Participating Whole Life Insurance As an Alternative Asset

Participating Whole Life Insurance As an Alternative Asset

Life Annuities

The Participating (Par) whole life insurance has emerged as a high growth asset class. Its comparison is drawn to fixed income investments like Government Bonds. Before making an analysis about this investment, it might be a good idea to underscore three key characteristics of a solid investment:1-Of course, the first key factor is the rate of return on any investment. What we tend to forget is that some costs are already factored into the returns; while other costs are not. Any viable investment must have positive net present value (NPV) after factoring in all possible costs (expenses).2-Second it is important to analyze the risk factors of different investments. Although there are many different types of risks associated with various investments, but three factors are critical: Volatility of investments typically judged using Standard Deviation metric; Liquidity or how quickly an investment could be transformed into cash; and potential loss of capital permanently because of business or market risks. In addition to these three key risks, there are also unique risks for specific investments like the interest rate risk for the fixed investments.3-Third, how does this investment fit into your holistic picture of wealth management (creation). Does it address your key need or objective?We can analyze Participating (Par) investment in the context of above framework as follows.1-Participating (Par) Whole Life Insurance is a conservative investment from the standpoint of returns. It can be compared to any existing fixed investments but it is not logical to compare it with any equity investments. Par Accounts of top insurance companies in Canada generally invest in stocks, bonds and even some private equity companies. There are two components of returns in case of a Par product: first the guaranteed portion of tax-preferred cash value and guaranteed death benefit. The second component is an opportunity for the policy holders to receive non-guaranteed dividends.2-Risk Assessment of an investment is as important as expectations about returns. The three key risks analyzed in the context of this Framework are as follows:-The Volatility risk of Par Investments is minimal. This is primarily due to smoothing techniques applied by the Portfolio Managers to smooth out short term fluctuations. The Standard Deviation of this investment is generally lower in case of Life Insurance Policy because of application of various smoothing strategies by top insurance companies.-Liquidity Risk in terms of potential recovery of invested premiums is quite high in the first 7-10 years, as the cash values are built slowly. Viewed in this sense, Par is a long term investment which not only performs excellent role in efficient estate management but also covers the longevity risk. Statistics point out that there is a substantial probability that Canadians may live many more years beyond age 65. The Par product may be the right fit under such circumstances owing to tax-advantaged cash growth inside the Policy.3-Needless to state, Life Insurance in particular is driven by the specific needs of investors. This also applies in case of other investments but “asymmetric information” embedded in most investments typically leads to less than efficient decisions. Another major advantage of Par Insurance is that dividends accrued to the Policy are vested regardless of any market movements; and these are not exposed to any losses or downside risks.

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