The case for investing in life insurance

Key Points

In 1980, Doris Christopher used a life insurance loan to launch her struggling kitchen gadget company. In 2002, she sold that company-the Pampered Chef-to Warren Buffett for a reported $900 million.

Even in the midst of the Great Depression, J.C. Penney used a loan against his $3 million life insurance policy to resuscitate his retail stores after the 1929 crash.

IF IT'S GOOD ENOUGH FOR BANKERS . . .

According to government disclosures, Federal Reserve Chairman Ben Bernanke has a majority of his liquid wealth-between $1 million and $2 million-invested in fixed and variable annuities, which are contracts issued exclusively by life insurance companies that promise guaranteed rates of interest.

What's more, the 401(k) Thrift Plan for Employees of the Federal Reserve System, according to a 2009 first-quarter Fed report covering 22,000 Fed employees, has 75 percent of its assets-that's $3.2 billion-invested in its fixed-income fund, which is invested exclusively in annuity contracts underwritten by major U.S. life insurance companies guaranteeing principal and an interest rate of 5.8 percent.

And this is not a new trend. A Deloitte audit affirms that in 2007 and 2006, Fed employees overwhelmingly chose fixed-income annuity funds over volatile mutual funds.

The nation's large banks invest immense sums of their Tier 1 capital reserves-a bank's most important asset and a key measure of its strength-into permanent life insurance underwritten by major life insurance companies. (See sidebar "Banking on life insurance" for more details.)

Why do banks look to insurance companies for sound investment? Unlike banks, life insurance companies do not use excessive leverage. If a bank has $1 million on deposit, it can lend out up to $10 million to the public. This leverage is called "fractional reserve lending," and it can lead to instability. Indeed, excessive leverage is a major reason why banks are failing today and have throughout history.

However, if a life insurance company has $1 million on deposit, that company may loan no more than $920,000, and usually only a fraction of that. As such, life insurers are 100 percent reserve-based lenders, which makes them stable institutions in down economies.