Is Life Insurance An Asset
Financial planning experts say life insurance as an asset class is a new idea.
"Life insurance as an asset class was a novel and perhaps even controversial idea 10 years ago"
- Richard M. Weber MBA "Life Insurance as An Asset Class" (2014)
So, what type of asset class is a life insurance policy?
Financial advisors say life insurance is like cash or fixed income. It depends on how it is being used.
Let's take a look at how life insurance works like fixed income.
A premium from a policyholder gets invested by insurance companies into fixed-income assets.
Insurers invest 85%+ of policyholder premiums in investment-grade fixed income. This offers high levels of capital protection and steady income from interest payments.
High-grade fixed-income investments also give insurers liquidity. In other words, insurers can turn their investments into cash on demand if they need to.
So, a policyholder can view their life policy's cash value as part of their fixed income portfolio.
But it gets better.
Life Insurance Guarantees
Life Insurance companies guarantee policyholder returns. It's worth saying again, life insurers give guaranteed returns.
The guaranteed return is often 1-2% per year. A very good return when global interest rates hovering around 0%. That's not the highest return. It's the minimum return.
And it's this guaranteed return that supports the policy's cash value growth.
Life insurance has lower risk and lowers volatility compared to a fixed income portfolio.
"life insurance is attracting attention among investors looking to improve the return or reduce the risk of the fixed-income portion of their investment portfolio."
- Life Insurance as an Asset Class by Miller, Arruda and Ng
Now let's take a look at how life insurance is like cash.
A life insurance policy's death benefit gets paid out in cash. The cash payment is guaranteed by the insurer. The fixed payout is known in advance.
This is unlike an investment portfolio. It can suffer from stock market crashes and bond market corrections. The result, fluctuations in a portfolio value.
Depending upon market conditions, some investments may be hard or impossible to sell. Liquidating investments into cash may be disadvantageous.
Compare this to a life insurance policy. It guarantees to pay out a cash lump sum whatever the market conditions.
The Role of Life Insurance in Your Portfolio
Life insurance can produce better rates of returns than fixed and cash.
"life insurance intended for a lifetime can produce at least as favorable a long-term return with less risk within a portfolio of equity and fixed components than a portfolio without life insurance"
- Richard M. Weber MBA "Life Insurance As An Asset Class" (2014)
It provides a very useful investment option for clients and their financial advisers.
When building an investment portfolio, diversification across asset classes is important.
Diversification is when investors buy different assets. Asset classes include equities, bonds, property and commodities.
How you put these together and how much you have of each will determine your investment risk.
The other factor is investment correlation. In other words, do these asset classes go up and down in value together. Or do they rise and fall at different times.
Most investors want a diversified portfolio. They want some assets rising, whilst accepting that others may fall or not rise as much. This approach smooths out returns and makes it easier for investors to sleep at night. Especially if we are already living off our investments or retirement planning.
This principle of investing is known as Modern Portfolio Theory.
Having a blend of asset classes produces higher expected returns and lower volatility. So taking this one step further, we add life insurance as an asset class. We know this increases returns and reduces risk.
But it also provides a death benefit. After your lifetime, the policy's death benefit cash payout will increase your portfolio value. This can pass to your family or the next generation.
Life insurance is a powerful tool in any investors portfolio.
Types of Cash Value Life Insurance
The following types of life insurance policies have a cash value.
- Universal life insurance (ULI) – Part of the premium gets invested. Policy owners can choose how this premium gets invested. A popular type of policy is indexed universal life insurance. The insurer credits the policy based on the underlying performance of the investment. Once returns are added, they cannot be taken away.
- Whole life insurance (WOL) – Part of the policy premium is invested by the insurer. It goes towards growing the guaranteed cash value. Once added, this cash value cannot be removed. Whole life insurance is the most secure type of life insurance policy.
- Variable universal life insurance (VUIL) – The policy premium gets invested into shares, bonds, property and commodities. Values fluctuate in line with market returns. Policyholder cash values can fall, as well as rise. Variable universal life insurance can have an asset allocation that meets an investor's exact needs.
Life insurance policies have other attractive features that make them a unique asset class. These features include:
Tax-Free Growth and Pay Out
The effect of tax is a key consideration for long term investors. Tax will drag your investment returns down.
But, life policies grow tax-free. The cash value component of a policy benefits from this tax advantage. A life policy also has death benefit protection which gives a tax-free cash payout.
A unique facility of cash value life insurance is the option to take a loan from your own policy. A policy loan provides short term liquidity to a policy owner.
A loan provides cash to invest into higher growth assets like private equity and real estate. The policy loan facility can create cash for a business needing a short term borrowing facility.
Cash Value Withdrawals
A very attractive lifetime benefit of life insurance is the ability to withdraw cash at any time. These cash withdrawals can provide policyholders with income. Most insurers allow a fixed percentage cash withdrawal from your policy every year. Usually without affecting the death benefit.
All 3 of these features make life insurance a unique asset class. It is unlike any other conventional asset class.
But how safe is life insurance as an asset class?
Investment into shares and bonds is only as safe as the company in which you are investing. The same is true with life insurance.
The guarantees insurers provide are only as good as the company giving them. So you should always choose an insurer with a very high financial strength rating. Ratings are given by credit rating agencies like Standard & Poor's, Fitch and Moody's.
You can check the websites of insurers to see how safe they are. Or read more about the importance of life insurance company financial strength.
There is growing acceptance that life insurance is its own asset class. It can bring extra benefits to a high net worth clients investment portfolio.
But this article is not about an investment portfolio vs. life insurance. It's about using a combination of these assets to create a better result.
Adding life insurance to your portfolio is a powerful way to add more value during your lifetime.
And perhaps above all, it's about creating a far greater legacy value for those who follow us.
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