Can you Invest Better than an Insurance Company?

The investment sales world is often interested in convincing us that their products are superior, but when proof of superiority is lacking one opts for a common secondary method…bad mouthing the competition. And while there are a number of ways that this sort of thing might take place throughout the financial services industry, one such practice that deserves time here for it utter nonsense is the claim that you and I can easily beat the investment performance of a life insurer and further it’s stupid to think that there is something special they could offer since they are bound to the same market you and I have access to.

The Logic

The “logic” behind this claim is pretty straightforward. Insurers invest in the same bonds, stocks (few), etc. that you and I have access to on our e-trade accounts, so it’s foolish to assume that by placing money with the insurer there is any better return we could ever hope to achieve—after all the insurer is going to hit us up with a myriad of fees that will surely drag down our return even further. So, we should opt for the DIY approach and invest in these same products ourselves. Great allusion for investment salespeople, and would be a really great point…if only it were true.

The Reality

For those who haven’t been in this personal (i.e. retail) investing for very long—or for those of you who refuse to face reality—the options afforded to a life insurer when it comes to investments are far more complex and multi-faceted than anything you and I generally have at our disposal. Even the small insurers have a couple of billion dollars at their disposal for investing, meaning they sit at the very top of any preferred institutional investor category.

In other words, when you have money (and I mean lots of money) you have access to trading executions and investment choices not just everyone can get a hold of. And I’ll use a very basic example to further prove my point. Anyone who has bought an A share mutual fund has no doubt been served a breakpoint disclosure form. This is generally a required disclosure that lets you know that if you place more money with the fund family in which you are about to make an investment, they will cut you a break on the sales load that is assessed against your investment, and more money means more discount. Why?

There are a few reasons behind the economics around breakpoints, but the general idea is that larger accounts are easier and less expensive to manage and as a result the fund company will offer you an incentive to give them more money. Armed with this information, do you honestly think that you would pay the same sales load (or management fee if you want to go that route) that someone with $100,000 in investable assets would pay if you have $1 billion?

Further, do you not think that the options you would have at your disposal if you had $1 billion in invested assets would be different? Try this, deposit $1,000 in a brokerage account, then call the brokerage house and tell them you want to short a stock (any stock, it doesn’t really matter) see how willing they are to lend you the position to pull off your short strategy. Now drop $1 million (you don’t even need a billion for me to make my point) and try the same thing.

There is More than One Market

This one is important because anyone who sells investment products learns this (I know they do because, remember, I used to sell investment products). There is more than just one market. The market that you and I general trade on is the secondary market. This is the market where securities are traded after initial issue. Sometimes we buy on the primary (like when your Merril Lynch advisor called you up with the good news that he could get you into Facebook at the IPO!) but for the most part, we buy and see on the secondary market. And a lot of people think this is it. If a security is traded, this market is where it goes down. Wrong.

As a matter of rule many large (institutional) trades take place on a pseudo-special market in order to prevent rapid price fluctuations. That’s right friends, large positions in your favorite security can be traded each and every day for prices far different than what you see on your Scottrader dashboard without your knowing about it. And this is the standard operating procedure established by the NYSE and other SRO’s in order to keep you (retail investors) from freaking, getting confused, or (and I’m being a tad cynical I admit) realize how screwed you got when you bought just now.

Insurance Company Yields aren’t just about Investment Return

Further pointing out the utter ridiculous of this claim is the complete lack of consideration for the fact that not all insurers derive all of their “return” on investments. For the more business savvy among you, you’ll easily comprehend the notion of return on equity (it is, after all, one of the primary drivers behind your reason to buy or sell many publicly traded stocks.

Insurance is a fairly profitable business and has been for a long long time. Lots of insurers receive hundreds of millions and in some cases billions of dollars in revenue each and every single year without lifting a finger (it’s called current policy holders). And many insurers use the profitability of being in business to further add to the yield cash value products offer (mutuals as we know share profits through dividends, and non-mutuals aren’t exactly interested in hoarding all of that cash if it puts them at a competitive disadvantage).

Things you can’t do with your General Investment Account

We’ve also noted before that there are many things you cannot do with your general investment account that you can do with cash value life insurance. Things like, access cash at any time for any reason without forfeiting the return you would have earned on that money if you had left it alone. Lending yourself money that has no fixed repayment schedule, is not reportable to any credit rating agency, and is not amortized (i.e. costs you way less). Leverage a death benefit either for cash, or the ability to use other assets more liberally because you have a death benefit to back it up. Leverage the cash value at a bank with a much higher percentage of loan to values since cash values don’t have to contend with principal risk like stocks and even bonds do.

So, the notion that you can best the CFA’s working at the helm of all major life insurer’s general accounts is utter nonsense based on a fictitious axiom that you all have access to the same tools and further defunct by the fact that return means more than just the yield you achieve by year’s end and should be thought in terms of what you can ultimately accomplish with the money.