When you design a portfolio by market capitalization and investment style, do you consider the cash value and death benefits of your client’s life insurance policy in the mix? Some experts say you should. Why? The death benefits and steady growth of cash value over the years can improve an overall portfolio’s risk-adjusted rate of return when combined with bond values.
“Investment managers should realize there may be a place for life insurance as part of the fixed income part of a portfolio,” says Richard Weber, principal with The Ethical Edge Inc., a Pleasant Hill, Cal., consulting firm. “Fixed income investments have low correlations to stocks. Life insurance cash values don’t move in the same direction (as stocks or bonds) during a crisis.”
When you factor in the life insurance cash value with bonds, Weber says, the return over time is higher and the risk lower compared with the all-bond portion of a individual’s portfolio. Weber coauthored a white paper, commissioned by Guardian Life Insurance of America, New York, on considering life insurance as an asset class. The study, published in 2010 with Christopher Hause, is titled “Life Insurance as an Asset Class: A Value-Added Component of an Asset Allocation.”
One of Weber and Hause’s studies compared an existing portfolio with permanent life insurance protection and without it. The portfolio with permanent life insurance outperformed the portfolio without life insurance and was less risky.
The researchers looked at a 45 year-old male in good health with $500,000 invested in municipal bonds, and assumed the municipal bonds grew at a 4 percent annual rate. The investment was worth $2.9 million by the time the male was age 89.
Next, Weber assumed that instead of reinvesting $20,000 of the initial municipal bond income, the money was used to buy a permanent whole life insurance policy. The individual purchased the policy for estate planning. After the first 19 years, the bonds and cash value outperformed the municipal bond-only portfolio. By the time male was 89 years-old, the bond and cash value portfolio totaled $3.5 million. The value is even higher based on the life insurance policy’s death benefits.
The combination of death benefit value, which includes cash value, and bonds was worth $4 million at age 89, outperforming the bond-only portfolio. In the first 19 years, however, the all-bond portfolio’s asset value was slightly higher than the life insurance.
Weber also looked at the return and risk of the municipal bond-only portfolio compared with the bond/life insurance portfolio. The bond portfolio, coupled with the life insurance cash value, was less risky. It grew at a 4.77 percent annual rate with a risk measure of 2.09. By contrast, the bond without life insurance grew at a 4 percent annual rate with a higher risk measure of 2.48.
“This discussion is not about portfolio investments or life insurance, but describes a synergy of assets that can produce more legacy value, potentially more net return and less market value adjustment risk,” Weber stresses.
By splitting up the life insurance policies among whole life, universal life insurance and variable universal life insurance together, Weber adds, other research indicates a policyholder’s cash value and death benefits will keep pace with inflation. In addition, the policyholder has access to the cash value, as well as increasing death benefits, especially at older ages.
Previous research indicates that life insurance as an asset class can act as an attractive hedge against the loss of “human capital”—or wages over a lifetime. To hedge against such a loss due to mortality, people should have cash value life insurance, suggests a 2005 Yale International Center for Finance working paper, by Roger Ibbotson and others. “Human capital—even though it is not traded and highly illiquid—should be treated as part of the endowed wealth that must be protected, diversified and hedged,” Ibbotson says.
For example, the study stresses that a person whose income heavily relies on commissions should consider human capital to carry the same risks as equities do. From one year to the next, the income can fluctuate in the same fashion that the stock market does. As a result, the individual should buy less life insurance and invest more in bonds to hedge against loss of commission income. But in good years, commissions can be substantial, just like a bull market in stocks. By contrast, the study suggests, a tenured university professor’s human capital is more like a bond, and that person should own more life insurance and stocks.
There is one caveat to considering life insurance as an asset class. You can’t plug historical life insurance cash value returns into an optimizer that uses Modern Portfolio Theory to determine the return per unit of risk of a mix of assets. Chief reason: Securities rules do not permit the estimation of cash value and death benefit returns--except in hypothetical life insurance illustrations.
“No broker-dealer would permit a registered representative to perform a sophisticated analysis because FINRA rules do not permit the projection of life insurance future returns,” said Richard Weber, principal with The Ethical Edge, Inc., and Pleasantville, CA.
Miccolis, whose company has $700 million in assets under management, does not look at life insurance as an asset class, but as part of a long-term financial plan. It is used to provide for the family when the loved one is no longer around or to pay estimated estate taxes, he believes. “I’m not sure it makes sense to consider it an asset class,” he says. “An investment portfolio is there to work for you during your life time and to meet your financial needs and goals.”
Counters Weber: “Life insurance may deliver greater legacy and living values in conjunction with the investment portfolio—for a given risk tolerance and reward goal—than a portfolio without life insurance. Large amounts of life insurance should be purchased on the basis of risk and reward considerations.”
