Life Insurance as an Asset Class
Our blog, “Life Insurance – A Primer”, concluded that Accumulation Universal Life and Whole Life policies have characteristics that warrant their consideration as a complimentary asset class. An asset class is any category of investment that might be held in a liquid investment portfolio. For example, large and small company U.S. stocks, international stocks, bonds, etc. Life insurance is not an investment and would not be directly held in an investment portfolio but can be an important complement to the fixed income, or bond portion, of a balanced portfolio.
Let’s first look at bonds to better understand how.
A typical long-term portfolio has a 60 or 70 percent allocation to stocks with the balance in bonds. The bond allocation serves to dampen portfolio volatility. First, because bond returns are less volatile than stocks, and second, because their returns have very little (.02) correlation with large-cap U.S. equity returns. Bonds also generate taxable interest income.
A bond portfolio’s return is the combination of changes in its market value and the interest income. The market value of a bond portfolio rises and falls inversely with the direction of interest rate movements. (In 2022, the worst year ever for bonds, the most popular bond index was down 13%, due to the Fed’s dramatic increase in interest rates.) In the accumulation phase of a portfolio’s life cycle, the income is usually reinvested. In the late-stage phase, the income is often distributed. The historical return for bonds is between 4% and 6% since 1926. Let’s see how life insurance complements the valuable role played by bonds.
Let’s use whole life policies to illustrate the concept. In addition to providing an income tax free death benefit for life, the policies build cash reserves. After the first year or two, whole life policies have guaranteed cash surrender values which increase with each premium payment.
