Ask the Expert ~ Guaranteed Insurance Contracts

Approached with an offer to fund a guaranteed insurance contract that will triple in value over 13 years, this doc wonders whether the proposal is sound. It seems, though, that the numbers don't add up.

I was wondering about guaranteed insurance contracts. I am 59 and have assets of around $2 million. I have been approached with a proposal to use 500,000 IRA monies to fund a guaranteed insurance contract which triples in value at age 72 and has a 5 percent rate of return. The principle returns to first my wife at my death and to our trust upon her death. The fees are ~3 percent annually. Your thoughts?

Mike Doran - Market Pulse

I have incorporated a similar type of insurance as part of my investment portfolio, and I would recommend considering the following: Find out if the policy is a universal life policy. The fees seem very high and will only net you a modest 2 percent return. Further, you would not achieve the expected triple return after paying these fees. You should also check the rating of this insurance carrier with Moodys and other insurance rating services to ensure they are financially strong. Some insurance companies have invested heavily in commercial real estate portfolios, which can be an issue.

Shirley Mueller - My Money MD

It seems that one question begs others. Do these numbers add up?

What commission does the broker get from the sale? That sum will be taken from the amount you have to invest.

Then, what is your net return on the money invested? You say it will triple by the time you are 72, thirteen years from now. Your insurance agent must be figuring about 8% return which would yield this gross, but if you get a 5% return, you will be receiving the net (8% gross return, minus 3% expenses, equals 5% net), which would be less than triple to you. As recently as June 2008, inflation was 5.2%. If it were to be higher in the future, your return would not allow you to keep up with the real cost of goods and services for the $500K you invested. In addition, it is taxed at ordinary income levels when withdrawn.

Another important aspect of guaranteed insurance contracts (GICs) is that they are guaranteed, but generally only by the insurance company, not the government. If the company has financial troubles so will the pledge for the contract. Therefore, whether or not the agreement is worth anything ultimately depends on the solvency of the insurance company. In this day and age, that can be problematical.

Lastly, there are other options that could provide you with more money to invest because expenses are less. In addition, they offer more flexibility and security, for example laddered (coming due in steps and then reinvested at the current rate) FDIC insured bonds. Another possibility is Treasury inflation protected securities (TIPS).

Tom Orecchio - Physician's Wealth Manager

There are multiple issues that you should consider when evaluating a Guaranteed Insurance Contract (GIC) as an investment strategy. The foremost issue to consider is counter party risk, which means you could lose your investment if the insurance company becomes insolvent. GICs are not backed by the full faith and credit of the United States Government and they are not insured by FDIC - they are simply a promise to pay by the insurance company. There is a heightened awareness of the dangers of counter party risk with the failures of Bear Stearns and Lehman Brothers, just to name a few. We would recommend that you diversify the position amongst multiple parties to help control counter party risk.

The second issue is that of high fees (3%) and the stated return (5%). You indicated the investment will triple in 13 years; however, the math is in conflict with tripling the money during this timeframe. You would need a 9% return rather than a 5% return to triple the value of your investment over a 13 year time frame. The financial industry is notorious for giving the appearance that they are creating value, so you will need to be careful that they are not just creating value for themselves through high fees and expenses.

You should consider the GIC investment relative to your financial planning goals and objectives. You should inquire about the flexibility to gain access to the money if you need liquidity and you should research the strength of the insurance company. You should check the offering for other hidden fees and expenses. You should consider tax ramifications for your unique tax situation. We would recommend you complete a comprehensive financial plan first, before diving into an investment for such a large part of your investable net worth.

Lastly, you should consider the current interest rate environment and other possible investment solutions. Since interest rates are low and you lock-in this investment for the term of the contract, it might make more sense to consider this type of vehicle in a high interest rate environment. If you were to consider this type of investment, we would recommend you limit your exposure to 5-10% of your investable net worth. We would recommend that consider coupling this strategy with other asset classes to complement the investment if you believe interest rates will rise.

In conclusion, we have expressed initial concern regarding the GIC proposal. We would need additional information to address the question in a more comprehensive manner.

This information and content is offered for informative and educational purposes only. The authors are not acting as Registered Investment Advisors, Investment Counsels, Tax Advisors, or Legal Advisors.