After the USA and Japan, Great Britain is the third largest market worldwide and the largest market in Europe. About one fourth of the investment capital managed in the United Kingdom stems from insurances. The British insurers count 290,000 employees.
One common form of savings and capital investment in Great Britain is the classical with-profit endowment policy. Over half of the policies are no longer with the original purchaser when they mature.
The reasons for this are mainly changed circumstances in the lives of the policyholders such as the purchase of real-estate property or divorce. Instead of cancelling the insurance policies which are no longer needed, the policies can be sold directly, for example, over the internet or at auctions.
Since 2002 British insurance companies have been required by law to point out the secondary market to policyholders wishing to cancel their policies. If the policyholder sells the policy on the secondary market, the with-profit endowment policy becomes a traded endowment policy (TEP).
As opposed to German life endowment policies, TEPs always consist of three components: the basic sum insured, annual reversionary bonuses and the terminal bonus. The sum insured is paid out at the end of the contract or in the event of the death of the person insured. The sum insured is guaranteed and its amount is fixed definitely when the contract is concluded. In addition, there are annual bonuses which are usually determined by British insurers in the spring and allocated to the individual policies. Once allocated, the current bonuses are fully guaranteed up to the time the policy expires. When the TEP expires, a variable terminal bonus may also be paid in addition to the sum insured and the accrued bonuses.
Another feature of TEPs as contrasted with German life endowment policies is based on the investment policy of insurance companies. German insurance companies are only allowed to invest a maximum of 35 percent of the interest-bearing capital in stocks – actually in practice, the share invested is well below 10 percent, while the British Financial Conduct Authority (FCA) permits the British insurers a significantly more flexible investment policy. Consequently, the share of stocks in the past averaged often more than 30 percent. However, the British insurers are required to be able to meet their liabilities at all times (i.e. guarantee commitments to the customer). To this end, they must, among other things, form large reserves. Beyond meeting these requirements, though, they can invest as they like.
A majority of the British life endowment insurance policies are sold before the end of their term. Institutional and private investors acquire these policies above their surrender values, but considerably below their actual ‘intrinsic value’.
The acquisition of second-hand policies (TEPs) takes place through policy trading companies, so-called market makers. These brokers evaluate the insurance agreements offered and subsequently submit a purchase offer. The prospective expiry benefit is extrapolated under consideration of the already obtained annual bonuses as well as the terminal bonus of a comparable (same company, same term), but currently expiring policy.
The purchase price is always higher than the surrender value, but also regularly considerably less than the actual ‘intrinsic value’ of the policy. The legal transfer as well as the safekeeping of the vested policy rights is performed by a British solicitor (lawyer and notary public).
The average sum invested in a TEP is between 10,000 and 25,000 pounds sterling. After purchasing the TEP, the investor pays the ongoing premium and when the policy matures – in addition to the accrued annual bonuses and the sum insured up to expiration of the policy – receives the variable terminal bonus.
Ultimately, all parties involved profit from the British secondary market:
• The insurant because he receives a considerably higher price by selling than by cancelling the policy. This is mainly due to the fact that British insurance companies pay out a large part of the balance as a terminal bonus only upon expiration of the contract. As a result, the premature termination of a British policy is associated with mostly higher losses than the cancellation of a German capital-forming life insurance policy.
• The investor because he acquires the policy at a discounted price which is below the policy’s actual ‘intrinsic value’. Moreover, most of his investment is secured because he is irrevocably entitled to the already allocated annual bonuses as well as the sum insured. At the beginning of the investment these sums often come to around 85 percent of the capital invested including future premium.
• The insurance company because the investor continues to pay the insurance premiums for the policies acquired and, thus, reduces cancellation rates for the insurers. This allows the companies to calculate better and invest more money since the policies are retained in its portfolio.
After the major adjustments of the maturity payments over the past years, the TEPs have proved to be a stable asset class once more. The long-term average of the surrender value development remains constant and no major fluctuations are expected in view of the stable economic conditions. Due to the fact that 80% of maturity payments are built up by policy guarantees, even large-scale fluctuations of the terminal bonuses have only a limited impact on the overall maturity payments of the policies. The legal conditions for the purchase and transfer of TEPs are reliable and granted. In view of the current interest environment, TEPs are particularly recommended for institutional and large-volume investments for portfolio and risk diversification.