Is Insurance an Investment?

Title: "Is insurance an investment?" The background photo is someone stacking a pyramid of wooden blocks. The image on each block represents a part of healthcare.

Healthy Debate

There’s some debate on whether insurance is an investment.

It helps to consider:

  1. the definition of an investment,

  2. how insurance benefits are taxed,

  3. the way accounting treats insurance premiums,

  4. how premiums are used by insurance companies, and

  5. the results of a recent poll.

1. Investment Definition

Investopedia says:

An investment is an asset or item acquired to generate income or gain appreciation.

That’s not how insurance works! Pure insurance protects against loss.

Title: "Insurance" in yellow on top. Subtitles of People and Things are also in yellow, though smaller. People: Health, Disability, Long-term care, Life, and Liability. Things: Auto, Home, Renters, Personal property, and Natural disaster.

Indemnity

Insurance pays for what someone loses. This concept of indemnity is at the heart of insurance.

If an insurance company paid more than what’s lost, bad things could happen.

Consider a warehouse. If the building was insured for more than it’s worth, the owner might hire someone to destroy it! Think: arson.

Yes, it’s illegal.

However, the incentives are bad. The situation creates a moral hazard.

Limited Payouts

Insurance companies work hard to prevent such situations:

  • Deductibles often require someone to pay out of pocket before insurance pays anything.

  • Exclusions keep insurers from paying for some types of losses such as negligence.

  • Long-term disability insurance typically pays 60-80% of income.

Insurance often pays less than what’s lost.

Title: "Insurance helps pay for losses." in black on top. The photo is an image of a truck which appears to have slid off an icy road into a field and tipped over.

2. Tax Treatment

It’s in the government’s interest to define income broadly.

According to the U.S. Treasury, about 94% of federal revenue came from income taxes in 2023:

  • 49% individual income taxes

  • 36% Social Security and Medicare

  • 9% corporate income taxes

The rest came from:

  • excise taxes, 2%

  • customs duties, 2%

  • estate and gift taxes, 1%

  • miscellaneous income, 1%

Title: "Federal Revenue, 2023" in black on top. Below it is a pie chart with Individual Income Taxes, 49%; Social Security and Medicare Taxes, 36%; Corporate Income Taxes, 9%; and Other, 5%.

However, insurance benefits usually aren’t taxed.

Payouts are typically either:

  • due to bad luck or

  • a return of premiums paid.

Since insurance payouts generally don’t make someone better off than they were before the loss, the government rarely treats benefits as income.

Claims Paid

If someone pays the insurance premiums, benefits often aren’t taxed.

Disability insurance usually works that way:

  • Benefits aren’t taxed if the employee paid the premiums.

  • Benefits are taxed if the employer paid the premiums.

Also, most lump sum life insurance payouts are tax-free to beneficiaries.

Return of Premiums

For policies that build a cash value, the federal government typically lets someone take out what they contributed tax-free. Limits apply.

Text: "Insurance payouts are often: due to bad luck or a return of premiums paid" in black on top. The photo is of a brick house which was destroyed by a fire.

3. Accounting Treatment

The U.S. uses accounting standards called Generally Accepted Accounting Principles (GAAP).

Insurance seldom pays out. Otherwise, an insurer would either:

  • charge a lot more or

  • drop the insurance coverage!

Because payouts are unlikely, GAAP treats insurance premiums as expenses - not as investments.

Title: "Generally Accepted Accounting Principles" in black on top. Under it in smaller red permanent marker is "CONSIDER INSURANCE AN EXPENSE." The background photo is of a spiral notebook with the spiral on top.

4. Use of Premiums

Essentially everyone wants insurance companies to receive more premiums than they pay in claims:

  • Companies - pay claims, employees, and shareholders

  • Policyholders - avoid bad things happening

  • Regulators - ensure the company can pay its claims

Commissions

Insurance agents are paid a commission when they sell a policy.

According to Insurance Business America, whole and universal life insurance often pay:

… at least 100% of the premiums the policyholder pays in the first year…

The same source suggests payouts for term insurance are lower at 30% to 80% of the annual premiums.

Title: "An agent's commission may equal the first year premium." in black on the right. The photo is of someone holding a small umbrella over simple wooden dolls made to look like a family of two parents and two children.

