt confused and exploited, which certainly isn’t nothing.

But the insurance companies! What dopes! The hard-to-grasp thing about the “fraud” here is that, while the insurers were maybe misled, they weren’t misled about anything that would be relevant to their decision about how to price their product. It’s stuff like this:

It was part of the scheme to defraud that CARAMADRE and RADHAKRISHNAN fraudulently represented to Insurance Companies that the terminally-ill persons named as annuitants knowingly and intentionally agreed to do so by submitting applications which contained signatures obtained by fraud and the identity information of terminally ill individuals, without their knowledge or consent.

And you might reasonably ask: so? If they’d consented, they’d be just as dead as if they hadn’t; nobody lost money because the annuitants didn’t knowingly and intentionally agree to be annuitants. They lost money because those people died. And because they did nothing to protect themselves from that risk – as ProPublica points out, “[f]or policies under a million dollars, they didn’t check the health status of people receiving variable annuities.”

But why would they? People just don’t do this kind of thing: you can’t, if you’re a regular human, go up to a dying person and say “hey, would you like your death to do some good, specifically in the form of making me a lot of money?” Instead they take out annuities referencing their own life or that of their spouse, and if they mostly do that then actuarial models should mostly work. The insurance companies clearly used this tendency in their pricing – they asked Caramadre how he knew the annuitants, even though no insurable interest was required in the annuitant, and were willing to accept the answer “acquaintance.” Because what were the odds you’d ask this even of an acquaintance?

That’s how retail financial services work: you make money because your clients often do not what has the highest expected value but what seems right. So debt collectors can convince people to pay off debts that they’re no longer legally obligated to pay, and mortgage banks can expect at least some people to keep paying underwater non-recourse mortgages – just because they think it’s the right thing to do. And nobody goes around choosing the sickest person they know to be a co-annuitant, because for most people no amount of money is worth having that conversation with a dying acquaintance.

In the, um, wholesale, financial world, not so much: no company pays a non-recourse debt on a valueless asset. And buying insurance on something you think is going to die – well, at least figuratively, that is kind of a thing. The financial firms got screwed here, basically, because they expected their clients to behave like humans, but instead attracted clients who behaved like financial firms. Which makes it hard to feel too bad for them.

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

* Allegedly! But. I dunno, read the complaint, or even the end of the ProPublica piece, it doesn’t look great for him.

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Comments (35)

  1. Posted by anonhfm | August 28, 2012 at 12:16 PM

    Seems to me that his scheme would fall afoul of the "insurable interest" restriction (you can only buy life insurance on a life in which you have an "insurable interest"), though I think that would be a civil issue between the insurance company and the beneficiary. There are limits on rescission after two years have elapsed, so perhaps that is how this guy still got paid. Maybe the criminal fraud is lying about the relationship in order to falsely establish "insurable interest"?

  2. Posted by 25thHourTrader | August 28, 2012 at 12:22 PM

    I'll throw in my own USD $0.02 – I agree w/ Matt that this guy did nothing wrong and he's only being prosecuted b/c the way he made money upset some people. This is no different than the MF market timing "scandal" a few years ago where no laws where broken yet the people that did this were attacked for doing nothing more than exploiting one of the last remaining arb opps.

    -Trader who promises to find something funnier to say in a future comment that involves Bigfoot and/or Barclays

  3. Posted by Sean | August 28, 2012 at 12:30 PM

    [youtube 6szE_qmzavQ http://www.youtube.com/watch?v=6szE_qmzavQ youtube]

  4. Posted by JT Marlin | August 28, 2012 at 12:36 PM

    I learned everythingI needed to know about selling annuities by watching Mexican street vendors. Now my annuity commissions pay the leases on my Range Rover, a cigarette boat and a Hummer.

  5. Posted by Dateraider | August 28, 2012 at 12:41 PM

    It's not technically life insurance, but annuities with a life insurance rider. Stranger-owned life insurance is illegal, stranger owned life insurance riders apparently not illegal. That's the essence of the loop hole if I am correctly informed.

  6. Posted by NakedShort | August 28, 2012 at 12:41 PM

    I've told my parents many times that when they get up there in years they should take a portion of their portfolio that they are planning on leaving future generations (preferably IRA money) and invest it as aggressively as possible in a variable annuity w/ a death benefit. You literally are playing with house money.

