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Wall Street made millions creating ways for investors to bet on the death of the housing market. Now, they want to go even further: They want to bet on your death.

No, big banks Goldman Sachs (NYSE: GS  ) , JPMorgan Chase (NYSE: JPM  ) , and Deutsche Bank (NYSE: DB  ) don't have it in for you personally -- or if they do, it's not because of anything I know about. What they do want to accomplish, though, is to help pension funds deal with one of the biggest risks they face right now: the possibility that retired workers end up living longer than expected, which could lead to gross underestimations of the amount of money that pension funds need to set aside in order to cover their eventual payouts.

Dealing with longevity risk
Living longer than your life expectancy seems like an unqualified positive. But it does raise financial concerns, as you obviously need more money in order to cover living expenses for longer periods of time. When you consider that some pension funds have some $23 trillion in assets and collectively cover hundreds of millions of workers, you can see how the problem is magnified for these large institutions.

Ideally, what the group of big banks, which also includes Morgan Stanley (NYSE: MS  ) , Credit Suisse (NYSE: CS  ) , and UBS (NYSE: UBS  ) , want to do is find investors who are willing to take on some of this longevity risk. Right now, insurance companies like Prudential plc have allowed some companies to buy longevity risk insurance. But concerns about regulation as well as capacity issues have led big banks to seek out broader markets.

True long-term investing
One challenge in getting investors to buy longevity risk products is that in a climate where short-term quarterly results and quick returns are essential, bets on longevity by definition take decades to sort themselves out. As a result, making a market for longevity-based securities liquid and tradable is essential to attract investor interest. Otherwise, an investor could easily get stuck in such instruments indefinitely.

In addition, any financial relationship that could last dozens of years raises questions of counterparty risk. Essentially, any pension fund using insurance companies to hedge longevity risk has to hope that it won't go the way of Lehman Brothers or other bankrupt financial institutions.

Why bet on death?
As morbid as it sounds, there's some precedent for investing in death. Life settlement companies like Life Partners (Nasdaq: LPHI  ) make secondary markets in life insurance policies, paying certain policyholders, such as terminally ill patients, a portion of their policies' face value in advance in return for the full proceeds after their death. The company in turn resells those policies to institutional and high-net-worth individual purchasers.

Yet the practice is controversial. Earlier this year, the Securities and Exchange Commission started an investigation of Life Partners over alleged misstatements to investors about policyholders' life expectancies. Then just last week, the SEC notified Life Partners that it was recommending civil action against the company's CEO and general counsel. With the business relying on aggressive sales tactics at both ends of the transaction -- both when policyholders sell their policies and when life settlement companies resell them to investors -- deals may often turn out to be too good to be true.

Life'll kill ya
Nevertheless, pension fund trustees have a primary job of managing and eliminating risks like these, and so you can count on there being a good-sized supply of risk on sale if death derivatives catch on. With life expectancies steadily rising in the U.S. and elsewhere, there's a lot of money at stake for the funds. If they can succeed in using Wall Street innovation to transfer that risk to others in a reliable way, then it could greatly improve the financial condition of many pension funds around the world.

An aging population is just one trend that could make a difference in how people invest. The Fool has identified three strong trends for the future, along with several money-making trades to take advantage of them. Just click here to get this free report on some of the other top innovations of tomorrow.

Fool contributor Dan Caplinger has nine lives, but he doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy keeps you going and going and going....

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