Disintermediation

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alta168

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CFAI text V2 P.397, 1st paragraph, line 5 When interest rates are high, insurers also face another type of disintermediation : the risk that policyholders will surrender their CASH VALUE LIFE INSURANCE POLICIES FOR THEIR ACCUMULATED CASH VALUES, in order to reinvest the proceeds at a higher interest rate. What is meant by “CASH VALUE LIFE INSURANCE POLICIES FOR THEIR ACCUMULATED CASH VALUES” ?
 
I am not sure, but the way I interpret it is they will surrender the future potential benefits upon death (cash value) for their accumulated cash value (amount they have paid in premiums at which have grown at the policy holder’s agreed upon rate in the contract)
 
The policy of a life insurance functions like a retirement account. Premiums paid grow or accumulate inside the policy tax free. So a policyholder may surrender a policy and invest that cash outside the policy when interest rates are rising.
 
I have a non-term life insurance policy. As I make contributions to it, it accumulates cash value based on the performance of the funds they are invested in. If I wanted to, I could terminate the policy and receive the cash value. It appears on the monthly statement.
 
think of a plan vanilla whole-life policy - you pay premiums every year, and when you die, the beneficiaries gets a fixed benefit.
Essentially, these policies have a built in rate of return. Let’s say I expect to die in 50 years, pay an annual premium of $500, and my wife gets $1,000,000 on my death, then:
PMT = 500
T = 50
FV = 1,000,0000
i can solve for rate of return:
so Rate = 11.5%
If interest rates start rising, i’m locked into a crappy 11.5% on my policy. Since these whole life policies are generally long term products, they typically carry a cash surrender value to protect me from this - all that means is i can forfeit the future death benefit for some value today (the “cash surrender value”).
THis is why rising interest rates can really mess up a life insurance company because (1) I will have a huge fixed income portfolio, and rising interest rates will reduce my asset values therefore eroding my surplus (equity) and (2) holders of the life policy will start to surrender the policy and demand cash immediately. THis puts a significant drain on my liquidity. To meet this increased demand for cash, i may have to start selling off fixed income securities at a loss.
 
smileygladhands, if I was a CFA grader, I would give you an A + on your response shun.
 
gotcha, i screwed up the details of the surrender value - so i’d probably still get partial credit?
 
soapalyer
Thats because AF site has been upgraded to newer version & old format URLs doesn’t work..
 
ragyks:
Thanks for the reply. So any solution to find old format URLs in new forum?
 
I should know this. WHole life insurance policies have cash value that grows tax free. Although the rate at which it grows is anything but specatular. When IR are high the rate you recieve at your whole life is still not so specatualar so people cancel their policies and this time actually invests their money. So insurance companies now have VUL, UL and variable annuities to combat disintermediation.
 
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