I believe that there’s some theory around how an investor should perform asset allocation - something that says x% in equities, x% in reits, etc.
Is there anything out there that speaks authoritatively to asset allocation when using a life insurance policy as an asset class?
The retail side of things suggests 20-25% of one’s portfolio (for HNW people). So I’m sure that’s nice to sell a huge policy (one of these paid for a kitchen reno a few years ago ). But, is there anything succinct that justifies this beyond ‘pulled it out of my nether regions’?
Or, is there anything that suggests 20-25% for fixed income assets? Since a life policy is generally suggested as an alternative, I could reasonably argue that it would be close to that number, but less.
Not life insurance specific but CAS Exam 9 definitely goes into some detail on this, but at the core it’s focused on risk tolerance. That said in my limited understanding I think life insurance really shines in estate taxes…?
Yeah, and risk tolerance is squishy stuff. So we get ‘questionnaires’ and from that we get ‘20-25%’, and I argue ‘10-15%’ and then someone says ‘so, why is your number lower’. And I have reasons it should be lower than 20-25%, but no reason it should be 10-15,and no basis for the 20-25% as the starting point.
I’d like to have some knowledge, if it exists, that says '10-15% is justified, because math.
I suppose it can be framed in a sort of confidence interval type of thing. You want to be at least such and such sure that your portfolio will appreciate by at least x at time t. If you can accept less of a guarantee (more tolerant) you can have higher expectations over longer periods of time.
Although I’ve just converted the issue of risk tolerance into an issue of how sure you need to be that your portfolio will do xyz.
Yeah, I get that, and have a better-than-consumer level grasp.
It seems like there is no answer, only generalities. Which is fine, I just don’t want to tell somebody ‘x% because of these rational reasons’ only to find out that there’s theory that says no, it should be exactly 18.5% or something.
Geez, if I had the time (and also about 50% more horsepower between my earlobes), I think it’d be cool to do a paper on estimating how much of one’s portfolio one should keep in a life insurance policy. And at what point one should consider using life insurance as an investment. I’m sure the industry would love to point to a paper that says 'if you have more than $2mm in assets, you should spend $250K on life insurance premiums".
Thanks for the input folks.
Except for tax considerations, I think it’s very rare that life insurance makes sense as an investment.
Now if you have a situation where you want some death benefit protection, and are considering permanent life vs “term and invest the difference”, permanent life might win (even ignoring tax considerations) in some cases, but even there most of the comparisons would have to assume that you would have a need for the death protection for MANY years.
In the real world, permanent life may also turn out to be a better choice for some who plan “term and invest the difference” but in practice “term and spend the difference.”
I don’t work in life so please excuse me if I have a misunderstanding. Doesn’t permanent life guarantee a certain level of return and provide for an opportunity for more? So similar to bonds, it provides a safe investment for a guaranteed return. After watching the stock market the last week and seeing a non-trivial amount of my retirement fund disappear, that kind of predicable and guaranteed return is attractive. Also, can’t the cash value in a life policy be converted into an annuity without being taxed? If that is the case, it provides an additional income stream in retirement with some tax sheltering benefit.
It’s not rare. not common perhaps.
Once you’ve got a few million in investable assets, you’re gonna have some money in fixed income - and some of the assets you’ll never touch in your lifetime.
Life insurance death benefits, over timeframe ‘until death’ will generally beat the heck out of fixed income - making it a great investment as an asset class.
At least, that’s in Canada. I think death benefits can sometimes be taxed in the US, which may make this less attractive. But in Canada, every time I run the numbers (and I’ve run these numbers past actuaries in the past), for someone in those circumstances, it’s a great investment.
Well, there’s two ways you can look at investing in an insurance policy. Either the cash/investment values, or the death benefit.
I’m never a fan of using the cash/investment values as an investment. I think it’s a weak arguement, and more a sales job.
Using the death benefit though - that’s absolutely a great idea.
Because the death benefit is often guaranteed, for any given timeperiod we know the return on premiums. Die in year 10, you just made a bajillion percent return. Die at 100, and you made maybe 2.5% or something. And again, with the timeframe assumed, the return is guaranteed assuming the db is guaranteed.
So you only need to weight it based on mortality. And doing that will give you a better rate of return than fixed income (compared after taxes) because the death benefit gets paid out tax free. After tax on fixed income, maybe 2% over your lifetime. After tax on a life policy, maybe 3-4% over your lifetime - those are the kinds of numbers I’ve seen.
Fixed income is often thought of as guaranteed, but it’s generally not. Even stuff like bonds and the like, they’re only guaranteed for the duration. you might be guaranteed 3% on a 5 year instrument now, but what’s not guaranteed is what it’s going to be in 5 years - or 30. Life insurance guarantees are better because of that - we know what the return is over 30 years, guaranteed.
So, for a married couple life insurance as an investment can make a lot of sense. You keep the life insurance on both spouses, collect the death benefit when the first one goes, and then cash in the other policy. Kind of the ultimate rainy day fund.
That works? For cash value insurance? I’ve never seen it presented that way.
There was a note in the CFA syllabus about human vs financial capital and using life insurance as a hedge. I’ll try to dig it up in the morning.
Moshe Milevsky is one of the authors.
I got to see him speak on life insurance once. A memorable experience.
The note is called “Human Capital, Asset Allocation and Life Insurance” (2005) by Ibbotson, Chen, Milevsky, and Zhu.
Slight tangent but I was interested to read more about the history of insurance in the US and I started reading a book about the history of US life insurance. Kinda interesting the US was slow to adopt due to morality concerns (although I think I’d argue neglecting life insurance is more morally problematic). I guess people get squeamish thinking about having to deal with the consequences of untimely death.
Thanks! I’ll read that in more detail but a quick overview seems to indicate that they’re just doing a fancy version of ‘buy term insurance to replace income’ and not so much using life insurance as an investing asset class.
Still worth a read though, thanks again.