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LOUISE FAIRSAVE: Value of insurance


LOUISE FAIRSAVE: Value of insurance

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OVER THE LAST FEW WEEKS, the topics have been about life insurance and about assessing the value of an investment. Today, these two topics will be merged in assessing the value of insurance as an investment vehicle.  

The approach of most life insurance sales representatives is to push whole life and universal life policies more so than term insurance policies. They provide a higher sales commission. The whole life and universal life policies, typically called permanent life insurance policies, usually accumulated cash surrender value over time unlike the term insurance policies.

The insurance sales representatives are eager to point out that a term insurance policy has no cash surrender value and it only provides a death benefit; such policies are therefore like throwing away money, especially when the policy holder outlives the term. On the other hand, the permanent life policy holder can see cash value accumulating for the policy over the years; owning the policy is like having a forced savings mechanism.

Let us consider that the premiums for the policies differ significantly.  For example, a term insurance policy bought at age 24 for $100 000 to cover a 36-year period may cost about $600 per year. The actual cost will depend on factors such as the age, health and lifestyle of the policy holder. On the other hand, for permanent life insurance for the same the same candidate for $100 000, the cost would likely be more like $3 600 per year usually broken down into monthly premiums.

Term insurance represents the pure insurance. Thus, the amount that, say, can be imputed as being invested in the investment aspect of the permanent life policy is ($3 600 -600) $3 000 per year. At 60 years old (24 + 36 years), should this candidate live, his term insurance policy would be all expended and there would be no payout benefit.

However, the permanent life insurance policy would have accumulated a cash surrender value somewhere in the region of $100 000 and would remain in force with no further payments while accumulating additional returns until his death.

If he had invested the additional $3 000 (the difference in the cost of the term and permanent life policies) in an investment that provided, say, a six per cent return compounded per year, after 36 years his investment pool would have accumulated over $400 000. Even invested at a modest two per cent compounded interest rate, his investment pool would have reached over $160 000.

The point is that the return actually received through the permanent life investment strategy is likely negative in the long run given prevailing inflation rates. It would make more financial sense to purchase term insurance as needed and invest the difference in cost between a term and a comparable permanent life policy.  This assumes that the policyholder has enough financial savvy to earn a return upward of say two per cent compounded per year.

In any event, it is in the policyholder’s interest to grow in understanding of investing and investment returns as a critical part of building personal financial wealth. Life insurance as an investment vehicle will tend to generate a lower return than the policyholder may be able to earn even through relatively safe investments like a bank or credit union deposit or government bonds.

After all, the insurance sales representative has to be paid his commission, and the company needs to cover its administration expenses, taxes and still make a profit.

Investing in the cash value of an insurance policy is more often than not a poor investment, especially for young persons who need to develop and hone investment skills as they advance in life.

Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.

This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.