Can Life Insurance Premiums Really Replace Fixed Income in Portfolios?

You get what you pay for. 

Life insurance policies with low premiums are naturally attractive to clients. They seem like a good deal compared to more expensive options, but there’s a big reason why they cost less. Simply put, policies with low annual premiums are priced that way because they have a low probability of paying out, generally because they are structured as term insurance that has a set expiration date set well in advance of the purchaser’s actuarial longevity projection. Conversely, policies with what seem to be very steep relative premiums have a higher (or even effectively guaranteed) probability of paying out, generally because they are structured as permanent whole life insurance. It’s critical for financial planners to understand this dynamic, and even more importantly, to communicate these differences to clients. 

This isn’t to suggest term policies don’t have value, said Bobby Samuelson, executive editor of the Life Product Review. Term life insurance provides affordable, temporary coverage for a set period, which can be helpful for covering debts like mortgages. Permanent life insurance, on the other hand, offers lifelong protection with a cash value component that can provide liquidity along the way, generally costing significantly more. In other words, term insurance is considered best for income replacement protection during working years, while permanent policies better suit long-term retirement and estate planning. 

Insurance as an Asset Class 

Within this general framework, financial planners are better off positioning high-premium permanent policies more as a long-term asset class to which one is making contributions, as opposed to a more traditional understanding of insurance categories like health, home or auto. In fact, Samuelson said, there’s a solid argument to be made that appropriately priced and structured permanent life insurance policies can supplement, or even replace, a fixed-income allocation in a long-term retirement portfolio. 

“The inclusion of permanent whole life policies changes the efficient frontier,” Samuelson said. Essentially, including permanent whole life insurance shifts the efficient frontier of a retirement portfolio:

• The strategies can offer a low-volatility, tax-advantaged cash position, potentially allowing for increased equity exposure. 
• Assuming it is held over long periods, a permanent policy functions as a true non-correlated buffer asset, reducing sequence-of-returns risk and enhancing sustainable income. 

“With big questions about whether bonds are really working as a non-correlated asset in today’s markets, it’s worth considering what role life insurance can play,” Samuelson said.  

A Big Growth Market. Financial professionals who can effectively tell this story and distribute more life insurance policies as part of a retirement strategy stand a chance of significant growth. “Today, the total amount of cash value in all fixed life insurance policies is about $1 trillion,” Samuelson said. “There are some Vanguard funds out there today with more than that. It’s a huge opportunity to build a business and differentiate yourself.”