Today’s robust US secondary market for life insurance first arose in the late 1980s. As young people affected by AIDS suddenly needed money for medical treatment and to maintain their standard of living, many chose to realise long-term assets, including life insurance policies. However, their shortened life expectancy meant their policies’ actuarial values (the risk-adjusted value of the death benefit, taking into account future costs) were significantly greater than their surrender values.
Through their monopoly powers, insurance companies were earning returns on the repurchase of impaired policies. If a term-life policy lapsed, a policyholder unable to afford the premiums simply lost their cover and received nothing. On surrendering a universal – or whole-life policy – the insurance company’s pre-determined schedule of surrender values (representing at most the reserve set aside to fund future insurance costs at standard rates) meant a policyholder did not receive the full actuarial value of the impaired policy. Liquid investors, meanwhile, were willing to purchase policies for substantially more than the prearranged termination terms offered by the insurance companies – and the secondary market for life insurance was born.