Life Insurance Companies

[sachin_patel]

Answer for CFAI EOC Q9 D.
“Life insurance companies are considered spread managers, in that they manage the difference between the return earned on investments and the return credited to policyholders”
What is this return credited to policyholders?
I thought policy holders simply pay premium and get their life insured. What is this return credited to them?

 

[S2000magician]

Whole life insurance has a cash value that increases every year. That increase is the return to the policyholders.

 

[Carlo]

Hi Sachin, you are probably thinking along the lines of pure protection policies. It may be helpful, when looking at life insurance, to focus on the other major category of life insurance, the so called investment policies.
As S2000Magician noted, this category includes Whole Life.
Insurers created these products in response to market forces (think disintermediation) which essentially pushed them to go to the policyholder and say “don’t draw the cash value of your policy to invest in high yielding instruments… I, the Life Insurance Company, am going to guarantee to credit (not necessarily to PAY) those attractive rates - or even more to attract more business - to your policyholder reserve account”.
Hence why Insurers are “considered spread managers”. If they want to survive they need to earn a positive spread between the rate of return they committed to credit to the policyholder reserve account and what they earn on the investment portfolio. If this spread is negative this will erode their surplus until the surplus is no longer sufficient to meet liabilities and, that’s life, they go bust.
Solvency 2 is aimed at avoiding Insurance company going bust… but I will stop here to avoid eroding your patience down to irreparable levels.

 

[sachin_patel]

Thank you Magician and Carlo!!
I was thinking only term life insurance. I read little more after seeing your responses and now I understand.
Appreciate your help on this!