Permanent Life Insurance Is An Asset Class

November 10th, 2011 | Author: Mitch Reynolds

Permanent Life Insurance Fits the Definition of an Asset Class

Traditional Whole Life Insurance can be added to your investment portfolio as a high performing asset class

Most Canadians don’t think of life insurance as an asset class in their investment or retirement portfolio. Permanent life insurance does meet all the criteria of an asset class and offers strong, stable returns over time with very low risk or volatility.

Wouldn’t you love to have an investment that offers stable, healthy returns, that is not subject to the volatility of the stock markets, is well diversified, tax efficient – and provides liquidity so you can spend some of the money while you are still alive. Sounds like the perfect investment plan! But how, you might ask, can a person use a life insurance policy to provide income in retirement years? This article will explain how permanent life insurance meets the definition of an asset class for investing, and how it is a very efficient asset to have in your retirement portfolio.

Modern Portfolio Theory defines an Asset Class

Life insurance as an asset class Modern Portfolio Theory is one of the most influential ideas that have shaped investment management in our lifetime. Developed by Harry Markowitz in 1982, the theory shows how all investment options in the marketplace that you can choose from sit either on or below the efficient frontier. The efficient frontier is the “optimal” balance of investment return for the amount of risk you are willing to take. There is a direct correlation between risk and return – the more risk you are willing to take on, the higher the potential return.

All the common recognized asset classes sit along the efficient frontier. That is to say, the best investments options within each asset class will give you the highest rate of return for the amount of risk they incur – and thus be the “optimal” investment sitting along the curve. Here are some common asset classes that make up a common Canadian investment portfolio:

Equities (stocks of a company)
Fixed income (bonds and mortgage backed investments)
Money Market (cash funds)
Guaranteed payouts (i.e. annuities)
Real Estate

How permanent life insurance fits in as an asset class

When we speak about permanent life insurance there are two main types of life insurance that have cash value accounts – Whole Life and Universal Life.

Universal Life has lost its lustre

Universal life insurance is about 30 years old in Canada. It was originally developed as a way to “buy term and invest the difference.” For a long time universal life insurance was the darling of the Canadian life insurance industry. It offered Canadians permanent life insurance coverage, affordable and guaranteed level cost of insurance for life, and a tax sheltered investment account where policy-owners could self-direct their investment portfolio.

The problem is the complexity of the investment account and the inherent risk of market base investments (mainly equities). The very nature of a life insurance contract is to provide security and stability, so when death occurs the life insurance is guaranteed to pay out. Universal life falls short of offering this iron-clad guarantee. Because market returns can be so volatile, the cash value of a universal life insurance policy can fluctuate significantly. Yet, the underlying cost of insurance remains constant, and premiums are drawn from the cash value monthly. When the underlying investments have gone down, the premium being drawn on off the cash value fund undermines the long-term performance of the fund.

When selling universal life insurance, the illustration could show 5 – 6% annual rate of return, but you might need to get a much higher average rate of return going forward to offset the capital depletion from a string of negative investment years like we have recently seen. For example, if you suffered a 10% loss this year, you would need an 11.1% gain in the next year to just recoup your loss.

Recent volatility in the world stock markets has wreaked havoc on the performance of existing universal life insurance contracts. Life insurance companies are also losing money on their universal life insurance policies because the underlying pricing assumption for the cost of insurance were based on a much higher interest rate environment. With continued low interest rates, Canadian life insurers are forced to increase the cost of insurance on their universal life insurance products.

Whole Life Insurance continues to perform well

Whole life insurance has been the strong and stable long term performer during the world economic crisis. Investing in whole life insurance as an asset class will give you much more secure long-term performance than universal life based on what we know now about market volatility.

It’s hard for people to accept 7-8% constant rate of return on an investment when everyone else is making over 20% in the stock markets. That is why Canadians flocked to universal life insurance during the first half of the last decade. Then, in 2008, the world chance with the collapse of Lehman Brothers. Stock markets crashed, market volatility has become the norm, and the world economic crisis seems to go on and on.

Life insurance as an asset class in Canada

Sun Par Whole Life Accumulator Account Investment Mix

Now, all of a sudden, a stable 7-8% rate of return through the last four years and beyond would sound like a very wise investment. In fact, over the last 25 years, participating (par) whole life insurance policies in Canada have returned an average of 9.2% return to policyholders. Couple this with a standard deviation (risk) of only 1.3% annually*, which is one of the lowest risk products on the market.

* A standard deviation of 1.3% means that in any given year the maximum the rate of return has moved either up or down has been 1.3% or less.

Whole life insurance has a very well balanced investment portfolio. Even though you don’t get to control the investments, the fund is managed by a team of professionals at your life insurance company who look for investment opportunities that give healthy returns and minimize risk.

Let’s look at why Participation Whole Life is a low risk, high return asset class

Good rate of return on money
Predictable returns with low volatility (risk)
No market timing as assets are invested for the long-term
An asset that is NOT correlated with the stock market
Tax efficient growth of funds and tax free death benefit
Liquidity of the cash value as tax free loans
Industry stability – life insurers vs. banks and mutual fund companies

Even if you intend on using the cash value of your whole life insurance policy as retirement income, the after tax rate of return on a series of loans from your policy will far surpass what you will ever get from GICs or tradition Bond Funds.

When you factor in the ultimate death benefit the policy will pay out, your rate of return on investment is very high. A whole life insurance policy can be used BOTH as an asset class for investing AND an estate plan to create a legacy for your heirs.

Resources supporting Whole Life Insurance as an Asset Class

Here are two resources you can read that support the idea of including whole life insurance into your overall investment portfolio as a secure asset class.

Modern Portfolio Theory, Asset Classes and Life Insurance by Guardian Life Insurance

Participating Whole Life Insurance As An Asset Class by Sun Life Assurance

Life Guard Insurance can Design Whole Life Insurance to Fit Your Portfolio

To find out more about whole life insurance as an asset class in your entire financial plan, please contact Life Guard Insurance. We can show you how life insurance can be a secure and high returning asset class amoung your investment.

The article was written by +Mitch Reynolds. If you found this article interesting or it made you think, please feel free to share your comments below. Liking us on Facebook, giving us a +1 on Google or Tweeting this article about permanent life insurance as an asset class would be very much appreciated.