Viewing Life Insurance as an Asset Class

The idea of positioning life insurance as a separate asset class sounds might sound like the latest way to sell a stodgy product. But the argument does have merit, according to Stephen Horan (left), Ph.D., CFA, head of private wealth management at the CFA Institute in Charlottesville, Va. Horan, who has no business ties to the life insurance industry, notes that defining an asset class is as much art as science.

"There is no standard setting body for asset classes," he said, in an interview. "Everybody has a different view but it is primarily a collection of assets that have a common set of risk profiles. So, for example, we often talk about equities as an asset class because they're the residual claimants in a corporate finance setting and that's kind of the common denominator."

Horan believes it makes sense to consider life insurance an asset class. "From a deconstructionist standpoint, an asset is something that generates an expected future cash flow either in the form of income or capital gain and that can be financial, (or) it can be physical," he says. "Life insurance fits that profile."

This is because it will generate cash flow under certain conditions. "What makes it unique and different from, say, a bond, is that the cash flow is triggered by a particular event, not on the part of the issuer but on the part of the owner of the asset; in this case it's death," notes Horam. "(That) makes it a unique asset and as such, in my view, distinct enough to represent a different kind of an asset class."

From that perspective, term life insurance is essentially a put option on the insured's life. The underlying asset is the insured's human capital or lifetime-earnings potential, and the option's strike price is the policy's face value.

Whole life insurance combines guaranteed cash values with the put option. Viewing the coverage this way gives clients additional insight into their portfolio allocations and insurance-buying decisions, Horan claims.

From a financial planning/risk management perspective, however, Black argues against the use of term insurance even if it does constitute a separate asset class. "Term insurance stops at a certain point in time," he points out. "I can't tell you if you're going to be alive or dead then. You can guarantee a permanent policy until the person is 125 years of age and that's way beyond any reasonable expectation of longevity."