Historically, life insurance policy valuations have been approximately 300% of cash surrender values. The obvious questions are – Why is the spread so substantial and what are the component parts to a policy valuation? Let’s examine these problems piece by piece.
Cash surrender value is the excess premium paid into a policy and administrative costs including broker commissions and policy over price of insurance. Many policies are financed at 100% of “target premium” a figure used to compute the first year’s agent fee. Perhaps it does not ensure that a policy won’t lapse even if the premium is paid in full and on time. Often the main purpose of the insurance is to make a level death benefit for the least amount of premium with cash accumulation values being a secondary factor. Average policy cash surrender values are 4 – 5% of the death benefit. In a surrender, you’re effectively selling the policy back to the issuing carrier for an amount predetermined at policy start predicated on projected premiums, interest or crediting rates and policy expenses. Carriers do not track the welfare the insured to issue revised accumulation projections. The only variables affecting projected valuations are changes in the estimates themselves.
Policy valuations in the secondary market (competitive bidding process) do possess the luxury of looking at a person’s individual health status to value the policy. The first premium on a new policy is actuarially determined based on a man’s age, sex, health and behavioral components (lifestyle). This premium often is projected on a level basis. In a secondary market valuation – the vital component is the current well-being the insured. The underwriting is a review of medical records by a company certified and registered to supply life expectancies on the insured. There’s an inverse association between the welfare the insured as well as the policy valuation. An individual’s life expectancy is that point on a mortality curve where 500 out of 1000 individuals with similar morbidity (disorder) variables continue to be alive. The shorter the life expectancy, the higher the policy valuation. Every prospective secondary market buyer will use exactly the same data. It really is fascinating to notice there can be wide disparities in policy valuations depending upon a buyer’s readiness to accept a higher or lower return on investment or how that particular policy may meet their portfolio parameters.
As the buyer wants to understand the ongoing carrying costs for the duration (life expectancy) of the contract. Ongoing premium is the next important element to policy valuation. Policy type, policy size as well as carrier rating are secondary components to the policy valuation models.
All prospective coverage bidders submit their offers to the broker who presents the largest offer to the client. You can see that there’s no correlation between a market valuation and the determination of cash surrender value even though it’s fashionable to say that there isn’t any incentive for a carrier to offer more than cash surrender value to an insured. There are circumstances where the cash surrender value is the fair market value. This really is where no one wants to bid on the policy – usually due to the good health/young age of the insured.