THE BENEFITS OF A SECONDARY MARKET FOR LIFE INSURANCE POLICIES

HEADNOTE

Editors' Synopsis: This Article analyzes the benefits that accrue to policyholders and incumbent insurers from an active secondary market for life insurance policies. It begins 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, it outlines 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 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 no external market for reselling policies exists, 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. Entry by firms in the secondary market erodes monopsony power. Finally, the Article examines the benefits of an active secondary market for life insurance policies to policyholders and incumbent insurers in the primary market and discusses the future of life settlements. The magnitude of the benefits is correlated positively 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.