# On Insurance, Part III – Life Insurance Calculations

I previously argued that insurance is useful for risk transfer, but less attractive as an investment.  I also think that under certain conditions – such as responsibility for minor children or limited savings, you need life insurance.

I thought a quick post using compound interest calculations could help illustrate why life insurance can be an effective risk transfer, but an ineffective investment.

As a 41 year old non-smoking man, \$100,000 of pure life insurance would cost me \$91.07 per month, for the rest of my life.[1]  I would need to maintain those monthly payments – without fail every month – in order (for my heirs) to receive the \$100,000 benefit when I die.  I cannot access the \$100,000 myself at any time, and I cannot waiver from the monthly contribution, or I lose my entire life insurance coverage.

Another option with \$91.07 per month would be to invest it myself.  Assuming a 4.35% return annually on that same amount of money, and assuming I live to precisely my expected life of 37 more years, l would have accumulated almost exactly \$100,000 in savings, to match the life insurance policy payout amount.

The big difference?  I don’t have to die to use that money, either at the end of 37 years or at any point along the way.

Not only that, if I could beat the 4.35% return and achieve a 6% annualized return on investment instead, my 37 years of investing \$91.07 per month would be worth \$149,397.

Of course, if I die early, my investment return goes up.  So I’d have that going for me.  But then, of course, I’m dead.[2]

In addition, if I’m unfortunate enough[3] to live longer than my expected 37 more years, my implied ‘return on investment’ via life insurance looks a lot worse versus a potential return available elsewhere.

Most importantly, if I skip a few months of investing \$91.07 monthly, I still control all of my invested money.  I have access to that invested capital at any point along the way in my lifetime, for other investments – or consumption – as I saw fit.

With life insurance, if you miss a few payments, your policy lapses and all of your money disappears.[4]  In fact, the life insurance business depends on the expectation of policy lapses, as I explained in an earlier post.

So insurance as an investment never matches up attractively, at all, to other investment options.

As a risk-transfer policy, life insurance works great, but keep that function apart from your investments.

And

Insurance II – The Good, the Optional, and the Bad

[1] That’s the quote I got today from my life insurance company USAA.

[2] Although the Lama did grant me total consciousness.  Which is nice.

[3] Yes, that’s sort of sarcastic.

[4] Yes, there are versions of whole life insurance which allow you to skip a few monthly payments, or in which you get to borrow against ‘accumulated value’ in the policy, but I’ll make two quick points about that.  1. That skipping option gets reflected in your premium price (which will be higher than the \$91.07 that I got quoted for a very stripped-down policy, and  2. That option to access ‘accumulated value’ is a way to ease you into the unholy alliance of risk-transfer and investment, violating my cardinal rule of insurance, which is to keep those two functions entirely separate.

## 7 Replies to “On Insurance, Part III – Life Insurance Calculations”

1. ToddR says:

Mike:
Nice calculation and very compelling. The insurance-as-an-investment mantra is just part of the sales pitch that the agent uses to sway unsophisticated prospects. As far as the prospect knows, “money is confusing and this guy in the nice suit seems to know a lot about it so I better listen to what he’s telling me.”

Point worth noting: you briefly alluded to the ROI potential if you die early. When framed as ROI, the return sky-rockets. But, the true purpose of a risk-transfer instrument is to act as a mitigation tool IF AND ONLY IF the sh*t hits the fan (i.e. drop dead tomorrow). Actuaries know this and they can consistently predict life span. It’s just like those “quants” that work at investment houses. There’s a model and it gets tested, adjusted, and re-applied.

1. The Banker says:

I agree with you, ROI is the wrong way to look at insurance. But I can’t resist any opportunity to show how useful compound interest calculations can be for folks in deciphering an otherwise confusing world of money.

2. ToddR says:

P.S. What’s the relevance of the Carl Spackler picture?

1. The Banker says:

Just a reference I made in the footnotes to my own death, and the fact that the Lama had granted me total consciousness, which is nice

1. ToddR says:

The flowing robes, the grace, bald, striking(!)

1. The Banker says:

Big hitter, the Lama. Long.

3. Life Insurance Is Not An Investment

Unfortunately, many (though certainly not all) insurance agents/brokers, some of whom I suspect have commented above, use Variable or Universal Life as if it’s the only tool in their tool box. And when you only have one tool, let’s call it a hammer, everything looks like a nail.

Yes, I’m pointing some fingers here.

The problem I have is when “Life Insurance” is sold to consumers as a cure-all tonic for whatever problem or issue they might have.

I also agree that there are circumstances when permanent insurance is called for, but these are much less often than typical insurance agents would lead people to believe.

If a person lives within their means and saves for their future, then their life insurance need should decline over time. With permanent insurance, even if sold as an investment, you’ll be paying the insurance “costs” for the life of the policy, even if you reach a point where you no longer need or want the insurance piece.

As with all things, buyer beware.

## Public Speaking

I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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