Bill Black, CLU, ChFC, with W. H. Black & Co. in Winter Park, Fla., began paying more attention to the internal rate of return (IRR) values he was seeing on the life insurance illustrations he was giving clients a few years ago.
The numbers showed the after-tax rate an insured would have to earn on his or her premium payments to outperform the life insurance contract. Under reasonable assumptions about life expectancies and no policy loans, the insurance contracts were projected to provide very competitive returns to insureds who kept the policies until they died.
Black cites several examples. In one case of a tax-free Section 1035 policy exchange, a 76-year-old client considered transferring $127,590 of cash value to a new policy that provided a $231,830 death benefit.
The client initially considered taking the funds and investing them, so Black ran several illustrations that showed the IRR for different life expectancies.
“If he lives to age 85, he would have to earn 6.15% annually after taxes on that money to have it grow to an amount equal to the life insurance,” says Black, in an interview with AdvisorOne. “But let’s push him out five years beyond life expectancy. He would have to earn 4.06% per year after taxes to have that $127,000 grow to the $231,830 in life insurance.”
The numbers also work for multi-premium cases, Black maintains. He has an 84-year-old client whose wife is 81; they are buying an $855,000 policy for an annual premium of $37,000. The numbers still favor the life insurance, says Black.
“If they live 10 years until he’s 94 and she’s 91, which is beyond life expectancy, they’d have to earn 14.42% per year after taxes to beat that deal. If they lived 15 years until he’s 99 years of age and she’s 96, they would have had to earn 4.96% per year after taxes to beat that.”
The catch is that it’s the client’s heirs who will reap the benefits of the higher IRR—the client won’t receive any lifetime cash flow or realization of the policy’s values. But as yields available to conservative investors continued to fall, Black began considering life insurance as an asset class and not just a risk management product.