Rising Costs

The fact that incumbents' costs have risen because of entry by viatical and life settlement firms, however, is not sufficient to demonstrate that consumers in the primary market are made worse off by such entry, as the incumbent carriers allege. For one thing, the increased costs to insurance carriers cannot be passed on, wholesale, to consumers in the primary market. The degree to which any cost increase is passed on to consumers is dependent on the elasticity of demand for life insurance in the primary market the more elastic the demand, the less of the cost increase the incumbent insurers will be able to impose on consumers. Indeed, our analysis in the following section demonstrates that consumers in the primary market for life insurance are made better off, on net, from the development of a robust secondary market for life insurance policies.

Insurance companies claim that as a result of this change in the marketplace, they would be forced to increase the insurance premiums that they charge policyholders. Furthermore, the insurance industry contends that, in the case of term life insurance, there is so much competition that some firms would become insolvent if they were forced to absorb the additional costs imposed on them by a secondary market.

The only "costs" imposed on an incumbent carrier by firms in the secondary market for life insurance policies, however, are the costs associated with the incumbent's continued honoring of the terms of its original policy--that is, the costs that the incumbent should reasonably have expected to pay in the absence of profitable lapses. If the incumbent carrier accurately accounts for these costs in the pricing of a given policy, secondary sales of policies will not cause the carrier to lose money on the policies. Secondary market transactions, by themselves, can only cause a carrier to lose money on its policies if that carrier under-priced the policies in anticipation of high rate of profitable lapses—a practice known as "lapse-supported pricing." Although incumbents are no longer supposed to use lapse-supported pricing, many insurers still have such policies outstanding from when the practice was allowable. Some even maintain that certain carriers continue to engage in the practice. CONTINUED