Life insurance is typically procured to protect against the loss of income in the event of a premature death of the insured. How much should be acquired is the topic for another essay; this one will focus on viewing life insurance as a non-correlated asset class.
A basic tenet of investing is diversification (see Modern Portfolio Theory). Hypothetically at least, investing in more than one stock (or any asset) will decrease the overall risk of the portfolio. Diversification across asset classes (a stock and a bond, for example) will serve to further decrease the overall risk of the portfolio. And diversification across investment classes that have a low degree of correlation reduces risk even further.
The primary investment classes are stocks, bonds and money markets (cash), but there are also sub-accounts to each class, such as large cap stocks, international stocks, municipal bonds, etc. By expanding the asset classes to include real estate and precious metals, even further diversification can be achieved. The question is, can the cash value of a whole life insurance policy serve as a non-correlated asset in an investment portfolio? Let’s take a look. (It should be noted that when used in this manner, the insurance is usually purchased with capital transfers rather than with budgeted income.)
The best policies have a guaranteed and a non-guaranteed portion of the cash value. The guaranteed cash value is not subject to market fluctuations, as it only goes up, never down (unless borrowed upon) and hence is uncorrelated. The non-guaranteed portion of the cash value is somewhat correlated to the bond and money market sectors, as it is dependent on interest rates. But while life insurance dividends tend to move in the same direction as interest rates, they also tend to lag market rates.
As long as the long term yield is comparable to that of the bond and money market sectors, I believe that it is appropriate to use a whole life policy to further diversify an investment portfolio. The younger and healthier the insured, the more likely it is that the yield on the cash value will compare favorably with that of the bond and money market sectors.