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How does a traded endowment policy work?
22 Nov 2020 (104 views)

In the past, the owner of a life insurance policy has to surrender the policy to the insurance company and receive the surrender value.

The owner now has an option to sell the policy to an intermediary and receive a higher surrender value. 

How does this work?

Suppose the endowment policy pays $50,000 in 5 years time and the discounted value, based on a discount rate of 3% is $43,130. 

The insurance company does not offer this value. Instead, it uses a higher discount rate of 5% and offer a surrender value of $39,176.

Suppose an intermediary is willing to buy over this policy and enjoy a return of 4.5%. This intermediary is willing to pay $40,122 to the owner. 

The original owner is willing to sell the policy to the intermediary as it pays $946 more than the insurance company. The intermediary becomes the new owner of the policy which is now assigned absolutely to the new owner.

The intermediary can keep the policy for 5 years and receive $50,000 at the end of 5 years. The return on this investment is 4.5%. After deducting the operating cost, the intermediary may get a net return of (say) 4%.

Alternatively, the intermediary may find a buyer for the policy who is willing to pay $43,130 for the policy, giving a return of 3% per annum.

The new buyer is happy to receive this return of 3%, as it is better than investing the money with a bank.

The intermediary can make a profit of $ 3,008 ($43,130 - $40,122) from getting the new buyer to buy the policy from the original owner. There are expenses involved in handling the transaction and executing the assignment of the policy. The net profit of the intermediary will be lower than $3,008 after deducting the expenses.

To facilitate this transaction, the intermediary sets up a platform and indicates the policies that are on offer. 

For most policies, there may be future premiums to be paid. These cash flows are taken into account in the calculation of the surrender value to be paid to the original owner and the amount to be collected from the new buyer. 

There are many ways in which the business model can be structured. I shall now go into the details of these different ways.  

Tan Kin Lian


How does a traded endowment policy work?
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In the past, the owner of a life insurance policy has to surrender the policy to the insurance company and receive the surrender value.

The owner now has an option to sell the policy to an intermediary and receive a higher surrender value. 

How does this work?

Suppose the endowment policy pays $50,000 in 5 years time and the discounted value, based on a discount rate of 3% is $43,130. 

The insurance company does not offer this value. Instead, it uses a higher discount rate of 5% and offer a surrender value of $39,176.

Suppose an intermediary is willing to buy over this policy and enjoy a return of 4.5%. This intermediary is willing to pay $40,122 to the owner. 

The original owner is willing to sell the policy to the intermediary as it pays $946 more than the insurance company. The intermediary becomes the new owner of the policy which is now assigned absolutely to the new owner.

The intermediary can keep the policy for 5 years and receive $50,000 at the end of 5 years. The return on this investment is 4.5%. After deducting the operating cost, the intermediary may get a net return of (say) 4%.

Alternatively, the intermediary may find a buyer for the policy who is willing to pay $43,130 for the policy, giving a return of 3% per annum.

The new buyer is happy to receive this return of 3%, as it is better than investing the money with a bank.

The intermediary can make a profit of $ 3,008 ($43,130 - $40,122) from getting the new buyer to buy the policy from the original owner. There are expenses involved in handling the transaction and executing the assignment of the policy. The net profit of the intermediary will be lower than $3,008 after deducting the expenses.

To facilitate this transaction, the intermediary sets up a platform and indicates the policies that are on offer. 

For most policies, there may be future premiums to be paid. These cash flows are taken into account in the calculation of the surrender value to be paid to the original owner and the amount to be collected from the new buyer. 

There are many ways in which the business model can be structured. I shall now go into the details of these different ways.  

Tan Kin Lian