Warren Buffett's Life Insurance: A Billionaire's Smart Choice

Warren Buffett is one of the world's richest and most successful investors, renowned for his frugal lifestyle and savvy purchases of businesses and assets. While he has not publicly confirmed whether he has life insurance, his involvement in the insurance business and views on insurance as an investment tool have sparked speculation about his personal insurance portfolio. Buffett's approach to investing in insurance companies and his perspective on insurance float offer valuable insights for investors curious about his strategies for maximising returns and building wealth.

Life insurance as a savings strategy

Warren Buffett is known for his frugality, living well below his means. He has also shown confidence in life insurance as an asset. In the 2004 Berkshire Hathaway Annual Report, Buffett revealed that Berkshire purchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. He also advises investors to put a large portion of their money where it is safe, liquid, and immune from market crashes.

Life insurance is typically purchased for its death benefit, but some life insurance policies can become a financial asset for you to use during your life, just like an IRA or mutual fund. These life insurance policies allow the owner to build cash value over time and provide access to cash value. In some cases, you can take a withdrawal, and in others, you can borrow against your policy; if done right, you can avoid a tax liability. Permanent life insurance policies enable you to invest in conservative investments like mutual funds or exchange-traded funds (ETFs). You can choose how you want to diversify your investments, allowing you to curate your policy to meet your risk tolerance and goals. Because of this, permanent life insurance can serve as a hedge against market risk.

There are two main types of permanent life insurance that can be used as an asset: whole life insurance and universal life insurance. Whole life insurance is the most common type of permanent life insurance, which, in addition to a death benefit, offers the policyholder the ability to accumulate cash value. This works because a portion of the premium you pay every month goes into a cash value account. Your cash value will accumulate over time at a minimum guaranteed rate indicated by your policy.

There are several ways to use your life insurance as an asset. As you contribute to your policy over the years, you earn the ability to borrow against what you’ve saved. All your earnings grow on a tax-deferred basis. You can borrow against the cash value of your permanent life insurance policy. Just read the fine print if you go this route. The interest rate can be fixed or variable, and it is set by the insurer. Also, if you take a loan against your policy and it’s not paid off at the time of your death, any outstanding balance that you owe gets subtracted from what your beneficiaries inherit. In some situations, you can use your life insurance policy as collateral for a loan, which can make it easier for you to get approved or perhaps get you a better rate on the loan you’re taking out.

When shopping for a policy, you should only consider policies that have a cash value. Typically, only permanent insurance policies fall under this umbrella – term insurance policies, which are generally less expensive and valid for a set number of years, don’t. When comparing policies, remember that life insurance is a very competitive business, and you’ll find differences of hundreds of dollars (for annual premiums) even among financially strong companies for essentially the same policy. Beware of “fractional premiums,” where some companies levy high charges for paying premiums frequently.

Life insurance as an investment

Warren Buffett, the vice chairman of Berkshire Hathaway, is known for his straightforward approach to insurance and investments. During the May 2024 Berkshire Hathaway annual meeting, he shared his insights on the insurance industry, describing it as a very tempting business. He highlighted the deceptive simplicity of the insurance model, where insurers receive money upfront in the form of premiums and then provide coverage for potential future claims. This upfront cash flow is enticing, but it also comes with the challenge of accurately assessing risks and pricing policies accordingly.

Buffett's perspective on insurance as an investment is influenced by the concept of "float." Float refers to the premiums collected by insurers before they need to pay out claims. This pool of money can be invested, generating returns and contributing to the insurer's profitability. In his 1997 shareholders' letter, Buffett emphasized the value of an insurance business when the cost of float over time is less than the cost of obtaining funds through other means. This principle has been successfully applied by Berkshire Hathaway, as their insurance float grew from $39 million in 1970 to $91.6 billion by 2016, providing the capital for acquisitions and investments that fueled the company's growth.

Buffett's approach to insurance as an investment is also reflected in his view on self-insurance. He and his colleague, Charlie Munger, advocate for self-insuring if one can afford it. Munger, with a net worth of $2.6 billion during the interview, explained that he could easily rebuild a house that burned down, so he saw no benefit in paying for fire insurance. However, they acknowledged that self-insuring comes with risks and may not be feasible for everyone.

Buffett's advice to investors regarding the stock market aligns with his philosophy on insurance and investments. He advises investors to keep a significant portion of their money in safe, liquid assets, such as dividend-paying whole life insurance policies, to protect against market crashes. By prioritizing savings over risky investments, investors can build a financial foundation that provides security and stability.

In summary, Warren Buffett views insurance as a tempting and important business, not only for its upfront cash flow but also for the investment opportunities provided by the float. His perspective on insurance as an investment extends to self-insurance for those who can afford it and the value of insurance policies as a safe and liquid asset class.

