An Oldie, but Goodie

An Oldie, but Goodie

I remember quite vividly the first time I saw this video.  I was still a career agent with one of the big 4 Mutuals and we had a special meeting conducted by the Director of Individual Life Sales.  He came from the Home Office to give us a presentation on the topic of life insurance as an asset class and brought with him this video recorded a few months prior on CNBC.


At the time, I was sort of busy with a lot of other things, and didn't pay nearly as much attention as I should have (I'll admit I quite enjoyed having my securities license at the time, and while I certainly appreciated the value of cash value life insurance, I loved talking about things like the Blackrock Global Allocation Fund, and all the super nifty riders one could get on a Variable Annuity).

Looking back this piece is pure gold.  Not because it's the best done news interview on the topic (it probably isn't).  But it's great because it was so timely.

This interview was done in early 2008.  At the time, we had already witnessed one colossal failure, and I was personally shorting the hell out of the market.  However, the worst had yet to come.  Jim Cramer hadn't even made his “crazy” Dow below 8,000 prediction.  In fact, you'll notice that on this video, the Dow is still comfortably above 12k.

The box that appears early in the interview with bullet points on why life insurance might be a good place to put your money is sadly not discussed in greater detail during the interview (understanding that live media news shows have precious little time and often have to resort to presenting information in this fashion).

In CNBC's absence of a discussion here, I'll take the time:

High Rate of Return

I know everything is relative and many of you may ask: compared to what?  And this is a fair question.  Generally speaking, we're talking about CD's, Money Markets, Treasuries, Muni-Bonds, and fixed annuities.  Cash value life insurance has an extremely favorable observed and guaranteed rate of return.  Currently the yield curve for U.S. Treasuries shows 30 Year bonds are yielding 2.86%.  Most whole life contracts are guaranteed at 4%, and most universal life contracts are guaranteed at 3%.  That's for life.  And most of the insurance contracts I've seen in my time are well above their minimum guarantees, even this year.

The risk adjusted rate of return (i.e. the bang for your return buck relative to the amount of exposure of losing your money) is superlative in cash value life insurance.  It can't go backwards (decrease in value) and it's beta is nearly zero (also on the bullet list, so we'll dive more into this a few headings down).

Mortality is Recession Proof

This one gets overlooked far too often in my opinion.  The primary business function for life insurance companies: issuing life insurance contracts, is a relatively easy business to predict (turns out it's profitable, too).  When the market crashes, people don't tend to die a lot more, they also tend not to lapse their insurance policies.  Buying new policies is a different story, but that's not the primary concern of a life insurer.

All throughout the financial debacle of 2008 life insurers remained strong, some even got stronger.  They maintained their stellar credit ratings.  Even the life insurance unit of AIG ended up changing its name to try and mask itself from being associated with the sub-prime mess the credit and banking wing of the company got itself into.  Also it should be noted that American General (AIG's new name in the life insurance biz.) has never failed to meet any obligations under any of its life related contracts, nor has it cut benefits to bare minimum guarantees.  In fact, the life side did get caught up in a “political” (of sorts) firestorm when it chose not to cancel it's club meetings (subsidized vacations insurers offer to agents who submit remarkable amounts of business in a given year).  Technically and logically they were right not to; politically speaking from a PR standpoint, it was a terrible idea not to.

Tax Free Gains

Not only does it beat the nominal return of Money Markets and CD's, but the cash also grows tax deferred, and can be accessed tax free through FIFO distributions and policy loans.  Meaning the real rate of return from a taxable point of view is even better.  But lets not overlook an elementary lesson about tax deferred vs. taxable gains.   Let's use this following two possible scenarios:

  1. Save $5,000/year in a tax deferred account
  2. Save $5,000/year in a taxable account (pay taxes on gains every year like a CD or any other investment held in a regular brokerage account like Money Market Mutual Funds, Stocks, Bonds, Mutual Funds, etc.)

This chart best displays what happens the blue curve is tax deferred and the red taxable:

The chart shows us that saving your money in a tax deferred vehicle will net way more money than an annually taxable vehicle.  Intuitively, this isn't all that hard to imagine.  There's less to compound year over year if some of the money is removed to pay taxes.

The difference is quite substantial overtime.  In this example I simply used $5,000/year for 45 years; in the end I have  c. $480,000 more in the tax deferred plan, and all I had to do to accomplish this was choose the right savings plan.  I know someone who used to refer to this difference as the stupid tax, perhaps ignorant tax is a nicer way of putting it.

Not Correlated to the Stock Market

Remember earlier when I said we were going to address what having a beta of zero was all about?  The time has come.  Life insurance cash value is not tied to stock market performance.  Sure there's an element of overall dividends paid or interest credited that depends on how life insurers' general accounts perform in a given year, but stocks make up a small proportion of the overall general account, so the impact of the market as a whole is relatively small.

Anyone who has studied finance, or taken an FINRA exam knows about the different types of investment risk.  A big one that is hard to overcome is systemic risk (you'll hear this talked about in bad financial times quite a bit).  Systemic risk is essentially the risk of decline in assets due to an overall retraction (or decline) in an economy.  Basically, when everything takes a hit and falls a little in value.

As any good finance pro knows, there's little diversification can do for you in the face of systemic risk (diversification as defined by most investment gurus as owning different asset classes, capitalizations, and sectors).  Cash value life insurance is one of those rare, non-market tied products that doesn't much care what happens when the economy stumbles a bit.  In 2008 when the market crashed hard, cash value life insurance policy holders saw there cash values increase.  For the last decade, those who have watched their investment accounts remain pretty much stagnant (a period knowns also as the lost decade) cash value life positions have done just what they promised to do, increase in value.

Can be used for Charity

I mentioned last time that this topic deserves it's very own post, and I intend to stick to that.  This is a topic of immense possibility.  In fact, instead of one post, it probably deserves a series.  For now, let's just keep in mind that like most other situations, cash value life insurance can make a lot of other things possible, that wouldn't normally be on the table if you didn't own it.

 Insurance Means Safety

I always get a kick out of the comment that if times weren't scary, these guys couldn't even get on CNBC and talk about this sort of thing, little did anyone know what was in store for later in the year.  It's sad, but we know most people life in the moment, concentrating on whatever the flabor-of-the-week topic calls to their most immediate attention.  Unfortunately insurance gets overlooked for its rather abysmal subject matter, and requires scary financial times or flat out tragedy to move to the forefront of most people's mind.

However, those in the know have benefited from owning this product for quite some time.  I don't particularly like the commodities comparison, since owning cash value life insurance requires far less sophistication (and is tons less risky) than commodities.

Stocks enjoyed a good run as the dominant asset class after having an incredibly lucky stretch that propelled them into the media's focal point.  That time has come and pass, the age of the Hummer, McMansions, and other ridiculous consumption fueled by a false sense of wealth brought on by unrealistic security and appreciation potential of a few asset classes has come to and end and it's time to get back to basics.  

About the Author Brandon Roberts

Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. A specialist in the design and application of life insurance cash accumulation features, Brandon is one of the foremost authorities on the subject of coordinating life insurance cash values in a financial plan.

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