As a life insurance agent, I am well-versed in the virtues of dividend-paying whole life insurance policies issued by mutual insurance companies and recommend that they be added as collateral to MakerDAO. What is whole life insurance? [https://www.life-benefits.com/what-is-participating-whole-life-insurance/#:~:text=Participating%20whole%20life%20insurance%20]
Whole life insurance is a contract that is designed to remain in force for the insured’s entire life and requires premiums to be paid every year otherwise the policy will lapse (i.e. become null and void). Premiums are level and the death benefit is guaranteed as long as you continue to pay the policy premiums. The contract is between the policyowner and the insurance company where the insurance company contractually guarantees to pay to the beneficiaries of the policy a certain death benefit upon the death of the insured and to share with policyowners the excess profits the company generates. This profit sharing is referred to as a dividend and for tax purposes is treated as a refund of premiums paid (i.e. tax-free). Dividend-paying life insurance contracts also provide for the buildup of something called cash value. You can think of the cash value as equity that grows the more premiums you pay into the policy. This cash value is contractually guaranteed to be made available to the policyowner through the policy loan provision. The only requirement to initiate a policy loan is by completing a simple loan request form referred to as a collateral assignment of life insurance which assigns the collateral in the policy to the lender.
A collateral assignment is a conditional assignment appointing a lender as the primary beneficiary of a death benefit to use as collateral for a loan (A Collateral Assignment of Life Insurance). If the borrower is unable to pay, the lender can cash in the life insurance policy and recover what is owed. In the event of the borrower’s default or death before the loan’s repayment, the lender receives the amount owed through the death benefit, and the remaining balance is then directed to other listed beneficiaries. For example, Alice has $100k in cash value and a $1 million death benefit. Alice assigns $100k of her death benefit to the insurance company in order to borrow that amount. If she defaults or dies before paying off the loan, the insurance company keeps $100k and pays $900k to her beneficiaries. The collateral assignment is like a lien on the policyowner’s death benefit similar to a lien on a property with a home equity line of credit that mitigates the risk of loss to the lender. The lender can be the life insurance company, a bank, or a private third-party lender.
The only way the lender can lose money in this scenario is if the policyowner decides to not pay the annual premiums and the contract becomes null and void. A way to eliminate this risk is by only lending to policyowners of whole life insurance that is paid-up. This simply means that the policy is paid in full, remains in force, and the policyowner no longer has to pay any premiums out of pocket. As a result, the contract cannot lapse and the collateral will be guaranteed to grow over time. This means that there is no risk of liquidation since the collateral is not volatile. If MakerDAO were to establish a Special Purpose Vehicle (SPV) to onboard life insurance policies using NFTs similar to the Real World Assets being onboarded through Centrifuge, then it can be the source of high uncorrelated risk-adjusted returns. MakerDAO would use the SPV to designate it as the lender in a collateral assignment of life insurance to mitigate the risk of default. MakerDAO would not need an oracle since the collateral is only going to appreciate. This is why banks treat cash value lines of credit as risk-free bonds.
This is an example of a dividend-paying whole life insurance policy from Guardian which illustrates the fact that the net cash value and death benefit grow at the same time that the base policy annual premiums fall. This is due to the policy becoming a paid-up policy in year 8. In other words, after 7 years the policyowner no longer has to pay out of pocket for their insurance because the dividends have grown to be larger than the annual premium. At this point, there is no risk of the policy lapsing which means MakerDAO has no risk of loss since the policy is guaranteed to be worth more every year. MakerDAO can use the SPV to lend 25% of the death benefit to the borrower by using a collateral assignment of life insurance. For instance, a reduced paid-up policy with a $1 million death benefit and $100k in life insurance loans. The SPV can loan $250k based on the death benefit minus any outstanding life insurance loan plus a 10% loan origination fee. The outstanding life insurance loans should be paid off before the borrower gets the money to mitigate interest from accruing which allows MakerDAO to collect all of the dividends. The loan origination fee is similar to that of a home equity loan origination fee but much higher because MakerDAO is going to be paid annually rather than monthly. Hence, $250k - $100k - $25k = $125k lent at 6-7%.
This has the potential to create a win-win-win scenario. The insurance company wins by locking in a stream of income for the rest of the policyowner’s life. The policyowner (i.e. borrower) wins by purchasing a cash-flowing asset when premiums are cheap and leveraging the power of compounding interest over their whole life with no risk of losing their principal. The lender MakerDAO wins by owning high-yield assets that are completely uncorrelated from traditional finance and are extremely liquid. @LongForWisdom This collateral can also serve as an elegant solution to the concentration risk of DeFi evinced by MakerDAO’s $475 million in stablecoins, $350 million in ETH, and $105 million in WBTC. Adding recursive assets like aDAI/cDAI as @SebVentures has proposed would help stabilize the DAI peg, but it might raise the probability of catastrophic failure due to smart contract risk whereas whole life insurance does not have any of the issues associated with DeFi. In conclusion, if MakerDAO is going to quickly scale it must do so in a sustainable fashion by bringing low-risk high-yield Real-World Assets to DeFi.