More on Life Insurance
More on Life Insurance
Patrick Hanzel, CFP®
Updated January 26, 2021|7 min read
Table of Contents
Life insurance is a risk management tool that ensures the financial protection of your dependents if you unexpectedly die. But some permanent life insurance policies have an investment-like cash value component, which can be used by the policyholder while they are alive.
Similar to stocks and bonds, the cash value of a life insurance policy is subject to market forces. And at the end of the day, life insurance is a business, which means it’s impacted by economic growth and contraction. But that doesn’t mean there’s cause for concern when it comes to your life insurance policy.
Despite initial COVID-19 fears that shocked the markets in the earlier months of the year, the year ended with historic highs. While this means cash value policyholders don’t need to brace for a major financial impact on their policy, they can be equally assured in adverse economic conditions. Thanks to regulations in place, a poor economic outturn doesn’t necessarily mean you’re going to lose your cash value or life insurance policy. Still, using your life insurance as an investment vehicle isn’t recommended, as it increases the cost of your policy with minimal payoff in returns.
Traditional cash value policies, like whole life insurance, have a fixed interest rate set when you purchase your policy
The growth of the cash value of indexed universal and variable universal life insurance policies are reliant on stock market performance
Term life insurance has no cash value and term policies are not impacted by market fluctuations
Life insurance is best utilized as a risk management tool and the gains on life insurance investments aren’t comparable to traditional investments
There are various types of permanent life insurance, and how their cash value fluctuates based on market trends depends on the type of policy you purchase.
The policies that will see the biggest impact from stock market fluctuations are indexed universal life and variable universal life policies. Traditional permanent policies have a cash value with an interest rate that does vary, but can be pre-determined each year based on how the insurance company did the previous year — safeguarding it against market volatility.
Aside from the cash value implications, purchasing a permanent life insurance policy isn’t impacted by stock market performance. The cost of your permanent policy is determined by your health profile and life expectancy, not market trends.
The interest earned on the cash value of a traditional life policy, such as whole life insurance, is set when you purchase your policy and remains the same regardless of market trends — unless altered by your insurer. Because the rate you receive is usually based on the insurer’s market performance, interest rates for permanent policies vary across insurance companies and policyholders.
A financially sound life insurance company might set high interest rates, while a life insurance company that isn’t as financially stable might set a lower interest rate. The better a life insurance company is doing, the more good fortune they can afford to pass along to their customers, which is why it’s important to ensure you’re purchasing a policy with an insurer in good financial standing.
As long as your life insurance company is in good financial health, you can expect some stability on your investment because your cash value’s rate of return won’t fluctuate with the market. While you shouldn’t see much of an impact on your policy due to a dip in the stock market, this means that when the stock market is doing well, you’ll see comparatively minimal gains.
Universal life, indexed whole life, and indexed universal life insurance policies have a variable interest rate that is based on the stock market index. They are most commonly set on the S&P 500 index, though the policy usually has a floor and a cap in terms of how low or high your cash value interest can build. Most policies have a floor of 0% and cap gains between 8% and 10%.
When there’s a lot of volatility in the market, the guaranteed floor set by the insurer means that in theory, your cash value won’t depreciate. But, you’re still paying into the cash value of your policy and not receiving anything in return, and this doesn’t account for the probability that your money could be worth less later due to inflation. Likewise, if your policy has a 10% maximum rate, you’ll see lower levels of return when the market is doing exceptionally well.
Similar to universal life policies, variable universal life and variable life insurance come with a cash value that isn’t guaranteed. But instead of being tied to an index, your cash value grows based on the performance of underlying investments — such as mutual funds, stocks, bonds, and more — that you select with your policy's advisor.
The performance of your cash value is completely reliant on the stock market performance; if things aren’t going well, you may need to adjust your death benefit or the premiums you pay to avoid losing the cash value or your policy entirely.
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If you already have a term life policy in force, you won’t see any changes to your life insurance policy based on what’s going on in the stock market. And if you’re currently in the market for a term policy, you can expect that the cost of premiums isn’t going to change much in the short term.
Although the stock market has seen record highs and lows in 2020, life insurance companies don’t make quick decisions. Based on the current market, a thorough evaluation of mortality tables, investment returns, and demand could lead to higher premiums in the future, but it’s too soon to tell.
Regardless, you shouldn’t expect to see any significant changes in how life insurance companies address applications now.
Are life insurance companies affected by fluctuations in the stock market? Yes — but most policyholders of the top life insurance companies don’t need to worry about their actual life insurance coverage. Federal guidelines for life insurance companies regarding reserves, ownership of enough stocks with fixed interest rates, and reinsurance are in place to minimize the impact of an economic downturn.
Policyholders are also protected by financial and market regulations from state legislatures and the National Association of Insurance Commissioners (NAIC), which aim to protect consumers against unfair pricing and safeguard their funds.
If you’re buying a life insurance policy, you can further protect yourself by considering the insurer’s financial standing with credit agencies such as A.M. Best, Standard & Poor’s, and Moody’s. Policygenius’ life insurance reviews break it down for you so you can get a sense of each life insurance company’s financial strength.
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The stock market is always fluctuating, so during each economic downturn — and uptick — you can expect that the markets will eventually correct themselves. And while there is some uncertainty about the future of the coronavirus and the U.S. economy, now is still a good time to invest.
When it comes to investing in your life insurance policy, the cash value of a life insurance policy is a low-risk investment, albeit an expensive one due to erroneous fees and administrative costs. Even in a thriving economy, the return on a cash value policy isn’t usually worth the high cost of a permanent policy — 45% of whole life policies are abandoned due to its unaffordability — and you’re likely to see a higher return elsewhere. Furthermore, combining your life insurance policy with your investments is putting all your eggs in one basket, and risks the chance of losing both.
"Since investing in the market through 401ks, IRAs, or other types of accounts doesn't also come with the additional cost of insurance, like you have with indexed universal or variable universal policies, it is usually best to keep those market risks separate from your life insurance," Patrick Hanzel, Advanced Planning Specialist and Certified Financial Planner at Policygenius, explains.
The low rate of return coupled with the fact that it takes decades of compounding interest for the cash value to generate any return makes it a poor investment choice for most people; the exception being someone with a high net-worth who has already maxed out all other investment vehicles. A financial advisor can help you determine how to diversify your portfolio and optimize your investments.
Life insurance and investment accounts offer completely different financial services. A robust financial strategy includes both, but a financial advisor can best determine your needs.
The cash value of permanent life insurance policies grows over time and can support long-term financial goals, like building a nest egg for retirement. However, the returns on a cash value are low compared to traditional investments. Term life insurance has no such cash accrual.
No. Unless you’ve maxed out all of your other investment accounts, whole life insurance should not be used to save for retirement.
Universal life insurance is often not recommended because of its high policy costs, many limitations, and minimal guarantees. Costs of these policies also usually increase over time, which can cut into your cash value growth.