Berkshire Hathaway buys Whole Life Insurance Policies?

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Caduceus
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Berkshire Hathaway buys Whole Life Insurance Policies?

Post by Caduceus » Thu Feb 28, 2019 2:08 pm

I was re-reading the 2016 Letter to Shareholders from Warren Buffett, and I was very surprised to find out that Berkshire Hathaway buys lots of Whole Life insurance policies from individuals and corporations that would otherwise surrender them. In fact, Buffett notes that he buys them at a huge premium - often multiples of their cash surrender value. He explained that Berkshire Hathaway registers a loss in the year it buys these policies as it is buying these policies at a premium to their surrender value, but that eventually, Berkshire Hathaway expects to register a profit beyond the cash surrender value.

Given how hostile the board is in general to whole life, I was quite surprised.

I wonder if the explanation is that, when held to maturity, whole life can give good returns? That is the only explanation I can think of. For most investors, whole life continues to be a terrible investment because they can either get (1) the surrender value, or (2) the death benefit, and those who are opting for the surrender value will almost always have done better buying term and investing the difference.

But Buffett is buying the policy with an eye to holding it until the policy actually matures/expires, and my understanding is that the face value of the death benefit will have increased to a large extent by that point (much larger than its surrender value). Do you think this is the main reason he's buying the policies?

Are there other reasons?

If this is true, then would the advice be for someone who is fine holding the policy for bequest purposes rather than investment purposes be OK holding a whole life policy for life?

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David Jay
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by David Jay » Thu Feb 28, 2019 3:15 pm

Caduceus wrote:
Thu Feb 28, 2019 2:08 pm
I wonder if the explanation is that, when held to maturity, whole life can give good returns?
Nope, it is because Berkshire is buying distressed assets for pennies on the dollar.

There is a whole industry that is offering to give you a small fraction of your life insurance benefit while you are still living. I see ads on TV all the time from a company called “Coventry Direct” that offer to buy life insurance policies.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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SlowMovingInvestor
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by SlowMovingInvestor » Thu Feb 28, 2019 3:24 pm

David Jay wrote:
Thu Feb 28, 2019 3:15 pm
Caduceus wrote:
Thu Feb 28, 2019 2:08 pm
I wonder if the explanation is that, when held to maturity, whole life can give good returns?
Nope, it is because he is buying distressed assets for pennies on the dollar.

There is a whole industry that is offering to give you a small fraction of your life insurance benefit while you are still living. I see ads on TV all the time from a company called “Coventry Direct” that offer to buy life insurance policies.
So it's a multiple of surrender value (which probably decides accounting treatment), but a fraction of actual value (statistically speaking, since the value for a particular invidual or his/her heirs varies depends on lifespan) ?

bgf
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by bgf » Thu Feb 28, 2019 3:27 pm

what page is this discussion? i just did a word search for "whole" "life" and "surrender" and im not seeing anything about this in the 2016 letter.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

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David Jay
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by David Jay » Thu Feb 28, 2019 4:05 pm

SlowMovingInvestor wrote:
Thu Feb 28, 2019 3:24 pm
So it's a multiple of surrender value (which probably decides accounting treatment), but a fraction of actual value (statistically speaking, since the value for a particular invidual or his/her heirs varies depends on lifespan) ?
Sure, maybe something like this:

Death benefit: $1M
Surrender Value: $100K
Annual premium: $10K

As a policy holder, I can close the account and take the $100K. Or I can borrow the $100K and keep paying the premiums as interest accrues and my beneficiaries get $1M less ($100K + accrued interest). But if I need the cash I probably don’t want to keep paying $10K per year. Or I can sell the policy to Berkshire for $200K. No more premiums. Berkshire pays the premiums and gets the million when I die.

