A Conceptual Model of Lapse Financed Life Insurance
A Conceptual Model of Lapse Financed Life Insurance
Life insurance premiums on multi-premium policies that provide policyholders an option of lapsing without recourse can be reduced if insurers fail to give lapsing policyholders 100% of the "reserve" for that policy —the excess of the expected present value of future death benefits over the expected present value of future premiums. A failure to provide the full reserve value means that, absent transaction costs, owners of life insurance who know to a certainty that they will not let the policy lapse can actually make a potentially large expected profit. They – rather than their estate – can realize a portion of this expected profit by trading ownership of the policy for cash to investors who diversify much of the risk away through similar transactions and whose greater liquidity may reduce the risk of lapse. This variant of a "life settlement" is known as "Spin Life." This Demonstration illustrates conceptually the relationship among premiums, mortality rates, and anticipated interest rates in long-term life insurance. It further shows the profits theoretically available through "Spin Life." The Demonstration allows users to set expected lifespans among lapsing and non-lapsing policyholders, as well as overhead charges on the purchase of insurance.