The risk of a rising interest rate environment causing policy holders to take the cash value of their policy and invest in higher yielding securities.
Confusion:
So let’s say I pay Insurance Company ABC a premium every month for my life insurance. If I die, ABC will pay my family a lump sum.
Disintermediation risk suggests that if interest rates rise I would pull my policy to seek better returns. Firstly, why would I pull my policy? I am investing in life insurance because I need life insurance! Pulling from my policy would mean no life insurance which would defeat the point of ever getting it in the first place?
Secondly: Why would an insurance company even offer a cash value for my policy?
I pay car insurance every month, I couldnt one day just stop paying mid year and the car insurers would say ‘here is a lump sum’, and even if they did, why would I take that lump sum and invest it in a higher yield security? I need car insurance and cant drive without it!
This Disintermediation risk in life insurance doesnt make intuitive sense to me. Or i’m being dim.
The policyholder borrows against the cash surrender value; the loan balance is deducted from the face amount on death. Car insurance policies don’t have cash surrender values.
Disintermediation risk is generally for the whole life insurance policies and not for Term life insurance. Whole life insurance is the policy where insurance is in effect for the whole life of policy owner. Term life insurance is only for a certain period.
Whole life insurance is costlier but it builds up the cash value. This is the cash that insured person 1) can borrow if required in which cash s/he still keeps the policy in force. 2) can withdraw once the policy matures. In this case his/her family will not get money after the death as money has already withdrawn from the policy. If prevailing interest rates are high then people can take this cash at contractual rate and invest at higher rate. Thus company cannot invest its cash at higher rates which is the Disintermediation risk
They can take the cash out at the contractual rate and invest @ the higher rate or they can also borrow @ the contractual rate in order to buy a house (instead of getting a mortgage and paying a higher rate.
Life insurance companies provide cash value for their policies in an effort to make their products more attractive to the investing public. The reading mentions several times that insurance industries are very competitive.