Life insurance: An overlooked asset class

When added to a portfolio, life insurance can boost both diversification and risk protection.

Financial advisors certainly have their work cut out for them in today’s uncertain environment. But they also have the opportunity to lead the way on best practices and become clients’ voice of reason.

Being a voice of reason includes the ability to clearly articulate the benefits of incorporating life insurance into a financial portfolio to help reduce large concentrations of risk, provide upside potential and add some predictability through a guaranteed death benefit.

In the years since the 2008 financial crisis, more people, especially those of higher wealth, are turning to advisors for a variety of reasons. One reason may be that a lack of intimate market knowledge — and the accompanying anxiety — has exhausted investors, driving them away from being involved in the day-to-day management of their accounts.

The Spectrem Group, a research and consulting firm specializing in the affluent, high net-worth and retirement markets, found in its Future Trends in Wealth Management 2011 report that about one-quarter of all investors, regardless of wealth, considered themselves to be self-directed and made all investment decisions on their own. That means three-quarters of investors are looking for knowledgeable guidance. Among them are wealthy investors, many of whom recognize their portfolios may have excessive risk exposure that needs to be mitigated.

That risk reduction can include greater diversification within a portfolio and, when done properly, can provide security and stability of assets — and sometimes even a guarantee.

Life insurance as an asset class

Generally, a large part of loss to portfolios is related to ineffective asset allocation strategies and oversight. One alternative solution often overlooked as an asset class is life insurance.

Life insurance has evolved and comes in many different forms. It is sophisticated and multi-faceted. Taking it a step further, some carriers have started blending different components of other insurance solutions to create combinations that meet a range of specific needs, including a guaranteed death benefit. That benefit has been the traditional, stand-alone use of life insurance, but it has never truly been viewed as an asset class.

Many traditional asset classes used in developing a financial portfolio are predominantly focused on accumulation. However, none are typically known for providing protection or guarantees around the asset’s value, regardless of the portfolio’s duration. In today’s environment, not paying attention to that particular risk can have enormous impact on the way wealth is transferred to heirs and beneficiaries.

According to modern portfolio theory, recognizing the relationship among asset classes is essential for constructing efficient portfolios. Fundamental to the theory is the idea of combining diverse asset classes, each possessing unique characteristics and attributes relative to other asset classes. Life insurance meets this broad definition, and some policies are recognized and useful as a separate and distinct asset class.

Advisors need to recognize the unique risk and return characteristics of life insurance that make it a legitimate, separate and distinct asset class with many non-conventional uses, such as in the construction of an optimal portfolio. Structured with the right combinations, life insurance can offer predictable value and a sure way to transfer financial legacies via a guaranteed death benefit with tax efficiencies and market-driven growth potential.

For advisors, this means new opportunities.

Special advantages for various life stages

According to a study of the Dow Jones Industrial Average by American Funds Distributors, a leading mutual fund company, bear markets resulting in a decline of 20 percent or more occur about every 3.5 years. That’s a good reason to help prepare clients for that risk by insuring a portion of their assets. Doing so can address longevity issues and protect retirement lifestyles while also ensuring the financial plan can continue to benefit survivors after a client’s death.

Perhaps a client has started a family and is concerned about protecting its members immediately as well as in the future. Maybe a client wants a tax-advantaged way to help strengthen his or her retirement strategy or a tax-smart way to help foot a child’s college tuition bill. A client may have maxed out all of his or her qualified plans and is looking for an additional savings vehicle. Or maybe a client wants to diversify his or her portfolio with an additional cash flow resource that doesn’t increase overall tax expense; reduce the benefits of government programs, such as Social Security; or increase the cost of Medicare premiums. (That is, assuming the life insurance policy is not classified as a modified endowment contract, where life insurance limits exceed certain high levels of premium, or the cumulative premium payments exceed certain amounts specified under the Internal Revenue Code.)

Whatever one’s stage in life, life insurance can offer special advantages to meet specific goals.

As people age, their needs frequently change, and investment risk-exposure can become more pronounced. This is why it is essential for financial advisors to review their clients’ portfolios on a regular basis, identify those changes, and help readjust and reallocate assets as necessary.

The value of education

In today’s constantly changing market environment, an advisor’s client depends on him or her to bring new ideas to all aspects of the financial portfolio. Life insurance is one vehicle that can add predictability to the portfolio. By reallocating a small percentage of the portfolio into life insurance, clients and the financial advisor gain the flexibility to strategically and actively manage the portfolio allocation, potentially improving risk-adjusted performance.

But before an advisor can develop an appropriate asset allocation strategy, it is critical that he or she has a clear understanding of how the assets are to be used.

Many advisors are hesitant to use life insurance because of financial events three decades ago involving sharp moves in interest rates, as well as a lack of understanding about how to apply life insurance as an asset class. Yet, the rules and uses of life insurance have markedly changed, providing a secure way for policies to be used as an effective asset class.

For example, a variable universal life insurance policy may be a good choice for today’s environment and offer the right combination of benefits for those who could gain from a good diversification strategy. Some VUL contracts offer guaranteed death benefits and market-driven potential.

Long gone are the days of big quick gains — though that’s not to say those days will never reappear. However, it’s important to look at the bigger picture of today and see the world for what it is, rather than what we hope it would be. Advisors have an opportunity to redefine their authority and value in helping clients prepare for their future. Those who achieve the greatest success will offer creativity, pragmatism and flexibility in building sound financial programs. The key is access to the right resources and information that clearly explain the value of alternative diversification solutions.

 By Tom Tooley for December 2012 issue of Life Insurance Selling Magazine. Tom Tooley is head of Insurance Solutions Distribution at Lincoln Financial Distributors

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