David H. Kinder, RFC®, ChFC, CLU
Myth #17: "Just Invest the same way that insurance companies do... without the costs!"
Updated: Jan 20
One common response or objection to life insurance and annuity insurance contracts is that, because they have various expenses or surrender charge schedules, critics say "just invest in the same things that they do and save the costs for yourself!" Unfortunately, that is a short-sighted way of thinking.
So, what can insurance companies do that we cannot do as individuals?
1. Transfer risk.
Whether it's insuring a life (life insurance), insuring income you cannot outlive (annuities), or the other provisions in these contracts, the fundamental premise of insurance is to transfer risk outside of yourself.
If you don't do this, you retain the risk. How do they do this? The risk is pooled.
My friend, author, economist, and PBS presenter Tom Hegna talks about "Mortality Credits" in retirement. These mortality credits offset the risks of life insurance which is why insurance companies are uniquely positioned to solve for these risks.
As a side note: there is no such thing as "self-insuring". That's a misnomer that sounds good, but doesn't exist in reality. Now, there can be a point where you no longer need insurance for the purpose of creating funds because your family would be destitute... but that's only one aspect of insurance. There are many others outlined in the tax-code where such advantages really benefit such a situation and help pay the possible taxes incurred at one's passing either for estate planning purposes or for the income taxes still yet owed on various retirement plans.
You can either "pay the premium or own the risk."
2. Have a long-term investment view without fear-induced portfolio management decisions.
Most insurance portfolios invest heavily into long-term corporate bonds. As I'm writing this, it's May 18th, 2022... and bond values are getting hammered. When there is volatility in the marketplace, what is the normal tendency to do? Most investors... panic. They see the interim bond values declining and believe they are losing money. If they sell at the current valuation, they will. Why? They see this as money 'disappearing' and they need that money, particularly for their retirement.
How does institutional money management thinking help? Insurance companies are long-term bond investors. Below is an image from Pacific Life that I found doing a Google Search. This is on their website for 2021 here: https://ssa.pacificlife.com/home/about-us/Insurance-Ratings-and-Financials.html
They often hold these long-term corporate bonds until their maturity. Why? Because, as an institution, they are planning for a far longer time period than just one or two people's retirement.
So, one huge advantage of insurance companies is that they help remove the emotions of the portfolio management, particularly of bonds.
3. Emotional decisions can create an additional risk when combined with Sequence of Returns risk.
It's one thing to take a systematic withdrawal against a given portfolio to create the income needed in retirement - either every month or every year. It's quite another to look at the whole portfolio and, out of fearful emotions, make large trading decisions that can impact the longevity of the entire portfolio. Again, my friend, author, economist, and PBS presenter Tom Hegna talks about the Order of Returns Risk in Retirement in this video clip here:
4. You can participate in the company's portfolio management returns. There are two ways to do this.
One is through a mutual company's participating policies. These are often whole life insurance policies and perhaps their annuity contracts as well. They can be eligible for dividend treatment to be credited to the policy's performance.
Two... is through the general investment account's ability to purchase stock market index call options. Now this gets a bit tricky, but I do outline most of this in another blog article on "How does indexed interest work with fixed indexed insurance contracts" here: https://www.davidkinderfinancial.com/post/2018/10/15/how-does-indexed-interest-work-with-fixed-indexed-insurance-contracts
Here's my bottom line: Having emotional reactions to managing your retirement portfolio... is optional. You don't have to live this way. You can have the safety, security, and guarantees of these insurance wealth contracts to help offset portfolio volatility and take advantage of their tax benefits.