I have many a times wondered if there is a way I could trade my insurance policies like I trade stocks. Wouldn’t it be interesting to be able to do that when I need money at short notice or when I don’t see relevant use of a particular insurance policy? A number of insurance markets like Europe and the US allow trading of life insurance policies, often called as life settlements or traded endowment policies (TEP).
Life settlements are second hand policies which are bought at steep discounts and the new owner receives the money when the original policyholder dies or becomes chronically ill. On the other hand, TEP are endowment policies which provide a return on maturity, and will often be traded because the original policyholder would like to exit early during the policy tenure. TEPs are attractive to original policyholders as typically these provide higher values than the surrender value in early years of the policy. The obligation to pay future insurance premiums lies with the new owner or the intermediary through which the transaction has taken place.
In 2003, the Monetary Authority of Singapore (MAS) sought feedback on this segment and issued a response to the feedback in the same year. It proposed certain guidelines such as minimum investment of S$20,000 (and only available to non-retail investors) and that the sale and purchase should meet requirements under the Financial Advisers Act. The Life Insurance Association (LIA) at that time had adopted a cautious stance and suggested that policyholders may not be mature enough to understand all the risks involved. It should be noted that the secondary insurance market is not regulated by the MAS currently.
A decade on from the last consultation and with further enhancements in the Singapore’s advisory framework and propensity of consumers and investors to use online platforms, I wonder if Singapore is ready for an insurance marketplace whereby policyholders could trade their insurance policies (just like a second hand car or second hand furniture)!
Currently, registered life insurers in Singapore do not buy policies from policy holders for re-sale, and also do not distribute TLPs and TEPs. The TLPs and TEPs being sold in Singapore are generally policies bought from other countries.
Benefits to customers
Having a marketplace for second hand insurance policies will provide flexibility and exit options to insurance customers. Imagine a scenario whereby a 65-year-old with a whole life policy becomes terminally ill and needs more cash than what various riders on the base policy can provide. All he needs to do is offer his policy on a marketplace and interested investors can bid for his policy. Of course the offer price will be higher than the surrender value offered by the insurance company and there will need to be some sort of mechanism for investors to verify this.
From an investor’s perspective, the downside risks are limited (assuming appropriate KYC has been performed and there are no legal risks) with a significant potential upside. Therefore, in some cases, the return can be quite attractive.
Compared to buying a life insurance policy, Life settlements or TEPs are complex investments and bear a number of risks. Some of these additional risks include checking whether the underlying policies are genuine, associated legal risks, and life extension risk in case of life settlements. Therefore, I agree that it is quite difficult for a retail investor to fully comprehend these risks. In addition, it is often argued that insurance policies are bought for long-term needs and therefore existing policyholders need to consider their long term needs before they decide to transfer their policies.
This issues however can be resolved by having an appropriate intermediary which performs a risk assessment on the investment as well as explains to the existing policyholder the impact of selling their insurance policies. These intermediaries can either be a third party provider or insurance companies themselves. Insurance companies can potentially benefit in this process for providing more flexibility to their customers and enhancing their customer retention ratio.
Investors should consider at least the following areas when investing in a TEP policy:
- What is the level of guaranteed benefits (sum assured plus historically attached bonuses) compared to the purchase price? This will provide an indication of the minimum return on the policy.
- What has been the historical bonus rate on the policy and recently declared terminal bonus rates for other maturing policyholders? Whilst this information may not be readily available and will vary for different policyholders, the intermediary selling the policy may provide some indication.
- If investors are buying TEPs issued in other countries, they have to take into account legal risks associated with a different jurisdiction.
- Investors should ask for detailed explanation about the TEP including information on projected benefits for the owner.
- The insurance company issuing the underlying policy should be a reputed name and appropriate due diligence needs to be conducted on the financial condition of the company.
There are further challenges that have been observed in the developed markets such as the UK and the US:
- One key issue to deal with life settlements and TEPs is around data privacy. It is spooky to know that someone out there has financial interest in your demise and this poses its own problems.
- At times, the life expectancy of individuals has not been determined correctly and retail investors may not be able to understand all the complexities. In particular for life settlement policies, this poses a significant risk with current medical enhancements.
- There is also a conflict of interest from advisors who get to earn a high amount of commission on the transaction. So policyholders may not get an attractive deal after allowing for the cost of transaction. An insurance marketplace may solve this problem where transacting parties just pay for independent advisory fees.
Second hand insurance policies are a complex concept to understand but they surely provide more flexibility to insurance customers and investors. With appropriate risk management and involvement of experts in these transactions, the idea has the potential to change the way insurance is bought and sold.