By FPA member Henry J. Ramirez, JD, CFP®

Last Updated: June 13, 2011

With all due respect to Mr. Shakespeare, insurance is “not to be” an investment. Long-standing wealth management clients will often ask me about the efficacy of purchasing whole life, or cash value, insurance as an investment. This usually occurs after they have had a very persuasive discussion with an often well-meaning (though frequently self-serving) insurance professional. Typically, they have been told that the insurance policy they purchase will, over time, build up a cash reserve that can be used in the future for possible loans to the policyholder, to help pay for college expenses or fund retirement expenses. In other words, it would be an investment for their future.

In its most straightforward definition, life insurance is a financial arrangement primarily used to transfer the economic risk of loss (in the case of premature death) from the individual to a life insurance company. For example, a father can purchase life insurance to provide liquid funds to replace his future earnings upon his death. The life insurance policy will provide a lump sum or annual payment to his family so they can continue to live in their accustomed standard even after the loss of the family breadwinner.

Life insurance is also used for estate planning. It provides a ready pool of cash to help pay any estate tax due after the death of an individual. It can also be used to provide liquidity to pay estate expenses. In cases where the estate is composed of securities/real estate that are not readily marketable, it can prevent the sale of the securities/real estate at fire sale prices.

What life insurance IS NOT is an investment. Sure, it may sound like a good idea: you pay a premium to the insurance company in exchange for a stated death benefit, the value of which is many, many times the value of the premium paid. There is only one thing wrong with this: you have to die to collect. 

Despite the persuasive argument that good-intentioned insurance agents may provide, here’s why whole life insurance should not be purchased as an investment: 

• Insurance contracts have many fees and expenses attached to them.  
• Whole life insurance pays a very low guaranteed rate of return — usually about three percent. This is similar to the return an investor might expect to get with a certificate of deposit (or, in better times, a money market or bank account) — not nearly the rate of return a smart investor would expect from a long-term, well-managed investment strategy that employs a well-researched and balanced allocation model.
• Policy loans are often subject to limitations and are always subtracted from the death benefit payment if the loan is still outstanding at the time of death. 
• The cash value build-up in an insurance policy is incorporated into the death benefit upon the death of the insured. As the cash value increases, the actual amount of insurance protection the company has at risk decreases. In other words, as the policy owner pays premiums into the policy, the economic risk is slowly transferred back to the individual.
• There may be surrender charges (which are basically back-end sales fees) if you cancel the contract in the first 10 years. 

If you’ve purchased a cash value insurance policy as an investment, there are only three ways to get back the money you’ve paid into the policy:

1. Surrender the policy for a cash payment. This is usually an amount less than the face value of the policy and may be subject to surrender charges.
2. Take out a loan — which usually must be paid back with interest and decreases the death benefit by the same amount of the loan outstanding at the time of death.
3. Die.

The first two options could be costly. The last one is not recommended.

Just as with fire, car, and health insurance, you hope you don’t need to collect on your life insurance policy, but you’re glad you have the coverage if or when a catastrophe happens and you need the proceeds. But as an investment, whole life insurance is “not to be.”

FPA member Henry J. Ramirez, JD, CFP®, is a financial advisor with Wescott Financial Advisory Group LLC, headquartered in Philadelphia, with offices in Miami and Boca Raton.