When we talk about asset classes, we tend to refer to equities, fixed-income, and sometimes, alternatives such as private equity. And when people think about life insurance, it’s usually in the context of estate planning.
But what about life insurance as an asset class?
Turns out, for some investors, there can be substantial merit in using a life insurance policy as part of a portfolio.
Par: Not Just a Golf Term
There are different types of life insurance policies, each with their own advantages and drawbacks. Term, for example, is really only used to pay a death benefit in the event that the insured passes away at an early age.
Within the permanent life insurance category, there is a specific kind of policy that may be beneficial to investors: Participating whole life, or “Par”, for short.
Participating whole life policies come with guaranteed premiums, guaranteed cash values, and a guaranteed death benefit. And the reason they’re called “Participating” is that owners of these policies literally participate financially. Premiums from these policies go into a separate pooled account, part of which is used to pay claims and other expenses. The remainder is invested in bonds, equities, and assets such as commercial mortgages. Assuming the participating account grows in excess of its obligations, account holders are eligible for so-called policy dividends.
A History of Solid Returns
It’s a truism that in the world of investing, there’s always a trade-off between risk and reward. But there’s not necessarily a linear relationship. Indeed, it is possible to spot investments that have what we call “superior risk-adjusted returns”. Another way of saying this is, some investments perform quite well even though they aren’t particularly volatile or come with significant downside risks.
Past performance is no guarantee of future results, of course. That said, participating whole life insurance has historically performed very well on a risk-adjusted basis. The following Sun Life chart offers a sense of how par accounts have done going back decades compared to various benchmarks.
Source: Sun Life
As you can see, the Par Account had 25-year average returns only somewhat less than Canadian equities, but with significantly less volatility. What’s more, the historical returns easily beat two fixed-income competitors: Government of Canada 10-year bonds, and 5-year GICs. And once again, the Par Account achieved this outperformance with a substantially lower standard deviation (i.e. volatility).
Is Par for You?
Par isn’t for everyone. For one thing, as Sun Life noted in a research paper, anyone considering this investment strategy must meet at least three criteria:
- The policy owner (the insured) must be insurable. This may sound self-evident, but someone who wishes to be a par account holder must qualify for life insurance. Certain risk factors may rule them out.
- A need must exist. A person applying for par must demonstrate a combination of physical health and financial health needs that the insurance will address.
- The insured must be willing to forego some liquidity. Compared to cash and fixed-income, par whole life is not nearly as liquid, although the cash value of the policy will build over time. Those who may require immediate liquidity should probably steer clear.
In addition to the above, it should also be noted that par account owners must have the resources to pay the premiums each year.
The Goal of the Strategy
Using participating whole life insurance as an investment has two broad objectives. First, an investor may be able to achieve returns that are not far off equities, yet with risk levels that can be even better than fixed-income. Second, some people can use life insurance as an alternative to traditional fixed income in their portfolio. This approach may allow them over time to devote more of their holdings to equities, which historically have come with the prospect of strong growth.
Interested in seeing if this strategy is right for you? Feel free to reach out to discuss with me further. I’d be happy to chat.