This is a guest blog written by Justin W. Smith, founder of the insurance consulting firm, Balanced Strategies, LLC. This is part 1 of a 3-part series from Smith on using life insurance to guard against the biggest threats to wealth preservation. Smith is also a general agent at Cavalier Associates.
Life insurance is never bought, it’s sold.
Many professionals feel this adage accurately describes the tough task of successfully selling life insurance.
Most clients don’t want to think or talk about life insurance. They‘ve been conditioned by other advisors – often wealth managers – that life insurance is an expense, a waste of money.
In reality, the life insurance professional’s real competition is not other agents. Rather, it’s the Goldman Sachs, Merrill Lynch or Bernstein wealth manager who has been handed the keys to an investor’s financial future.
They’ve successfully conditioned investors to think about risk and reward, returns and efficiencies and balanced, diversified portfolios. The investor expects a quarterly meeting to review results, discuss objectives and make changes.
life insurance as an asset
One of the by-products of this conditioning by wealth managers is that the life insurance professional fights an uphill battle when talking about tax-advantaged aspects of life insurance, leaving legacies and caring for loved ones. I’m not saying that any of those approaches are inappropriate, but certainly challenging.
However, a client, who’s also an investor, needs to see and understand life insurance as what it really is: A non-correlated financial asset with tax advantages that’s designed to provide liquidity in different ways.
And the real returns from cash value and death benefits can be designed in a manner that squarely competes with the real returns of other assets. In fact, when designed appropriately, it can predictably outperform other assets.
studying real real returns
Thornburg Investment Management published an eye-opening piece of research in July 2013, titled A Study of Real-Real Returns. The study focuses on three factors that impede real wealth generation: Inflation, Taxes and Investment Expenses.
Chart obtained from Thornburg Investment Management’s “A Study of Real Real Returns”.
It’s a riveting piece that demonstrates that while the S&P Index celebrates a NOMINAL, compound annual return of 10.80% for 30 years ending December 31, 2012, the real real return, after adjustments for inflation, taxes and investment expenses is 5.79%.
Similarly, for the same period, the Barclay’s U.S. Corporate Bond Index enjoyed a NOMINAL return of 8.84% while delivering a real real rate of return of 2.12%.
And as JP Morgan Asset Management forecasts in their 2013 Long Term Capital Market Return Assumptions, the outlook for the next 10 to 15 years among commonly advised asset classes is more modest on a nominal basis than the 30-year period just experienced.
Everything is subject to inflation, and while there are many varying concerns on the subject, it remains low and JP Morgan expects 2.5%.
life insurance as part of the portfolio
When an investor contemplates the real real returns of all asset classes, life insurance rises to a more pronounced place in the asset class discussion.
Whether it’s high cash value life insurance that can outperform other cash alternatives and deliver tax efficiencies, or a properly constructed tax-free death benefit that significantly outperforms equities on a real real return comparison, life insurance has to be considered as a part of a diversified portfolio.
Policies can be designed to provide a real real return (inflation adjusted) on death benefit that exceeds 7.5% at age 95, for example.
The key is in presenting on the same playing field as the competitor – not the competing agent, but their Goldman Sachs, or Merrill Lynch, or Bernstein wealth manager that has likely achieved real real returns that are far less appealing than the nominal returns discussed at the quarterly review.
I suggest, rather than talking about the taxable-equivalent IRR, which paints a picture far from reality, show the real real returns and place that squarely in the discussion. Clearly, in the real returns analysis, life insurance stands a part as a distinctly attractive asset class.
It’s about resetting expectations of the investor – the potential client – on asset classes and their returns. It’s also about the foolishness of not including properly-designed, tax advantaged life insurance as an alternative asset class in a diverse portfolio.