The rate of return one achieves on a cash value life insurance policy is sometimes hotly debated. This is especially true when opining on the adequacy of the rate of return. On the one hand, we have a crowd of people who think it's paltry and represents a foolish financial move because–allegedly–you can do so much better by simply investing in broad U.S. stock markets.
On the other hand, there is the argument that cash value life insurance products–excluding variable products–aren't designed to compete with the rate of returns high-risk investments like U.S. equities represent. They are instead intended as low-risk savings plans that seek to accomplish stable returns with a much higher degree of predictability. When looked at in this light, and compared to similar savings/investment options, life insurance shines quite brightly.
You'll often see comparisons that seek to “analyze” life insurance rate of return beginning in year 1 and moving on to some random point in the future. Since we tend to like whole and even numbers, this is often something like 20 years into the future. These scenarios are so common because few of the people who wish to talk about the subject have any real experience with these types of products, so they aren't sitting on any data that would allow them to evaluate how policies that are actually in force do.
We, of course, are an exception to this. We have many clients who bought whole life and indexed universal life insurance years ago. And we've been able to watch those policies and note how they unfolded since the original purchase.
We've talked a bit about results in the past. Today I want to focus on the rate of return accomplishable by these policies now that some time has passed.
Whole Life Insurance Rate of Return Moving Forward
I looked at a number of policies we have in force. These policies represent a diverse group of people from different ages, policy size, gender of insured, and planned payment period. There is one thing they all have income. They were all designed with best practices to optimize cash value growth for their specific goal.
I pulled current in-force data on these policies and calculated what the effective rate of return for them will be over the course of the next year. The average is slightly over 5%. This means that these policyholders have, on average, a position of money that will earn about 5% next year. Some are a good bit higher than this, none are significantly lower than this. Oh and all of them have been in force for at least five years.
But after just five years of being in force, these policyholders now have something in their portfolios that grows around 5%. It's extremely difficult to buy something now with a similar risk profile to whole life insurance that can accomplish the same thing.
Indexed Universal Life Insurance Rate of Return Moving Forward
I performed the same review of active in force indexed universal life insurance policies using the same criteria above. We have fewer indexed universal life insurance policies in force, so the sample size is a tad smaller. That said, the rate of return for the coming year averages to basically the same number, 5%. All of these policies also achieved index interest earnings in the past year above the policy expenses–something that we didn't necessarily assume would happen for them at the outset.
Life Insurance Gets Stronger with Age
As a life insurance policy ages and cash value increases, the accumulation of cash value through guaranteed and non-guaranteed mechanisms is substantial. There are some who might wish to argue over the lifetime effective rate of return and note that it's lower than the 5% these people will achieve this year–they are mostly correct. But so what? We can't go back in time and change where they put the money. Five years ago we didn't know that the U.S. stock market would take a frightening fall in early 2020 and then roar back to new records. We didn't know that bonds would still be near zero. We didn't know that crypto-currency would play the role it does today–hell 90% of the cryptos that people regularly trade today didn't exist or were so obscure no one knew about them.
The point is that people make a lot of different decisions with their money and that will dilute rate of return. We can't worry about what is done. It's done and cannot be undone.
I'm not going to pass on an investment today because if I had invested three years ago my rate of return by next year would be different.
The fact of the matter is those who bought cash value life insurance–from us–now have an asset that is producing around 5% year-over-year. That's extremely tough to beat in this market with comparable risk profile options.
What's more, life Insurance does not operate in a vacuum. If fixed-interest options improve, so will life insurance. In other words, the relative position life insurance holds among similar risk-profile assets will remain constant. If interest rates go up and those other asset options begin to show higher returns, life insurance is likely to follow this trend.