The UK Secondary Market

After the U.S. and Japan, Great Britain is the third largest market for life insurance policies worldwide, and with a share of just under 11 percent it boasts the largest market in Europe. One of the most common forms of savings and capital investment in Britain is the classical with-profit endowment policy. The annual returns of British endowment life insurance policies with 25-year maturities have averaged between 7.2 and 9.1 percent since 2005. 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 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).

Special Characteristics in the UK

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 definitively 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 has to do with the investment policy of the insurance companies. German insurance companies are only allowed to invest a maximum of 35 percent of the interest-bearing capital in stocks; in actual practice, the share invested is well below 10 percent.

British companies are monitored by the British financial authorities who permit a more flexible investment policy. Due to the financial strength of British insurance companies, the share of stocks in the past averaged between 30 to 50 percent. They are required to be able to meet their liabilities at all times (meaning guarantee commitments). To this end, they must, among other things, form large reserves. However, beyond meeting these requirements, they can invest as they like.

The Mode of Operation of the British Secondary Market

A majority of the British endowment insurance policies are sold before the end of their term. Fund companies and 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. First of all, the guaranteed sum insured is stipulated when the purchase price is determined. 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 (notary public and lawyer). 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 premiums 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.

Advantages for All Parties Involved
Ultimately, everyone involved profits from the British secondary market:

1. The policyholder, because he receives a considerably higher price by selling than by cancelling the policy. This is particularly 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 considerably higher losses than the withdrawal from a German capital-forming life insurance policy.
2. 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 90 percent of the capital invested including future premiums.
3. The insurance company, because the investor continues to pay the insurance premiums for the policies acquired and thus reduces cancellation rates for the company. This allows the company to calculate better and invest more money since the policies are retained in its portfolio.