You know the value that whole life insurance provides to your clients, in both good times and bad. In today's economic uncertainty, however, many clients are naturally focusing on their investments. How do you remind clients of their protection needs when their attention is on their portfolios?
The answer is simple: Demonstrate the benefits of factoring the value of human capital into an overall financial strategy. Insurance and investments -- what was once divided is now united.
It's not surprising that insurance needs and investment strategy have been separate discussions -- one protects them from the future's uncertainty, while the other helps families prepare for the future.
This missing part of the equation
Traditionally, financial professionals have focused solely on financial capital when valuing an individual's net worth. However, what they're leaving out of the discussion is the value of an individual's human capital -- the present value of future earnings. An investor's true economic worth consists of these two components combined, and leading investment researchers now know that bringing them together provides additional benefits.
Human capital can more easily be thought of as your earning potential. For example, a 35-year-old who earns $40,000 a year and plans to retire at the age of 65 has the earning potential of $1.2 million, while a 55-year-old who also earns $40,000 a year and plans to retire at the age of 65 has the earning potential of $400,000. In general, as one's career progresses, a person sets aside a portion of their human capital and creates financial capital through savings and investments.
If we assume the 35-year-old's financial assets are worth $60,000 and we combine that person's financial capital with his or her human capital, we realize that his or her true net worth is actually $1.26 million. Without life insurance, a person's total economic wealth is not protected and, in this example, the family would lose nearly 95% of the total wealth in the event of that person's death.
For most of a person's working years, one's human capital is often the largest portion of his or her overall wealth and its amount and volatility should be considered when building an asset allocation. Life insurance, of course, is uniquely suited to protect human capital. The cash value of that life insurance also affects the risk and return characteristics of the overall portfolio, and independent research proves it.
Impact on asset allocation
Since human capital is determined in part by earnings volatility, human capital can have an effect on an individual's overall asset allocation. It's easiest to view the stability of one's career choice as either a stock or a bond. A relatively stable profession like a government employee could be viewed as bond-like. However, a career with earning potential dependent upon the volatility of the stock market might be viewed as more stock-like, with higher earning potential but increased risk.
Identifying whether an investor's human capital is bond-like or stock-like will influence the overall asset allocation. An individual who has a highly stable career such as a teacher can theoretically afford to be more risky in his or her investments because that risk can be balanced by stable income. However, an individual with a highly volatile career such as a stock-broker may need to be more conservative in his or her financial capital asset allocation.
New research on life insurance's positive impact
The benefits of combining insurance and investments go beyond simple theory. The following scenario illustrates that having life insurance as part of the overall asset allocation provides optimal total economic wealth.
First scenario -- no life insurance: Investor A's total economic wealth consists of $1.5 million, with $800,000 in human capital and $700,000 in financial capital. Because the investor does not have life insurance, her legacy amount (financial assets bequeathed to surviving household members) is limited to only $700,000.
Second scenario -- life insurance: Investor B also has economic wealth of $1.5 million, with $800,000 in human capital and $700,000 in financial capital. However in this case, Investor B allocates $10,000 of his financial capital to purchase $600,000 in life insurance. Investor B's total economic wealth is marginally reduced to $1.49 million, but he has increased his legacy amount from $700,000 to $1.29 million.
An additional point is that Investor B, by having life insurance as a portion of his asset allocation, has more than the advantage of an increased legacy. The life insurance cash value portion of the portfolio represents a bond-like asset, based upon the life insurer's conservative portfolio of investments underpinning its long-term commitment to policyholders. Therefore, Investor B may be more aggressive in other areas while still meeting his overall target asset allocation.
Those who have separate life insurance discussions may not be appropriately factoring in this stable asset, unintentionally overweighting their overall portfolio to fixed income and keeping return potentials lower over time.
Introducing insurance into the conversation
The traditional benefits of permanent life insurance -- tax-deferred accumulation; potential to receive dividends if declared; guaranteed cash value; access to cash value via policy loans (which accrue interest and reduce cash value and death benefit); and generally a tax-free death benefit -- are well known. Most life insurance professionals can effectively demonstrate these benefits when discussing protection needs with clients. The challenge we frequently face is engaging clients in a discussion about life insurance in the first place.
Without that discussion, clients won't have the opportunity to identify their protection needs and learn about solutions to fulfill those needs. The integration of insurance and investments within a single strategy provides a relevant and engaging starting point with clients.
Life insurance and investments each offer many benefits to clients. But uniting them provides a much greater impact -- the dual benefit of hedging against a family's loss of human capital while also optimizing their portfolio. Considering the protection and risk profile of human capital, while also assessing risk tolerance and setting asset allocations for financial capital, is critical to properly helping our clients. Armed with this knowledge, you'll be able to focus your efforts to help your clients with multiple needs, all within the same conversation.
Michael J. Gordon is senior vice president, Agency-Life Operations for New York Life Insurance Co., and Timothy J. Leahy, CFP, is a Boston-based agent with New York Life Insurance Co.
