"Distorted Values"

While the Armstrong Commission’s non-forfeiture values addressed the outright “theft” of policyholder assets by insurance companies, “endowment at age 100” distorts the accumulated cash value available to the policyholder.  Let’s consider an over-simplified example.  Assume a $500,000 whole-life policy; the insured is age 75.  The policy currently has a guaranteed cash value of $100,000. Also assume the insured suffers from severe health problems and has approximately one year to live.  Looking at this situation in a little different light: the policyholder could sell the policy to the insurer today for $100,000 or collect $500,000 in a year.  Holding the policy for that last year results in a dramatic annual return of 400%!    Obviously there is a distortion between these values -- a distortion caused by two factors:  an assumption of perfect health resulting in endowment at age 100 and the fact that there is only one purchaser, i.e.,  the insurance company.  Now suppose there is a purchaser willing to buy the policy today for $350,000.  The purchaser, who is responsible for any future premium payments, names himself as beneficiary.  When the insured dies -- perhaps in a year, perhaps sooner, perhaps later -- the purchaser collects the death benefits and earns a return on his investment.  The original policyholder is relieved of future premium payments and receives a quarter million dollars more than the cash value offered by the insurance company; money that can be invested or used immediately for other purposes.  Granted, the original beneficiary receives nothing under the policy.  And that is a trade-off the original policyholder must consider -- but it is an alternative that may be attractive to many policyholders.  

Since insurance companies’ “guaranteed cash values” are based on a life expectancy of age 100 -- which statistically speaking very few of us reach -- they undervalue the “true” value of that policy.  That distortion is even more pronounced when the insured’s health is impaired, as in the earlier example.   The insurance companies’ monopsony power -- in essence, they are the only game in town -- allows them to enforce a “below-market” valuation of their policies based on the insured‘s perfect health.  Policyholders are given a “take it or leave it” choice.  Approximately 40% of life policies issued in the U.S. terminate without paying out a death benefit -- in other words, 4 out of 10 policies are “bought back” by the insurance companies at “below-market” prices.