The guideline answer for 2007 Q6 - A FI question talks about fixed rate annuities being exposed to disintermediation risk more than Whole or Term Life policies. Why is this? I assume it’s due to the annuity fixed rate being uncompetitive in a rising interest rate market, thus policy holders surrender the policy for a higher rate annuity (standard disintermediation). My question is, why is this more likely to happen for the annuity rather than the Whole/Term Life policies? Also, a clarification point, are shortening liability durations due to disintermediation, or are they an issue leading up to it as rates rise? If the former, why?
Guess that the insurance products has a pure insurance component in it as well, so LESS inclined (but not totally immuned) to withdrawal as the pure savings products like fixed annuities. In case, you are not sure about the difference about different insurance products, try this link. http://www.analystforum.com/phorums/read.php?13,1140927,1141040#msg-1141040 >Also, a clarification point, are shortening liability durations due to disintermediation, > or are they an issue leading up to it as rates rise? If the former, why? shortened liability duration is a consequence of disintermeditation. It is because the insurance companies are forced to offer more interest-rate sensitive products --> more floating like --> shorter duration instead of fixed rate (less rate sensitive).
For the first part, look at it in an exaggerated form. An annuity with no backend fees would constitute a 100% monetary investment. Liquidated the insurance company lose the whole amount. Life Insurance purchased in the first year, may only have a Cash Value of .05% and the rest of what has been paid into it is for the insurance portion. As the years go on cash will build up. Liquidated in first year they lose their premium payments going forward and .05% cash value but don’t lose the same amount of loss as in the annuity. elcfa has a good explanation of the shortened liability.
Annuities are more exposed to disintermediation risk exactly for the what you described rise in interest rates. So if I can earn 4% and annuity is offering me 3% why would I stay. The issue is not so pronounced in term life/whole life insurance policies because there is no “arbitrage”/advantage gained from turning in your policy. Depending on the terms, possibly you will get some sort of refund/premium back.