Whole Life Insurance Versus Bonds as Asset Classes

Author
Dr. Robert P. Murphy
Date
December 11, 2023
Categories
Whole Life Insurance, Bonds, Fixed Income, Investing
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At infineo, we help households and businesses set up customized Whole Life insurance policies not merely for the death benefit, but also the “living benefits” that the policyholder can enjoy even while the insured is still alive. In this article I won’t summarize all of these advantages — I refer interested readers to my previous post for a primer on Whole Life as a cash management vehicle.

In the current post, I want to contrast the properties of Whole Life insurance as an asset class, with those of conventional bonds. As we’ll see, within the universe of fixed-income assets, Whole Life insurance is remarkably robust. Every household and business should consider adding a suitably designed Whole Life policy into their financial plan.

Advantages of Whole Life Over Conventional Bond

The first thing people want to know is the rate of return. In particular, many have heard that the internal rate of return on the Cash Surrender Value of a typical Whole Life policy is under 2%. However, if this statistic has any truth at all, it must be referring to people who surrendered their policies early on. In the long run, owners can expect a cumulative annualized return on their Whole Life policy above 4 percent, and in some cases above 5 percent. (See my earlier post devoted entirely to the rate of return on such policies.)

Further, keep in mind that for US policyholders, so long as the policy is managed properly, that internal growth does not trigger tax liability. Moreover, the wealth can be accessed via guaranteed policy loans which are advanced by the carrier itself, with the underlying cash value of the policy serving as the collateral. Again, so long as the owner has funded the policy properly, these policy loans do not constitute income and hence do not trigger tax liability. That means the 4–5 percent long-run returns on the policy should be compared to after-tax returns on comparable bonds.

Even though their internal growth is respectable, life insurance policies are also quite safe. Different carriers have slightly different ratings (which are publicly available), but the big picture is that each state has specific regulations mandating reserves be set aside for life policies. Moreover, there are often “guaranty funds” specifically established to make policyholders whole in the case of a company problem. Finally, in actual cases of a mismanaged life company, its peers will often take over the now-orphaned policies to ensure continuity of service. The people in the life insurance industry want it to be boring. They don’t seek exciting quarterly returns precisely because they want the public to know that their death benefit will be there for their beneficiaries.

Besides a fairly low default risk, is the supreme virtue that Whole Life insurance has zero interest rate risk. Specifically, once a dividend has been issued and a Whole Life policy’s cash value is marked up, that is a new floor; the available cash can’t go down. Even though the carrier itself has used incoming premium payments to buy other fixed-income assets — which do suffer from interest rate risk — the carrier absorbs that risk. The Whole Life policyholder’s asset doesn’t get marked down when rates spike.

This of course is not true of conventional bonds, even Treasury securities. As Silicon Valley Bank discovered, investing in the “risk-free” asset of Treasuries didn’t prevent their company from folding as the Fed raised rates. In contrast, Whole Life policyholders didn’t see the market value of their assets drop by a penny.

As a final note on this issue, I should reassure readers that the insurance companies themselves are not as vulnerable to interest rate risks as the banks. This is because the insurers have future dollar-denominated liabilities in the form of death benefit payments. Therefore, when interest rates suddenly rise, yes it reduces the value of the typical carrier’s assets, but there is a similar reduction in the carrier’s liabilities. Even though the carrier assumes the risks and takes them off the plate of the Whole Life policyholder, by the nature of its business, the carrier is in a better position to shoulder those risks than other institutional money managers.

A Possible Disadvantage of Whole Life versus Conventional Bonds

Considered as an asset class, one possible drawback of Whole Life versus bonds is that a typical Whole Life policy comes with contractually required premium payments, sometimes decades into the future. In contrast, if someone buys a bond, it is a one-shot expenditure.

For some investors, this difference in required cashflows might be a point against Whole Life. Even in this case, such investors will still be able to enjoy the benefits of Whole Life without this drawback, by taking advantage of infineo’s structured products (built on top of Whole Life policies).

However, it’s important to realize that for many investors, including typical households, even this difference is actually an advantage of Whole Life. Specifically, if you think a Whole Life policy is preferable to a conventional bond on several other criteria, the fact that a Whole Life policy can accommodate large influxes of future cash is yet another feature, not a bug.

In contrast, the typical bond, even if it’s (say) thirty years in duration, acts like a leaky bucket. It keeps shooting off coupon payments along the way, which may not be able to be reinvested on comparable terms if interest rates have fallen in the interim. And then at the tail end at maturity, the entire principal is returned. The investor must then start afresh to find a home for his wealth.

There are no such problems with a Whole Life policy. If it’s a policy taken out on the owner him or herself, then by construction it will continue to provide service for the entire lifespan of the owner.

Finally, I should clarify that there is significant wiggle room in the required premium payments necessary to keep a Whole Life policy in force. For example, many policies are designed with optional “Paid Up Additions” riders, which expand the capacity of a policy to take in more cash, but don’t require it.

Even focusing just on the contractually required “base” premium payment, once the policy is sufficiently mature (several years into it), the owner can elect to use the annual dividend payments to reduce or (eventually) entirely cover the premium payment. Further, if there is available cash to be borrowed via a policy loan, the owner could use this approach too if he or she doesn’t want to pony up additional out-of-pocket money into the policy.

Conclusion

To sum up: A properly designed Whole Life insurance policy is an incredibly flexible vehicle for cash management, as well as the obvious death benefit protection. It has several “dials” that allow its capacity to vary, giving its owner a variable capacity to carry wealth on at an attractive growth rate, with very little risk, and with immediate liquidity.

In contrast, a conventional bond can only “place” cash on the front end, and often returns bursts of cash (which must be reinvested elsewhere) continually, along with a return of the entire principal at some point. Its returns will typically be subject to tax, and even bonds safe in terms of default risk are still subject to interest rate risk.

NOTE: This article was released 24 hours earlier on the IBC Infinite Banking Users Group on Facebook.

Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.

Twitter: @infineogroup, @BobMurphyEcon

LinkedIn: infineo group, Robert Murphy

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