Grim reaper helps hedge funds rake it in

November 1, 2007

The most recent involved Dow Jones board member David Li, who is charged with making an $8.1 million profit along with his friends after Rupert Murdoch offered to buy Dow Jones.

Bob! I thought that was your chest CTA I was reading. What brings you to the ER?"

"I was at the barber, and he told me I had a positive D-Dimer and . . ."

"Barber?"

"Yeah. A customer died of a PE recently in his chair, and the dead guy's family is suing him. He's installed an in-house lab to test for anything that might put him at risk."

"You're kidding."

"So my D-Dimer was elevated, and he sent me to the ER. He doesn't risk being sued again, but unfortunately most of his clients can't get a haircut."

"That's absurd. Why did the ER doctor order a CTA?"

"Said he couldn't risk not doing it. It's negative, right?"

"You're breathing on the scan. This one funny area is probably nothing, but I can't risk missing a PE, so I'm saying it may be positive."

"That means I'll have to be anticoagulated for six months! You know I have that weak knee with several bad falls because of it. The doctor says I run the risk of bleeding to death if I fall."

"Hmm. Got life insurance?"

"Yes. Why?"

"I might be able to help you. I run this small hedge fund, and you're just the type of investment we're interested in."

"What kind of investment?"

"Death bonds."

Insider trading is very profitable, and most perps don't get caught. The Securities and Exchange Commission files dozens of cases every year.

The most recent involved Dow Jones board member David Li, who is charged with making an $8.1 million profit along with his friends after Rupert Murdoch offered to buy Dow Jones.

Former U.S. senator and cardiac surgeon Bill Frist (R-TN) was a large shareholder in Hospital Corporation of America, which his father founded. Frist, his wife, and their children all sold all of their stock two weeks before the release of a very disappointing earnings report. The stock took a major dive, but they didn't get in trouble. Martha Stewart, Joseph Nacchio, and Ivan Boesky are big names who did get in trouble, but hundreds of nameless people profit every day from insider information. Why not you? You don't have access to Wall Street insider information? Think again.

Hedge funds make big profits by taking on big risks. These can lead to huge losses like the recent collapse of the Bear Stearns subprime mortgage portfolio, which dropped $3.6 billion. So how do you manage "risk" for a good return with little downside? Death bonds-because everybody dies.

Matthew Goldstein provides the gory details in a BusinessWeek story, "Profiting from mortality." He explains that this business is expected to bring in $30 billion this year and will soon be worth $160 billion.

How does it work? An elderly person with life insurance decides to have some of his or her money now rather than all of it after dying. This person finds a broker who, for a commission of 5% to 6%, sells the policy to an investor for 20% to 40% of its face value. The investor then pays the premiums and just waits for the person to die to collect. A hedge fund will then bundle about 200 of these policies together to minimize risk and turn them into asset-backed securities, which the fund will sell to investors with rates of return of about 8%, comparable to stocks.

What makes these investments so attractive is that they are considered uncorrelated assets, because death rates are not related to what is happening in other financial markets. The interest in this market is huge, with major players clamoring to get involved. Moody's has already rated one death bond issue.

Another great thing is the paucity of regulation, as most states do not require any licensing. You can even take out insurance policies on people you've just met and resell them. About $10 to $20 billion worth of stranger-initiated policies have been created by hedge funds/investors since 2004. One hedge fund tried to insure the entire population of the islands of St. Kitts and Nevis. I wonder if any highly connected politicians have policies on the people of Iraq. Opportunities abound!

The key is that the sooner the person dies, the greater the profit. Find a lung mass on CT? Ka-ching! Apple core lesion on a BE? Ka-ching! Malignant calcifications on a mammo? Ka-ching!

You have quality inside information regarding who is going to die early, which you can trade on before anyone else knows. Before the patient leaves the department, offer to buy an insurance policy, and you have created a highly profitable death bond.

Curtis Somoza and Robert Coberly tried another approach by raising

$69 million from investors to insure the 2000 members of a black inner city church, based solely on the sales pitch that these parishioners would die sooner than the average person. Morbid? Distasteful? Racist? Yes. But I am confident others will do it for the money.

The question is how to manage risk in our quest for profit. Most physicians are risk-averse, and avoiding risk is a risk itself. Our barber eliminated his risk but also his income. Doing nothing does not protect you from risk. In certain circumstances, it can increase your risk, such as being paralyzed by fear of choosing the wrong direction to escape a burning building. Those companies that invest the most in R&D are consistently the most profitable, but 90% of those R&D dollars never show any return-a risky investment. Drug companies throw away billions every year on drugs that go nowhere, but not to do so would be even riskier.

Dramatic forces at play in radiology are disrupting our business practices. Times of instability and change, however, create opportunities for those willing to take risks. Dr. Paul Berger of NightHawk and Dr. Sean Casey of Virtual Radiologic Consultants, both radiologists, have reaped the early rewards of taking risks. Some will find opportunity, while others will lose big. We get calls every month from money managers looking to pull deals together, and they are not necessarily radiologist-focused. Many radiologists are not even aware of what is taking place around them.

Is your group prepared for what is coming? Do you have a strategy? Are you evaluating new technology and all possible scenarios for how these may adversely or positively affect your practice? If you see a downside, can you minimize it, or even turn it to your advantage? Are you willing to assume risk to take advantage of an opportunity? Are you willing to take on risk to ward off or adapt to a threat? How risk-averse are your partners? What is your competition doing? Could the hospital administration be using technology against you, knowingly or unknowingly? Are the clinicians more in control than you?

These are all questions you should be addressing each month, because the MBAs with the money surely are, and you clearly are not invited to their strategy sessions. Too many groups just live in the status quo and expect it to remain so.

I have seen numerous groups expire suddenly. Hmmm. I wonder if you can take out a life insurance policy on a radiology group? I know several groups that will prove profitable with little risk . . .