No argument here for Whole Life policies being good investments - they aren’t. Typically 2%-3% nominal if held to “maturity”.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by Beliavsky » Thu Feb 28, 2019 4:17 pm

David Jay wrote:
Thu Feb 28, 2019 4:05 pm
No argument here for Whole Life policies being good investments - they aren’t. Typically 2%-3% nominal if held to “maturity”.
I think whole life and universal life insurance policies purchased from reputable companies will typically have returns similar to investment grade bonds if held until the death benefit is paid. I own some and have analyzed them before and since purchase.
Last edited by Beliavsky on Fri Mar 01, 2019 7:32 am, edited 1 time in total.

inbox788
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by inbox788 » Thu Feb 28, 2019 5:02 pm

Caduceus wrote:
Thu Feb 28, 2019 2:08 pm
I wonder if the explanation is that, when held to maturity, whole life can give good returns? That is the only explanation I can think of. For most investors, whole life continues to be a terrible investment because they can either get (1) the surrender value, or (2) the death benefit, and those who are opting for the surrender value will almost always have done better buying term and investing the difference.
What do you mean by maturity, and what is a good return? If you mean maturity = expiration, the return actually goes down over time.

Average surrender value is always well below the expected return of past premiums paid as well as forward expected value of future premiums. If you know you have short lifespan, a term policy will yield higher return. If you know you have long lifespan, don't waste it on insurance and just invest it instead. Plus, for most policies, the excess insured amount (face value - cash value [similar to surrender value]) is a decreasing function of time.

Viatical settlements exist because there gap in surrender value is so far below the expected net benefit that they can offer substantially more than surrender value and still come out ahead. They expect short remaining lifespan, but term life isn't available or reasonably affordable at this stage.
If this is true, then would the advice be for someone who is fine holding the policy for bequest purposes rather than investment purposes be OK holding a whole life policy for life?
If you already have a policy, it would depend on the insurance policy and how long you've had it. For the most part, it wouldn't make sense buying one for that purpose. There is also the MEC (modified endowment contract) issues to best avoid completely.

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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by Nate79 » Thu Feb 28, 2019 6:37 pm

David Jay wrote:
Thu Feb 28, 2019 4:05 pm
SlowMovingInvestor wrote:
Thu Feb 28, 2019 3:24 pm
So it's a multiple of surrender value (which probably decides accounting treatment), but a fraction of actual value (statistically speaking, since the value for a particular invidual or his/her heirs varies depends on lifespan) ?
Sure, maybe something like this:

Death benefit: $1M
Surrender Value: $100K
Annual premium: $10K

As a policy holder, I can close the account and take the $100K. Or I can borrow the $100K and keep paying the premiums as interest accrues and my beneficiaries get $1M less ($100K + accrued interest). But if I need the cash I probably don’t want to keep paying $10K per year. Or I can sell the policy to Berkshire for $200K. No more premiums. Berkshire pays the premiums and gets the million when I die.

No argument here for Whole Life policies being good investments - they aren’t. Typically 2%-3% nominal if held to “maturity”.
+1 horrendous products sold to unsuspecting consumers with horrible return.

Rwsawbones
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by Rwsawbones » Thu Feb 28, 2019 8:32 pm

It is likely that Berkshire Hathaway gets a major tax advantage with the purchase which includes the purchase price and associated loss. Plus additional premiums are a tax deductible business expense. But as consumers of such products we pay premiums with pretax funds.

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SlowMovingInvestor
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by SlowMovingInvestor » Thu Feb 28, 2019 9:28 pm

inbox788 wrote:
Thu Feb 28, 2019 5:02 pm
Viatical settlements exist because there gap in surrender value is so far below the expected net benefit that they can offer substantially more than surrender value and still come out ahead. They expect short remaining lifespan, but term life isn't available or reasonably affordable at this stage.
I have a vague recollection that a number of AIDS patients sold their life insurance policies with a decent premium because they weren't expected to live long. But because better drugs came along, their life expectancy increased and the purchasers of those policies lost money.

