Life insurance as an investment

Occasionally we hear about life insurance as an investment tool. As I have already mentioned, the use of a life insurance policy for retirement with a collateral loan strategy (movable mortgage) requires great caution. However, when we talk about the generation next, it's different. If there is a will to inherit, it is then possible to consider a life insurance policy as an "investment" tool. With an additional uncertainty component relating to when the death benefit will be received, this tool is a kind of "fixed income".

I often see illustrations of the returns generated by a life insurance policy. In fact, it is a comparison of the return that would be required in a traditional investment tool to generate the same after-tax amount (capital) as that of life insurance.

If the policy is considered to be in the fixed-income category, the alternative tool may be a Guaranteed Investment Certificate (GIC). Otherwise, any income breakdown can be applied to this comparison product. I will call this return the internal rate of return (IRR) by the end of the article.

Hard to beat

Such illustrations show that the IRR thus calculated is often very difficult to beat, even at an advanced age of death, especially when compared with a GIC. One of the reasons is taxation.

A life insurance policy is, at a certain level, a tax equivalent of the TFSA. We pay premiums and we will receive a non-taxable death benefit one day. Thus, when the TFSA space is full, investing in a life insurance produces essentially the same tax effects as unlocking the TFSA limit.

Of course, when we talk about fixed income, it's just the amounts involved ... The death benefit will be received with certainty, but we do not know when. A policy taken on the head of a person currently 70 years of age is likely to pay the death benefit in 30 years ... but it can also be paid within two years.

The illustrations should show the IRR for each year. Obviously, this return will decrease with time. The sooner the death benefit is paid, the higher the return. Imagine the return that would be needed after one year to get a $ 1 million principal if we only paid one $ 50,000 bonus ...

As I said, illustrated IRRs are often interesting up to a very advanced age of death. For example, the IRR may be equal to more than 3% per year even if the insured dies at age 100.

Beneficial for companies

Moreover, if it is a corporation that subscribes to the policy, the IRR is even higher. In order to avoid a taxable benefit to the shareholder, the company must be beneficiary of the policy.

Upon death, the Company's Capital Dividend Account (CDA), which pays a non-taxable dividend to shareholders, is increased by the death benefit less the policy's adjusted cost base (ACB). CBR must, therefore, be taken into account in the illustrations because a portion of the dividend paid out of the death benefit will be taxable if the CBR is not nil. Nevertheless, the IRR is often very interesting, especially if the insured persons are not subject to surcharges.

In addition to the age of death and taxation, the other main reasons that a life insurance generates an attractive IRR are:

The return obtained by the insurer. The insurer invests the sums in reserve until death in long-term investments.

Premium rates. In order to be as competitive as possible in its premium rates, the insurer takes into account a factor known as a lapse. The insurer thus takes into account the fact that some of the insureds will not keep their long-term contract and cancel it before the death. In fact, the lapse rate is the basis of the difference in premiums between a life insurance policy with cash surrender value and a 100-year temporary policy.

Risks of loss

In addition to the fact that this strategy is interesting in many cases, it involves almost no risk. Indeed, the main risk is the non-payment of the premium. Of course, if a policy is abandoned before the death benefit is received, the premiums are simply lost, generating a return of -100% ... For this reason, a policy with a limited payment term may be preferred.

The risk of losing its capital in a bankruptcy of the insurer, meanwhile, is so low that it can be virtually ignored.

Finally, the risk of seeing the insured person die at a very advanced age - thus making it more profitable to invest the premiums in any one account - is not a risk of losing money, but rather of realizing a lower return than other possibilities.

Attention to the need for insurance

Although this strategy does not cause any legal or tax problems, insurers will still want to see a link between the amount of the death benefit and the assets of the insured. Again, it's case by case.