Using Life Insurance Products to Fund Long-Term Needs

I have noted recently a number of advertisements offering risk-free investing.  When I dig into them, they are selling life insurance and annuities.  They claim high rates of return with virtually no risk.  Here are the problems:

  • Life insurers have come off of 3+ decades of falling interest rates, portfolio yields are high relative to what you can get in the market today.  Some insurers may show above average rates, but if enough take advantage of them, the rates will fall to market levels.
  • Commissions to agents are relatively high, which has two effects: 1) less investment performance goes to the insured, and more to the agent, and 2) High surrender charges.  If you ever need your money in full, you will never get it back from an insurance contract.
  • People have forgotten the 1970s, with rising interest rates, where many insurers were near bankruptcy, and on a market value basis, many were technically bankrupt.
  • Life insurers that have written a lot of variable business or a lot of indexed business have taken on a lot of hidden equity risk.  Imagine a Great Depression scenario, where equities fall 90% over 3 years, and it takes 20 years more for values to recover.  Guess what?  Virtually all of the life insurance industry dies, whereas most survived the Great Depression.
  • From Mutual Insurers, life insurance dividends are not guaranteed.  In a real crisis, dividend scales could drop to zero.  The insurance you thought was free regains a price.
  • Equity indexed products rarely return well.  When I analyzed them back in the early 2000s, T-bill yields were the result of my models.  Today, T-bill yields are so low that the returns must be better.  That said, you will have to accept low returns versus a long surrender charge.

Insurance is meant for protection, not savings.  It is also meant for scamming the tax man, especially with respect to estate taxes.

Just be wary here, I’m not naming names, because many of these parties are litigious, another sign of weakness.  But there is no “one size fits all” method for Wealth Management.  One of my clients recently complimented me because I don’t try to get all of the assets of a client.  Indeed, I want my clients to feel that they have chosen me for their purposes.  I do not want them to allocate more to me than they are comfortable allocating.

So, be aware of the limitations inherent in life insurance products.  And when you hear that something is virtually risk-free, take a step back and hold onto your wallet.  Nothing is risk-free.  Even with the guaranty funds backing the insurers, the full value of large policies is not guaranteed, much like large depositors in the banks.

The regulation of the solvency of life insurers has been better than that of banks for the last 30 years, but it hasn’t been perfect.  I was on the takeover team that tried to have AIG to take over the Equitable.  AXA overbid, and bought a bad situation just as it was about to turn.

As for AIG, some of those promoting insurance products say that AIG’s life insurance subsidiaries did not need a bailout in the crisis.  That was false, because of the securities lending agreements, and a few other things.  Most of the domestic life companies of AIG received bailout money.

The good record of life insurance lack of default over the last 30 years is the result of three things:

  • Falling interest rates
  • Better solvency regulation than banks
  • AIG’s life insurance subsidiaries were bailed out.

Be diversified, and don’t use just one set of entities to fund your retirement.  Using only insurers runs a lot of regulatory and taxation risk.  A future government may find clever ways to undo the clever tax avoidance that has been achieved there so far.  Spread your regulatory risk.  If you are wealthy enough, spread out your country risk, but be wary as you do so.  Who will support the rule of law better than the US?  Where will governments not tap assets under custody in a crisis?  Remember Cyprus.  It will not be the last place where assets are expropriated for the good of locals, even if locals got hurt as well.