I have to start by saying I don't think that taking out life insurance on someone else's life should be a strategy for your retirement or financial independence plan. But as life happens, sometimes children take over their parents' life insurance coverage as a way for the kids to inherit from their parents. I want to delve into the pros and cons of continuing a life policy, find the breakeven point and return on investment(ROI). We will find out if life insurance can be an investment. 

What is life insurance?  

Life insurance is a financial product that provides a lump sum on the death of a designated policyholder to a beneficiary. Old-generation life insurance had a savings element included in the policy, but modern life insurance works similarly to car insurance where you pay to cover certain risks. If you cancel the policy you don't get your money back. This is where the tricky part comes in when deciding to continue with a life insurance policy or not. 

Life insurance policy risks are taken into account at the initial assessment of the policyholders' risk level. Life insurance companies assess risks based on health and lifestyle factors such as your drinking habits, do you smoke, whether you are educated, what gender you are, previous health issues, any dangerous hobbies, etc all of which play a role in their risk assessment for the policyholder's life. The life insurer will determine a premium for the policy based on the assessed risk levels. The policyholder can then choose a premium pattern for the future based on affordability.

Life insurance pros and cons

I mentioned the tricky part of life insurance: you don't get your money back once you cancel the policy. Assessing your life insurance needs and ability to pay future premiums is vital to thinking about life insurance as a potential investment. Let's delve into some of the pros and cons 

The math behind life insurance as an investment 

There are a few things to keep in mind when thinking of life insurance as an investment. These are: 

Premium start date: Did you pay the policy from the start or took over payment responsibilities a few years after inception? Starting to pay at a later point has obvious benefits to the beneficiary as the cover amount is much higher than contributions to date.

Premium start amount and escalation rate: Percentages stay relative. If your premium starts at R500pm a 10% increase is only R50 bucks extra, but a premium of R2000pm has a R200 increase, which is four times more. The higher your starting premium the more you should consider the affordability of future premiums.

Cover start amount and escalation rate: The same principles above apply to the cover amount, which could have different escalation rates depending on the initial agreement. 

Examples of life insurance as an investment 

Let's take a look at two examples. The first one will be a valid investment case for life insurance as an investment, the second is not a good choice as an investment. The tool will then turn to the dark side by inserting expected death dates for the policyholder, which will then calculate your ROI at death for the life insurance as an investment. Let's dive into the first example:

The first example has a start date of 1 Jan 2020, this person took over a life insurance policy with a value of R1m(increases at 5% per year), which they pay R500pm (escalating at 10%)

As can be seen, the breakeven point for this investment is at 60 years, which is a very long time for this policy to remain in the money. I inserted a random year(2040) this person will pass away and we still have a 590% profit on this investment. 

The second example has the same start date of 1 Jan 2020, this person took over a life insurance policy with a value of R1m(increases at 5% per year), which they pay R1500pm (escalating at 15%) due to the policyholders' pre-existing medical conditions.

As can be seen, the breakeven point for this investment is at 24 years, which is a much shorter time for this policy to remain in the money. I inserted the same random year this person will pass away as per the first example and this beneficiary will have a 24% profit on this investment. Affordability and likelihood of this policy being canceled would have been very high.

Summary

This article indicates that there could be cases where the life insurance can be continued as an investment, but you need to ensure your affordability of future premiums. Download the tool on our website for free and calculate your potential return on life insurance as an investment. 

At Finsights, we want you, the everyday hero, to take control of your finances, become aware of financial independence, grow your knowledge, and let us be your financial independence partner. 

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