Life Insurance: The Asset that Hedges

Unique among the various types of investments is an asset class unto itself known as life insurance. Life insurance is unique among all the various types of insurances in that it insures against an event, death, that will occur as opposed to an event that may occur.

Although death is a certainty, what is uncertain is the timing; hence, the hedge as to when it will occur.

From an investment point of view, the timing of a death is totally unrelated to the ups and downs of the market and other investments one may hold. In essence it is this stability that may hedge against one’s portfolio of other assets.

Life insurance, looked upon as a hedge, compared to other strategies individuals use against uncertain future events is quite unique. Farmers and ranchers may buy or sell commodity futures as a hedge to protect their future profits in the event of price fluctuations. Investors may purchase puts in order to lock in profits on their various securities. Life insurance, on the other hand, is a hedge against the uncertainty as to when death will occur.

The following lists the various reasons one uses life insurance as a hedge against an untimely death.

1)  Preventing the necessity of selling assets at the wrong time.

We have all seen over the last few years how asset values have greatly declined. As a matter of fact, most people are even from where they were in 2000. Survivors of an untimely death may need cash now and wish to avoid having to liquidate assets at a loss.

2)  Averting a forced sale.

The production of immediate death benefits can mitigate a need for a forced sale to pay estate taxes for provide liquidity.

3)  Guarding against loss of income.

Insurance can provide an immediate source of income if the bread winner should die and income ceases.

4)  The payment of taxes.

Most people, when asked, would not want their assets to be depleted in order to pay estate taxes. Life insurance will provide the immediate source of cash in order to pay those taxes.

5)  Cash to purchase the business from a co-owner.

Businesses with multiple owners will typically have a buy/sell agreement in place. Upon the death of one of the co-owners, the insurance can be used to provide the immediate source of funding to those purchasing the deceased’s shares.

Insurance as an asset class should be managed much like any other assets one owns such as securities, business interests, and even real estate. Policy audits should be routine in order to achieve the highest probability of delivery of the death benefit.

At the time one purchases a policy, an illustration is provided. The illustration is based on multiple assumptions which will change over time. These changes can have an adverse effect on the continuance of the policy. It is possible that interest rates governing how much premium needs to be paid have gone down and thus if a higher premium is not paid the potential for the policy lapsing is great. This is just one example of the various types of assumptions used. Depending on the kind of policy, there could be upwards of three to five different sets of assumptions, all having a bearing on the policy and the amount of premiums or longevity.

Many thousands of dollars are being spent on annual premiums for a policy that you may believe will remain in force all the way through and beyond life expectancy. Life expectancy is only a 50% chance of dying. It is incumbent upon you and or your trustee to review your policies to make sure they are performing in the manner you had originally intended them to.