Many people mistakenly believe that insurance is an investment that you buy for its benefit.
Almost all life insurance policies are purchased for risk management, not to provide cash in the event of an unexpected death. Most of us still own other life insurance policies that provide a death benefit in case we die prematurely. It’s intended to pay off debt or to provide a survivor income.
Because of its tax advantages, life insurance can also be used as an investment. And that’s not just because of permanent insurance’s cash value.
However, many people mistakenly believe that insurance is an investment that you buy for its benefit. But, when you look at it from a financial perspective, insurance companies are actually just selling investments.
How insurance works?
Many people don’t know the ins and outs of how insurance companies work but they should. Here’s a brief primer on how an insurance company maintains itself financially by using the “residual” model as opposed to the “premium” model:
1) The company charges an initial premium on its products (e.g., car). This charge is in addition to other outflows made by consumers, such as operational expenses and advertising costs.
2) What remains is what’s known as residual belonging to the policy holders. This assumes the policy holder needs to make payments toward the policy.
However, if the policy holder doesn’t need to make payments, insurance company can retain the residual as profit. It is important to note that all types of insurance policies use this mechanism. Such mechanism includes life and health insurance plans.
Not all companies are created equal when it comes to securing their profits. The insurance industry is a great example of this point; there are many different types of insurers that sell various types of coverage at different prices.
People can say insurance companies to be created on a supply and demand basis. It is when it comes to getting new business as well as retaining customers who already have a policy.
Ok, let’s get to the main point…
Is Insurance a Form of Investment?
Well, if you see your insurance policies as a form of investment, then yes, it is. Here are some things to consider when you compare what you currently spend on insurance with what you can get from investing:
1) You are investing upfront and the insurance company is only taking a commission at the end of the process.
2) The insurance company is taking a risk by assuming that it will pay out to its policyholders after paying their expenses. Investors, however, do not take this risk. Instead they’re compensated in case their investments do well through profit sharing system.
3) Most people are able of making more money. But most people are able to lose more than they can ever imagine when it comes to investing in stocks (especially real estate). Insurance however, is designed to pay out of the money you’ve already contributed to it.
4) If a person doesn’t have enough money invested with the insurance company, they’re not able to get any benefits or payments from the policy. However, if you invest in stocks and real estate, you can use your profits to buy more stocks and real estate.
5) While insurance companies are are regulated by different regulatory bodies compared to regular financial investors like banks and investment companies, most insurance companies aren’t regulated that much because they do not make loans (like investment banks).
6) Investing in stocks and real estate is not guaranteed and insurance policies are guaranteed by government agencies (such as the SIPC for investors who use brokers to buy and sell stocks.)
The best thing about investing in any kind of financial instrument is that even if you lose money, you still can be compensated by the tax code as long as your losses are greater than your gains.
Can Life Insurance Make you Rich?
In short: No. Life insurance is a contract that guarantees to pay out a benefit if a specific life event occurs(death, dismemberment, theft, etc.). It is designed to provide financial protection.
It is an important tool for protecting your family’s financial future. Additionally, it ensures that enough money will be available to cover final expenses. And continue your loved ones’ standard of living after you’re gone. However, it shouldn’t be considered as a form of investment.
FAQs about insurance as investment:
1) Difference between insurance and investment?
- The main difference between investment and insurance is that one is secured by something physical (real estate); while the other is secured by something virtual (the insurer’s ability to pay).
2) Should I buy life insurance?
- If you have dependents, life insurance can be a smart way to protect yourself and your family from financial hardship due to death. That said, it’s not something you should overbuy because most companies only pay out the face value of the policy. Moreover, you can always start by calculating how much cash flow your family will need in case of your untimely death. Then, you can back-out what you already have saved for this purpose (e.g., 401(k); and other investment accounts) and that will be the value of your life insurance policy.