Cash-value life insurance provides a safe harbor in the current storm

When equity markets are up and the economy is running smoothly, it’s easy to overlook the value of the downside protection you get from investing in life insurance

April 16, 2020 By Marc Schechter & Jordan Smith

In light of recent market challenges that have impacted the diversified investment portfolios we manage for our clients, many have asked how the cash values in their investment-oriented life insurance policies are weathering the storm. Whole life, universal life and indexed universal life have traditionally maintained their values through tough economic times because they are designed with that very goal in mind. Today is no different.

When equity markets are up and the economy is running smoothly, it’s sometimes easy to overlook the value of the downside protection you get from using life insurance as an investment. Life insurance will never be your best performing asset when things are good – it’s not supposed to be – but in times of turbulence, it can provide a stabilizing influence on the overall portfolio and a potential source of cash that can be drawn upon without having to incur market losses. When structured and funded properly, these policies are designed to provide moderate, steady growth with extremely low risk of loss.

It’s important to keep in mind a few key differences between insurance companies and other corporations, including banks, to understand why insurance companies are generally more financially stable than banks, particularly during times of market volatility:

Investment risk. Insurance companies invest the premiums they collect from policyholders in long-term assets, such as bonds, to ensure that they can pay out insurance claims as they occur over time. The vast majority of life insurance company assets are required to be made in high-quality investments, with approximately 85% in investment-grade corporate bonds and Treasuries, which traditionally perform better than stocks when corporate finances weaken. This means that insurance company investments are generally less risky when compared to the investments made by banks and their affiliates, whose structure and regulations do not limit their investment of lender deposits in a way that corresponds to their anticipated liabilities.   

Insurance carriers are not allowed to use leverage. Unlike banks, investment funds and operating companies, government regulations prohibit insurance companies from using leverage to enhance their performance. This prevents any losses from being compounded during market downturns.

Insurance carriers are heavily regulated. Insurance companies can become insolvent. However, this is historically rare. The states that regulate insurance companies take poorly performing insurance companies into receivership if and when their assets drop to approximately 90% of their liabilities. At that point, they have approximately 90 cents on the dollar to pay off their liabilities. In contrast, most financially challenged corporations are left with an extraordinarily small amount of assets or value when they go bankrupt, and creditors are typically fighting for a much smaller 10 cents or 20 cents on the dollar. Insurance companies have failed in the past, but due to the state oversight and intervention, the companies and the industry ensure that payment of the companies’ guaranteed obligations are made to policyholders

In challenging economic times like these, clients are even more appreciative of the slow and steady 4% to 6% tax-free compounded long-term returns that insurance investments offer. Many of the dollars that our clients have allocated to these products are longer-term dollars that would otherwise have been invested in stocks or bonds. 

Some of our clients own these contracts inside of their estate (in cases where they intend to access tax-free dollars during their lifetime), while others have invested dollars that they had already transferred to an irrevocable trust for the benefit of their children or grandchildren (where the death benefit component of these policies will ultimately enhance the amount of wealth that passes to the next generation). In either case, it is in an environment like we have today that these policies are most appreciated because their value is unlikely to be impacted in any significant way by the volatility that is currently battering the rest of the economy.

While these are turbulent times, policyholders can rest assured that their assets at these life insurance companies are secure in an industry that has secured such assets for hundreds of years. We anticipate nothing different in the challenges to come over the next hundreds of years.

This article was co-authored by Marc Schechter, senior managing partner at Schechter, a boutique, third-generation wealth advisory and financial services firm, and Jordan Smith, the firm’s vice president of advanced design.