Self-insurance

Warren Buffett, along with his associate Charlie Munger, is a strong advocate of self-insurance. Munger, the vice-chairman of Buffett's company Berkshire Hathaway, shared his philosophy on self-insurance during the 2023 Daily Journal shareholder meeting, just months before his death at 99 years old.

Munger explained that if you can afford to take the risk yourself, it is better to self-insure than to "pay for the other fellow's fraud". He gave the example of fire insurance on his houses, saying that it was "ridiculous" for him to have it because he could easily rebuild a house if one burned down. He also pointed out the waste involved in paying for insurance, which includes the costs of dealing with fraud.

Buffett himself is said to have a reputation for thriftiness, living well below his means. He is known for his straightforward approach to money, and has said, "If you don't find a way to make money while you sleep, you will work until you die".

The financial structure of insurance companies is another reason why Buffett is attracted to them. He has referred to insurance "float", the stable flow of premiums to an insurance company that can be used to fuel investment and acquisitions. Berkshire's insurance float grew from $39 million in 1970 to about $91.6 billion in 2016.

Life insurance for liquid cash

Life insurance is a unique product in that it is purchased with the hope that it will never need to be used. While it is not technically an investment, it does have a powerful savings component. Warren Buffett, a legendary investor, has shown his confidence in life insurance as an asset. In the 2004 Berkshire Hathaway Annual Report, Buffett revealed that his company buys life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, Berkshire Hathaway pays any premiums that become due and ultimately collects the face value of the policies when the original holder dies. This is known as a life settlement.

Dividend-paying whole life insurance is a great strategy for storing and growing liquid cash. Financial author Rick Bueter calls this concept a "Financial Bunker". When compared to other savings vehicles, whole life insurance has tremendous advantages. It is the only kind of savings strategy that is "self-completing", meaning that it will pay out eventually. While it is not a bad idea to have some physical cash on hand, life insurance is a great way to ensure you have liquid cash available when you need it.

In addition to the benefits of the savings component, life insurance is also an attractive investment for investors like Buffett. Life insurance contracts are often repriced annually, allowing them to be adjusted for inflation. The non-life insurance sector is also ESG-friendly, playing a key role in the transition to a green economy. With the recent challenges of the COVID-19 pandemic, the insurance sector is poised to benefit from rising inflation and interest rates.

However, it is important to note that life insurance is not the only way to ensure liquid cash. Billionaire Charlie Munger, vice chairman of Berkshire Hathaway, shared that he and Buffett always self-insure. They believe that if you can afford to take the risk yourself, it is a better option than dealing with insurance companies and the potential for fraud. For example, Munger says it is "ridiculous" for him to carry fire insurance on his houses because he can easily rebuild a house that burns down. Therefore, for those who can afford it, self-insuring may be a more practical option.

Life insurance for passive income

Warren Buffet, known for his frugality and simple tastes, has shown interest in life insurance as an asset. In the 2004 Berkshire Hathaway Annual Report, Buffet revealed that his company purchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. This is known as a life settlement.

Life insurance can be a source of passive income, which is a strategy to build wealth and plan for retirement. Passive income can be defined as regular earnings from a source that requires little to no effort and can include things like annuities, bonds, dividend stocks, and content creation. Life insurance can be used as a passive income strategy in several ways:

• Permanent life insurance: This type of policy provides coverage throughout your life, regardless of your health condition. It accumulates a cash value that can be used as a loan source or collateral for a loan. The cash value of permanent life insurance can be accessed tax-free and used to finance high-ticket items, like a car or house, while simultaneously earning a rate of return. This strategy is a way to build wealth and capture the opportunity cost of your cash.
• Term life insurance: While most term policies do not build cash value, they can still be used to convert to income through loans. The loan amount, plus interest, is typically repaid from the policy's death benefit after the policyholder's death.
• Accelerated benefits: Available for both Term and Permanent life insurance policies, accelerated benefits are like cash advances that can be received if the policyholder has a terminal illness, a specified disease, or a long-term care illness. The amount paid out to the policyholder, plus any applicable interest or fees, is deducted from the benefit paid to the beneficiary upon the policyholder's death.
• Annuities: Annuities are a product issued by insurance companies that can provide passive income through monthly payments. They require an investment upfront but can guarantee periodic payments for a specified time or the rest of the annuitant's lifetime.
• Viatical settlements: Also known as life settlements, this option involves selling your life insurance policy to obtain income. This is available for both Term and Permanent policyholders.

It is important to note that converting a life insurance policy into income can be complex, and it is recommended to consult with a professional before making any changes to your coverage. Additionally, utilizing life insurance as a passive income strategy can provide a buffer against market volatility, protecting your financial needs during times of stock market downturns or high inflation.

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