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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by desiderium » Thu Feb 28, 2019 11:25 pm

If you are interested, this article gives an in-depth perspective on the concept of investing in life settlements
http://www.glenndaily.com/lifesettlementfunds.htm

It is essentially the reverse of selling life insurance. Actuarial estimate of lifespan x premiums = cost; payoff determined in a similar manner. Portfolio needs to be diversified (this was the pitfall for the collapse of viatical settlements for AIDS patients). The article goes into depth on the risks and due diligence required.

Most states have a regulated market for purchasing life settlements. For individuals it offers a market value for their policies often significantly higher than the insurance company will pay; for investors, there is a lack of correlation with other asset classes. Returns have evidently been going down as capital has flowed into this market. Because these transactions typically involve older people, small improvements in life extension could disrupt the actuarial calculations.

This is a post on White Coat investor https://www.whitecoatinvestor.com/inves ... viaticals/

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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by inbox788 » Fri Mar 01, 2019 12:23 am

SlowMovingInvestor wrote:
Thu Feb 28, 2019 9:28 pm
inbox788 wrote:
Thu Feb 28, 2019 5:02 pm
Viatical settlements exist because there gap in surrender value is so far below the expected net benefit that they can offer substantially more than surrender value and still come out ahead. They expect short remaining lifespan, but term life isn't available or reasonably affordable at this stage.
I have a vague recollection that a number of AIDS patients sold their life insurance policies with a decent premium because they weren't expected to live long. But because better drugs came along, their life expectancy increased and the purchasers of those policies lost money.
Yeah, somewhat of a black swan event. Here’s a recent article I just looked up.
https://www.theatlantic.com/health/arch ... en/572044/

From the insurer side, they’ve got to pay off these losses by making up the difference in the other policies, hopefully they’re well diversified. I suspect there are CDO like transfers of risk bundles to help manage the risk, while the servicing side provides a steady cash flow. Is Berkshire buying or selling these risky bundles? Maybe both, and in either case, I expect they have the resources to manage it well enough.

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Caduceus
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by Caduceus » Fri Mar 01, 2019 1:51 am

bgf wrote:
Thu Feb 28, 2019 3:27 pm
what page is this discussion? i just did a word search for "whole" "life" and "surrender" and im not seeing anything about this in the 2016 letter.
I am reading on a Kindle, so I don't have the exact page but it is near the beginning.

"You should be aware of an accounting rule that .... Berkshire purchrases life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, we pay any premiums that become due ... the price we pay for it is always well above its cash surrender value (CSV). Sometimes the original policy holder has borrowed against the CSV to make premium payments. In that case ... our purchase price will be a large multiple of what the original policyholder would have received, had he cashed out by surrendering it ... under accounting rules we must immediately charge as a realized loss the excess over CSV ... when the proceeds from these policies are recorded in the future we will record as realized investment gains the excess over the then-CSV."

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Caduceus
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by Caduceus » Fri Mar 01, 2019 1:55 am

desiderium wrote:
Thu Feb 28, 2019 11:25 pm
If you are interested, this article gives an in-depth perspective on the concept of investing in life settlements
http://www.glenndaily.com/lifesettlementfunds.htm

It is essentially the reverse of selling life insurance. Actuarial estimate of lifespan x premiums = cost; payoff determined in a similar manner. Portfolio needs to be diversified (this was the pitfall for the collapse of viatical settlements for AIDS patients). The article goes into depth on the risks and due diligence required.

Most states have a regulated market for purchasing life settlements. For individuals it offers a market value for their policies often significantly higher than the insurance company will pay; for investors, there is a lack of correlation with other asset classes. Returns have evidently been going down as capital has flowed into this market. Because these transactions typically involve older people, small improvements in life extension could disrupt the actuarial calculations.

This is a post on White Coat investor https://www.whitecoatinvestor.com/inves ... viaticals/
Thank you very much. I learned so much from the link you posted.

HIinvestor
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by HIinvestor » Fri Mar 01, 2019 3:04 am

That White Coat Investor article was very helpful. I would have to say that predicting deaths is a very dicey business. That’s why you would need a sufficient number of policies to mitigate the risk.