Closer to Investments

There are insurance products which offer something like investment returns. Take Indexed Universal Life (IUL).

According to Progressive:

IUL policies allow you to grow your cash value by putting a portion toward an index account like the S&P 500 or NASDAQ.

Cap and Floor

Indexed Universal Life policies may have a:

  • cap of 8-12% and a

  • floor of 0%.

If the stock index rises 25%, the balance might only grow 10% because of the cap.

However, if the stock index falls 25%, the balance wouldn’t fall because of the 0% floor.

Text: "Indexed Universal LIfe policies often have 8-12% cap 0% floor" in black on top. The background photo is of someone using a pen to complete a Life insurance policy application.

Let’s consider the S&P 500® with a:

  • 10% cap and

  • 0% floor.

There’s more volatility with the index than with a cap and floor.

According to Morningstar, the range of annual returns from 2014 to 2023 was:

  • -19.50% to +31.61% for the S&P 500® and

  • 0% to 10% for the example floor and cap.

The index hit the:

  • cap seven of the ten years (70%)

  • floor two of the ten year (20%)

Title: "S&P 500® Total Return and 0% Floor, 10% Cap" in black on top. Below it is a graph of the Total Return in dark red and the 0% Floor, 10% Cap in gray. The dark red line is much more volatile.

The value of $10,000 invested over the decade might have grown to:

  • $30,520 with the S&P 500® index

  • $19,666 with the 10% cap and 0% floor

Title: "Value of $10,000 S&P 500® and 0% Floor, 10% Cap" in black on top. Below it is a graph with the Total in dark red and the 0% Floor, 10% Cap in gray. The dark red line grows above $30,000 while the gray line grows to below $20,000.

These results exclude fees. Past performance does not guarantee future results. Also, this example isn’t a recommendation to either buy or sell the S&P 500®.

Participation Rate

A similar setup is participation rate.

Let’s say the participation rate is 70% and the index rises 10%. The account balance would grow 7% (70% of 10%).

The floor would likely still be 0%.

Follow the Money

Insurance companies must receive more in premiums than they pay in claims.

The premiums, caps, and fees cover:

  • insurance agent commissions,

  • marketing and operating expenses,

  • years when the index falls, and

  • profits or dividends.

Title: "Premiums, caps, and fees cover:" in black on top. Below it is: insurance agent commissions, marketing / operating expenses, years when markets fall, and profits unless a mutual company." The background photo is of many umbrellas in the air.

5. Recent Poll

91% of people who voted on a LinkedIn poll I ran didn’t consider insurance an investment.

The poll ran from 7/26-8/2/2024 and received 65 votes.

Title: "Insurance = Investment?" in white on top. It's a screen capture of a LinkedIn poll: Is insurance an investment? Yes 9%, No 91%. There were 65 votes. The source is a LinkedIn poll which ran 7/26-8/2/2024.

People who commented on the post considered insurance:

  • a transfer of risk,

  • protection against lost income,

  • an estate planning tool,

  • future security, and

  • an expense.

Insurance is probably a bit of all of them!

Usually Not an Investment

Insurance isn’t generally considered an investment.

It normally:

  • doesn’t generate income or appreciation,

  • isn’t taxed by the IRS as income,

  • is considered an expense by U.S. accounting standards,

  • funds the commissions, expenses, and profits of insurers, and

  • wasn’t considered an investment in a recent poll.

Title: "Insurance = Investment?" in black on top. There are red X's next to: Investment definition, Tax treatment, Accounting treatment, Premium use, and Recent poll. The background photo is a tan parchment paper.

For more, check out:
How Disability Insurance Works!
Shop Auto Insurance

I hope this helps!

If you’re interested in a review of your specific situation…

Disclaimer

In addition to the usual disclaimers, neither this post nor these images include any financial, tax, or legal advice.

Kevin Estes | Founder | Scaled Finance

Kevin Estes is a financial planner helping T-Mobile employees and their families live their best lives.

He worked in T-Mobile Financial Planning & Analysis for nine years and has extensive experience with T-Mobile’s compensation and benefits package. He received a certificate in financial planning from Boston University, passed the CERTIFIED FINANCIAL PLANNER™ exam, and founded Scaled Financed in 2022.

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https://www.scaledfinance.com/
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