You can’t shake a stick these days without hitting some kind of sales pitch for life insurance, but what is sorely lacking is actual historical information on the performance of various options. While this piece is not intended to speak about all life insurance, I thought it would be helpful to look at the actual performance of a successful whole life policy over the last 20 years to see what lessons could be learned.
Whole life policy: a 20-year analysis
Below you will find the actual performance in table format. The more important columns to look at are “End of Yr Cash Value” and “Cash Value IRR Since Inception.”
Please note that this policy began with a 1035 exchange from an existing policy, so it had a little bit of a head start in cash value accumulation. As a result, the policy was in a breakeven state by the end of year 3. (It would have taken an additional year or two for a policy that did not have a 1035 exchange.)
Here are some lessons learned:
- This policy was not funded all the way to the MEC limits, but it was relatively richly funded and had a maximum term blend. Note that by the end of the 18th year, all that term had been replaced with “inside” additions and the death benefit started to grow above the original amount of $750,000.
- After a negative return in the first year, the year-over-year cash value rates of return have been positive in every year and generally increasing as the annual drag tends to decrease over time.
- By the 20th year, the policy provided a year-over-year cash return of 5.03% and an IRR since inception of 4.28%.
I have not ascribed any value to the $750,000 of death benefit protection that was provided since inception. There is value to the death benefit, as it allowed a smaller term insurance policy to be purchased. However, the point I am making with this analysis is more about the cash accumulation, as life insurance is often trumpeted as a quasi-investment alternative.
Whole life policy vs. bonds
Next, let’s look at how the performance of the whole life policy (black dotted line) over time compares with some fixed income alternatives.
Overall, this whole life policy has provided steady returns without any significant volatility over the years.
- The policy clearly dominated T-Bill returns on both a pre-tax and post-tax basis. (I assumed a 30% combined tax rate and no investment expenses.)
- The whole life performance falls between the pre-tax and post-tax returns of Baa corporate bonds.However, the cash value in the life insurance is not as liquid as a bond portfolio, and you cannot access all the cash value without paying ordinary income tax.
Can insurance work as an investment option?
Practically speaking, life insurance as an investment doesn’t make sense unless there is a 100% commitment to keeping the policy in force until death, and that means that access to the cash as a living benefit will be limited to a prudent amount of surrenders (up to cost basis) and policy loans, resulting in perhaps 80-85% of the cash value accessible as a living benefit. The rest of the cash value must remain in the policy and support a residual death benefit, thereby locking in the tax-free nature of the death benefit and avoiding tax on all the gains along the way.
The analysis shows that on a risk-adjusted, tax-adjusted basis, this particular policy has performed extremely well over the last 20 years and has a reasonable expectation of continuing to perform well on a relative basis going forward. It provides a concrete example of how insurance policies, when designed correctly, are able to provide meaningful long-term returns in a similar way to how a long-term fixed income investment would.
One major caveat: This policy was designed with the guidance of a fee-only insurance advisor, such that policy values were maximized at the expense of agent compensation. Company quality is also a major factor. Results will vary dramatically for policies that are designed less efficiently and/or purchased from inferior companies.
If any reader has a policy that has been in force for 20 years or more and has saved annual policy statements since inception, then I will give you a complimentary historical analysis on your policy in exchange for your permission for me to anonymously publish the results. Please reach out to me if you wish to participate.
Does your client need help with a life insurance decision?
Casual conversations or debates on this subject can be very misleading for consumers. The only way a proper decision can be reached is to carry out a full-scale analysis like the one we outlined in this piece.
I am an Actuary and a Consumer Advocate (not an insurance agent) who helps high-net-worth individuals with $100,000 or more invested in cash value life insurance or annuities to maximize the value of their policies.
High-net-worth individuals and their advisors hire me to help:
- Analyze existing life insurance policies and annuities to provide customized recommendations for optimizing value
- Consider impact of objectives, longevity, tax considerations, and opportunity cost on life insurance and annuity decisions
- Access/design life insurance policies and annuities that eliminate (or reduce) agent compensation and maximize policy value
- Provide an unbiased perspective free from any conflicts of interest
- Avoid making critical mistakes and provide peace of mind
- Provide a qualified appraisal on life insurance policies
- Assess whether to buy term and invest the difference or buy a cash value policy
To learn more, please contact me.
Disclaimer
Witt Actuarial Services does not guarantee any specific level of performance, the success of any strategy that Witt Actuarial Services may use, or the success of any program. Information contained herein may become out of date; Witt Actuarial Services is under no obligation to advise users of subsequent changes to statements or information contained herein. There is no guarantee that the information contained herein is accurate. This information is general in nature; specific advice applicable to your current situation is only available through an engagement. Any perceived similarity with persons living or deceased is entirely coincidental.