The viability of a secondary market in mid-term life assurance policies.
The surrender of life policies accounts for a large proportion of the total outgo of life
assurance companies, in 1987 amounting to £3.6bn or 46% of funds returned to policyholders.
In practice most surrenders involve a simple two way interaction in which a policyholder
requests a surrender price from the issuing office, and accepts the value without question or
However, the increasing volume of surrenders, coupled with increasing dissatisfaction of
policyholders with the level of surrender prices, has lead to the emergence and development
of an imperfect and unorganised market in secondary policies. This market trades less than
5% of the potential volume of tradeable policies.
The volume of surrender and the absence of an organised market (which could provide
alternative purchasers of mid-term policies, competition and improved values) provides the
context and underlying hypothesis for the study.
From observation, it appeared that, for the market to evolve, the following developments were
i) A level of organisation and co-operation in which intermediaries co-ordinate the
offer for sale from large numbers of individual policyholders with secondary
investor's offers to purchase large volumes of policies.
ii) Computerised procedures for valuing policies and bundling them appropriately
to meet the needs of investors.
The research project was interactive with the developing secondary market and included a
close involvement in the development of a sophisticated trading system for one group of
The heart of the thesis is the development of a number of algorithms which are designed to
value portfolios of secondary life policies. The valuation procedure uses a discounted cashflow
approach which allows the calculation of IRR on the basis of expectations about the
future bonus performance of life offices. For each policy there is a statistically measurable
chance of the policyholder dying before the maturity date. The implicit value of this effect
is accounted for in the valuation procedure.
The valuation procedure is based upon an understanding of the sorts of policies likely to be
available, the valuation services demanded and the sorts of investment products which may be
created through the bundling and packaging of policies. This understanding is developed
througha study of the economic interrelationships between policyholder and issuing office and
from the viability study of the level of surrender demand in the market and the size of margins
between surrender and investment value.