    -Guy who now wonders if the insurance companies will be banging on his door in the future

  7. Posted by Guest | August 28, 2012 at 1:04 PM

    Regarding Matt's point on the difference between wholesale and retail behavior: I'd agree that what he says is true at the extremes, but the difference isn't as clear-cut as he presents it.

    There are lots of instances of financial institutions propping up affiliated entities more than legally required – SIV's, money-market funds, etc. – because they decide that the reputational downside of not doing so would cost them more than the money involved.

    On the retail side, paying an underwater mortgage can easily make financial sense since walking away entails direct financial costs – a damaged credit rating, moving costs, etc. – not to mention that someone may logically value living in the home they've selected at somewhat more than its market value. I agree that these factors don't make sense for houses that are massively underwater, but for people up to 30% or so underwater I can see how these factors outweigh the attraction of walking away.

  8. Posted by Guest | August 28, 2012 at 1:10 PM

    Ned? Ned Ryerson??

  9. Posted by Gues | August 28, 2012 at 1:19 PM

    Is it too early for flapjacks?

  10. Posted by Guest | August 28, 2012 at 1:22 PM

    It's a God damn bespectacled tadpole!

  11. Posted by Matt Don't Kill Me! | August 28, 2012 at 1:26 PM

    Hmm, I wonder if this explains why I saw a nice looking young man with Goldman Sachs business cards was buying people margaritas and asking me to sign some papers for him and that then they'd be called in for a few rounds of offsite interviews some time next week. He seemed to focusing mostly on malnourished looking types who seemed unlikely to survive a 96 hour lecture o the history of the world as seen through the eyes of a derivatives salesman with a fetish for efficient capital markets.

  12. Posted by guest | August 28, 2012 at 1:37 PM

    You really should proofread before you click submit comment.

  13. Posted by Guest | August 28, 2012 at 1:43 PM

    I'm surprised, Matt – usually you don't get conned this easily.

    Haven't you wondered why this story is now on Huffington Post AND on NPR AND in Forbes? Caramadre is scared of going to trial (in a couple months' time), so he's trying to get the public on his side. Just like some play the race card or the sexism card, he's playing the just-a-scrappy-little-guy-beating-the-big-guys-at-their-own-game card.

    Personally, I think he's a scumbag who should rot in jail. But even if you don't, you at least ought to call him on his bullshit games. I do feel a bit sorry for his codefendant/patsy, the 23 year old who actually conned the dying into signing the forms. He's being represented by a public defender.

  14. Posted by Everyone else | August 28, 2012 at 1:52 PM

    I would disagree with everything you said here.

  15. Posted by Matt Don't Kill Me | August 28, 2012 at 1:54 PM

    Dude, I'm pretty sure there was something in that margarita he gave me, I feel cold….

    Sorry, that did really suck, apologies.

  16. Posted by Koolaidisfun | August 28, 2012 at 4:55 PM

    But what about the patients' yachts?

  17. Posted by WTF__k | August 29, 2012 at 5:25 AM

    Try to keep up, dipshit – Matt already covered this.

    Ask yourself the question: Cui opposite-of-bono? (Cui Plagalis?)

  18. Posted by WTF__k | August 29, 2012 at 5:25 AM

    Try to keep up, dipshit – Matt already covered this.

    Ask yourself the question: Cui opposite-of-bono? (Cui Plagalis?)

  19. Posted by CDO-Guy | August 29, 2012 at 1:29 PM

    So, what you're saying is Caramadre essentially found a piece of risk that was misspriced and exploited it. Since we're in the business of makin money, folks, isn't that what we're *suposed* to do?

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  21. Posted by Erik | August 29, 2012 at 4:02 PM

    The "victims" weren't even bamboozled… this was simply found money for terminally ill people that they wouldn't have received otherwise. Everyone wins (except for the poor insurance companies).

  22. Posted by Erik | August 29, 2012 at 4:06 PM

    He allegedly didn't even have to lie… the "Relationship" line was either left blank, or he wrote in "None."

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  27. Posted by Don C. | September 25, 2012 at 11:39 AM

    There didn't need to be an insurable interest! He never claimed there was one, either. He stated that the annuitants were 'acquaintances'. He read the fine print and beat them at there own game!

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