The Benefits of a Secondary Market for Life Insurance Policies

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 other financial service industries, including home mortgages, catastrophic risk insurance, and Nasdaq-listed securities. Next, we outline the economic theory of a life insurance market both before and after the introduction of a secondary market. Without an active secondary market, the equilibrium quantity of impaired policies that is surrendered is inefficiently low. 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. If there is no external market for reselling policies, insurers have no incentive to adjust their surrender values for impaired policies to competitive levels because they wield 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. We conclude that the incumbent life insurance carriers’ efforts to deter entry by life settlement firms are motivated by the anticompetitive desire to maintain monopsony power over policyholders.