1. 11 Financial Educators Association Case: Insurance and Investing: Don’t Confuse the Two Jim Brau and Bryan Sudweeks September 28, 2016

2. 2 Abstract This case allows the ability to bring out important areas of both the investing and insurance decisions. Insurance is a complex product that is difficult to understand and apply. We try to improve its understanding and transparency. Investing is an equally difficult challenge. We try to make it easier to understand as well. This case brings both areas into sharper focus allowing the students to determine important principles and understand the key issues to make better insurance and investment decisions. But insurance is not investing and investing is not insurace. Don’t confuse the two.

3. 33 Purpose An insurance executive commented: Insurance companies make their products so complicated that the consumer must trust the insurance salesman to understand the product I found that not even insurance salesmen understand their products An alumni was pitching me on cash value insurance and said: The product would give a 6% yield The product was competitive with other investments It would be a great investment for me

4. 44 Background I teach personal finance at a large private university I was an asset manager (investing in emerging markets) in a previous life I teach peripherally about insurance and its uses I felt that I needed to get much a greater understanding of permanent products There is a lot of misinformation out there

5. 55 Background (continued) I found out some interesting things Tax implications of permanent insurance Guarantees versus illustrations Current versus maximum charges Calculating rates (similar to IRRs) Most importantly, we should not confuse insurance and investing. Just because you can, doesn’t mean you should

6. 66 How is the Case Best Used The case was meant as a springboard The case is flexible I have PowerPoints depending on case direction You can go insurance, and talk about principles, key questions, and term and permanent insurance (FP Case – Life Insurance Basics.pptx) You can go investing, and talk about investing principles, investment vehicles and key factors (FP Case – Investment Basics.pptx) You can do both, depending on your time I have used it for both directions

7. 77 Case Logic The insurance vehicle chosen is Variable Universal Life It was chosen because of its similarity with a Roth vehicle: Both offer multiple investment accounts: Both invest with after-tax dollars Both returns are tax-free Both returns can be negative and volatile Both can take principle out without tax Since these are somewhat similar vehicles, we can compare the costs of each

8. 88 Case Discussion There is a place for cash value insurance 1. Risk transfer/Income replacement (term) 2. Estate Planning 3. Guaranteed insurability 4. Retirement Planning 5. Forced Savings However: 90% of those who purchase cash value insurance is for estate planning purposes Very few are for guaranteed insurability Retirement planning and savings are not good use of this vehicle due to the high costs of insurance

9. 99 Case Discussion (continued) A common mistake is to assume that the cash value of permanent insurance is an investment Most insurance salespeople would say it is You can calculate an IRR You can calculate a Rate of Return Just because you can is not reason enough However, the fees are not disclosed and it is very difficult to get performance numbers The only way to determine your fees on the product is from the illustrations Realize that the illustration is not a guarantee Cynics say it is a way to hide the product costs

10. 10 Class Discussion (continued) We can make assumptions Lets assume the Cash Value is your inflow and your premium payments your outflow IRR = Use Excel rate function: RATE(number of periods, cash outlay per period,, cash value, guess) Rate of Return = [(cash value/(number of periods * cash outlay per period))^(1/periods)]-1 IRR on Death Benefit = [(death benefit/(number of periods * cash outlay per period)) ^ (1/number of periods)] - 1 Calculate these for all 75 years for each of the 5 illustrations and each return (1,125 calculations)

11. 11 Class Discussion (continued) We then can build an Excel tool to help compare return metrics across insurance and investments You estimate your investment expenses (i.e., 0.3%) We start with the illustration percentage (8% - 0%) less the expenses gives your rate of return (i.e., 8% - 0.3% expenses gives a 7.7% return) You put in the year of the analysis, i.e., year 5 It brings up the IRR or ROR you requested IRRs and Rates of Return generally improve in later years of the insurance illustration Then it gives the difference between the investment return and insurance return

12. 12 Class Discussion (continued)

13. 13 Class Discussion (continued) Clearly the costs for insurance products are significantly higher than for investing But you can take this case many different ways

14. 14 Insurance: Topics Insurance PowerPoints Purpose and principles of insurance Types: Term versus permanent insurance Key factors: mortality risk, investment control, policy cost, investment choice, and policy flexibility Term insurance: Types Annual, Renewable, and Convertible Term Permanent Insurance (Cash Value): Types Whole life, Universal Life, Variable Life, Variable Universal life, Equity Indexed Universal Life

15. 15 Insurance: Objectives A. Understand Life Insurance 1. Benefits 2. Principles of insurance 3. Five key questions about Life Insurance 4. Types of life insurance B. Understand types of term life insurance C. Understand types of permanent life insurance D. Understand which life insurance is best 1.For students 2.Steps to buying life insurance

16. 16 Investing: Topics Investing PowerPoints Purpose and principles of investing 401K qualified retirement plans Roth 401k versus traditional retirement plans Importance of the company match Company match vesting periods Tax implications of qualified retirement plans Individual retirement plans Contribution limits Phase out limits Penalties for early withdrawal Tax implications of IRAs

17. 17 Investing: Objectives Investing PowerPoints A. Understand principles: 1. Investment basics 2. Before you invest 3. Factors controlling investment returns 4. 10 Principles of successful investing B. Understand application: 1. Selecting asset classes 2. Building a portfolio 3. Selecting investment vehicles 4. Determining your asset allocation 5. Selecting assets

18. 18 Bottom Line Insurance and investment have two different objectives Use insurance for what it does well It transfers the economic loss of death from an individual to a insurance company It is a fee heavy product by nature Use investments for what it does well It invests your savings now in order to have more in the future It has imbedded volatility by nature

19. 19 Bottom Line (continued) Insurance Objective: Get the best coverage for your needs for a given amount of monthly premium This entails understanding yourself, your goals, vision, values and budget Develop a good insurance plan and follow it Determine and buy the coverage you need Buy coverage from a reputable company that will be around a long time Minimize costs/taxes and maximize benefits Be careful of distractions and buying things you do not understand or need

20. 20 Bottom Line (continued) Investment Objective: Get the highest after-tax return by asset class for your needs for a given monthly investment This entails understanding yourself, your goals, vision, values and budget Develop an investment plan and follow it Get a good asset allocation (stay diversified) and keep it Reduce underperformance and costs by indexing many of your asset classes Minimize costs/taxes and maximize benefits Be careful of distractions and buying individual securities (until you have $0.5mn or more)

21. 21 Summary This case is a good starting point for discussion Both insurance and investment are challenging, time consuming, but important topics Understand yourself, your goals, vision, values and budget Educate yourself to the costs and benefits Determine your needs in both areas Develop an insurance and an investment plan and follow them Minimize costs/taxes and maximize benefits Be careful of distractions

22. 22 Appendix There is a place for permanent insurance for some individuals. However, think about this: Commissions: If it is such a good product, why pay such high commissions for sales? First year commissions to agents can be 50-120% of first year sales. Annual fees/expenses: Why must fees be so high on investment sub-accounts? These investments are not complex products Assumptions: Why can the company change contracts even after the product is sold? Payments on cash value products (except whole life) are based on assumptions which the company can change any time even after the contract is sold Transparency: Why is anecdotal return evidence so poor, which shows that 20 year returns on permanent products have generally been only slightly above inflation? Why is performance data so very difficult to find for these products?