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The Benefits of a Secondary Market for Life Insurance Policies

38 Pages Posted: 22 Apr 2003 Last revised: 26 Nov 2011

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department; University of Pennsylvania - Business & Public Policy Department

Hal J. Singer

Economists Incorporated

Abstract

In this article, we examine the benefits that accrue to policyholders and incumbent insurers from an active secondary market for life insurance policies. We begin by examining the benefits of secondary markets in the home mortgage and catastrophic risk insurance industries as points of comparison for the benefits of the secondary market for life insurance policies. Next, we outline the economic theory of a life insurance market both before and after the introduction of a secondary market. Although competition among insurance companies in the primary market leads to reasonably competitive surrender values given normal health, surrender values based on normal health do not appropriately compensate individuals with impaired life expectancies for the resulting appreciation of their policies. Without an active secondary market, the equilibrium quantity of impaired policies that is surrendered is inefficiently low. Incumbent insurance carriers have no incentive to eliminate this inefficiency because they hold monopsony power over the repurchase of impaired policies. Viatical and life settlement firms erode this monopsony power. Finally, we examine the benefits of an active secondary market for life insurance policies to policyholders and incumbent insurers in the primary market. The magnitude of the benefits is positively correlated to the quantity of coverage sold to life settlement firms and to the improvement in the terms of accelerated death benefits offered by incumbent carriers. The emergence of the secondary market for life insurance policies has been pro-competitive and pro-consumer. Lawmakers should therefore design regulations that encourage, rather than dissuade, participation and investment in this secondary market.

Keywords: Life insurance, secondary market, life settlement, viatical

JEL Classification: A1, D0, G2, G22, D81

Suggested Citation

Doherty, Neil A. and Singer, Hal J., The Benefits of a Secondary Market for Life Insurance Policies. Real Property, Probate and Trusts Journal, Vol. 38, 2003. Available at SSRN: https://ssrn.com/abstract=387321

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department ( email )

Philadelphia, PA 19104-6365
United States
215-898-7652 (Phone)
215-898-0310 (Fax)

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

Hal Singer (Contact Author)

Economists Incorporated ( email )

2121 K Street N.W.
Suite 1100
Washington, DC 20037
United States
202-747-3520 (Phone)

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