For example, I just spoke to a friend. She was mourning the death of her husband—he had been told by the doctor he’d likely die 25 years ago but he lasted until 2018! Similarly she had breast cancer long ago and is still among us.

Two decades ago, I and several friends were told to get our affairs in order due to serious health conditions (aggressive cancers, severe COPD and others)—we are still around and thriving. True, many others did die as predicted or before but for many of us, the crystal ball is hazy.

ivk5
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by ivk5 » Fri Mar 01, 2019 5:50 am

David Jay wrote:
Thu Feb 28, 2019 4:05 pm
SlowMovingInvestor wrote:
Thu Feb 28, 2019 3:24 pm
So it's a multiple of surrender value (which probably decides accounting treatment), but a fraction of actual value (statistically speaking, since the value for a particular invidual or his/her heirs varies depends on lifespan) ?
Sure, maybe something like this:

Death benefit: $1M
Surrender Value: $100K
Annual premium: $10K

As a policy holder, I can close the account and take the $100K. Or I can borrow the $100K and keep paying the premiums as interest accrues and my beneficiaries get $1M less ($100K + accrued interest). But if I need the cash I probably don’t want to keep paying $10K per year. Or I can sell the policy to Berkshire for $200K. No more premiums. Berkshire pays the premiums and gets the million when I die.

No argument here for Whole Life policies being good investments - they aren’t. Typically 2%-3% nominal if held to “maturity”.
Good summary.

Another way to look at this is that changes in the health status / life expectancy of the insured theoretically change the FMV of the policy. The contractual surrender value doesn’t reflect this revaluation.

The sale to third party in effect achieves a kind of re-underwriting or re-pricing of the risk, to unlock the trapped value for the insured.

Accounting rules don’t recognize that valuation until the benefit is received (or the policy is resold).

desiderium
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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by desiderium » Sat Mar 02, 2019 12:22 pm

Caduceus wrote:
Fri Mar 01, 2019 1:55 am
desiderium wrote:
Thu Feb 28, 2019 11:25 pm
If you are interested, this article gives an in-depth perspective on the concept of investing in life settlements
http://www.glenndaily.com/lifesettlementfunds.htm

It is essentially the reverse of selling life insurance. Actuarial estimate of lifespan x premiums = cost; payoff determined in a similar manner. Portfolio needs to be diversified (this was the pitfall for the collapse of viatical settlements for AIDS patients). The article goes into depth on the risks and due diligence required.

Most states have a regulated market for purchasing life settlements. For individuals it offers a market value for their policies often significantly higher than the insurance company will pay; for investors, there is a lack of correlation with other asset classes. Returns have evidently been going down as capital has flowed into this market. Because these transactions typically involve older people, small improvements in life extension could disrupt the actuarial calculations.

This is a post on White Coat investor https://www.whitecoatinvestor.com/inves ... viaticals/
Thank you very much. I learned so much from the link you posted.
This firm http://www.vidacapitalinc.com has been at this for a while and runs a fund that I have looked at. The materials give an interesting insight into how these investments work. They price the policies they purchase using ~12-15% discount rate based on actuarial estimates on the payoff date. It appears to be a good deal for both parties mainly in the over 85 demographic. After fees returns have been very good and consistent. Until lately when returns are lower. Seems like they needed to tweak the actuarial model, lowering the valuation of some of their fund assets. Also more hedge fund and HNW portfolios are requiring them to lower the discount rate target due to competition. Overall there appears to be a well functioning market but as discussed in the Glenn Daily article the fine details can be tricky.

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Re: Berkshire Hathaway buys Whole Life Insurance Policies?

Post by gmaynardkrebs » Sat Mar 02, 2019 7:25 pm

So Buffet is willing to pay me more than $100K for my $100K cash value whole life policy? Since I'm in excellent health and don't need it anymore, does anyone have his home number?

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