Key Points in This Section
- Life insurance has traditionally been a buy-and-hold financial instrument, with the only exit options being lapse (term) or surrender for cash value (permanent)
- Surrendering a policy to the insurer is a monopsony — a market with only one buyer — producing less-than-optimum economic results for the policyowner
- A true secondary market for life insurance has emerged, making policies a marketable financial asset like stocks, bonds, and real estate
- The secondary market was initially spurred by the AIDS crisis of the 1980s, when terminally ill policyowners needed cash to pay for costly treatments
Introduction
Traditionally, life insurance buying decisions are built around two basic benefits. The first is protection against the adverse financial consequences of death. The second driving force lies in the tax advantages of life insurance that make it such a powerful tool to achieve specific personal and business financial planning goals.
Nevertheless, circumstances can change that reduce the need for the death protection, the value of the tax advantages of a life insurance policy, or both. What happens then? Until recently, policyholders had few options. Since life insurance is fundamentally designed as a buy-and-hold financial instrument, terminating a policy does not favor a policyholder from a financial point of view.
In the case of term coverage — the policyholder could simply let the policy lapse, terminating future premium payments and any potential death benefit. In the case of permanent insurance — the policyholder could surrender the policy in return for a pre-determined cash value (less any surrender charges). Policyholders who surrender a policy, in effect, sell back the policy to the insurer for that pre-determined amount.
Economists refer to this type of situation as a monopsony: a market with only one buyer — in this case, the insurance company. And as with any constrained market, monopolies and monopsonies produce less-than-optimum economic results.
All that has changed over the past three decades. A true secondary market for life insurance policies has emerged and matured — a market governed by competitive economic forces. Initially spurred by the AIDS outbreak in the 1980s — and driven by the need for cash to pay for costly treatments — life insurance policies have become a marketable financial asset, much like stocks, bonds, real estate, and other investment vehicles. The old buy-and-hold mindset gave way to a new, more flexible way to think about life insurance. What began as a niche market has grown into a multi-billion-dollar industry: the face value of policies transacted in the secondary market grew from approximately $200 million in 1993 to over $4 billion annually today, with institutional investors — pension funds, asset managers, and hedge funds — now the primary buyers. This course explores how that market works and what it means for agents and their clients.