The interest rate risk of bonds negates the value of using them as a long-term hedge against equity risk. Life insurance and annuity products provide this protection.
Thanks for the insightful post. I did have a few questions:
1. It sounds like the life insurance and annuity products behave like a bond fund + a long-dated ATM put option. In an efficient market, we should expect the two to be equivalently priced. Is that roughly the case in reality? Put another way, should I expect to get the same risk/return/correlation profile with a life insurance or annuity product as with, say, a portfolio of TLT and some puts? I'm aware that life insurance and annuity products may have some tax benefits and may be more convenient to implement, but am curious about a comparison in which these are not primary concerns.
2. In the context of stocks, we know that they are risky, but the diversification benefit of myopically buying puts to hedge that risk generally does not outweigh the premium paid. Is this story any different in the context of bonds or life insurance and annuity products?
Thanks for reading! Yes, in an efficient market you would expect it to be priced equally.
Unfortunately, with life insurance a lot of people pay into the product and don't understand what they're buying, cancel the product, get hit with huge surrender charges and walk away with very little.
This allows those who structure the product properly to benefit at the expense of those who are using it inefficiently. In your world, imagine you have sophisticated traders trading against novice beginners. It's an unequal trade where you have traders of different skill sitting across the table from each other.
So it's more a function of profiting off inequality and an inefficient system based on poor policyholder behavior. Novices make foolish choices and mistakes, and sophisticated/wealthy individuals benefit as a result of it.
It's not really comparable to trading in an efficient market with equally capable parties on both sides of the trade.
It's more comparable to a multilevel marketing scheme where you sell everyone on a dream so that a lot of people buy in and quit so that a few at the top can redistribute everyone else's earnings to those few who stay in.
Thanks for the insightful post. I did have a few questions:
1. It sounds like the life insurance and annuity products behave like a bond fund + a long-dated ATM put option. In an efficient market, we should expect the two to be equivalently priced. Is that roughly the case in reality? Put another way, should I expect to get the same risk/return/correlation profile with a life insurance or annuity product as with, say, a portfolio of TLT and some puts? I'm aware that life insurance and annuity products may have some tax benefits and may be more convenient to implement, but am curious about a comparison in which these are not primary concerns.
2. In the context of stocks, we know that they are risky, but the diversification benefit of myopically buying puts to hedge that risk generally does not outweigh the premium paid. Is this story any different in the context of bonds or life insurance and annuity products?
Thanks for reading! Yes, in an efficient market you would expect it to be priced equally.
Unfortunately, with life insurance a lot of people pay into the product and don't understand what they're buying, cancel the product, get hit with huge surrender charges and walk away with very little.
This allows those who structure the product properly to benefit at the expense of those who are using it inefficiently. In your world, imagine you have sophisticated traders trading against novice beginners. It's an unequal trade where you have traders of different skill sitting across the table from each other.
I've written about this previously:
https://separatingvaluefrombias.substack.com/p/whole-life-insurance-reaping-rewards
https://separatingvaluefrombias.substack.com/p/8-the-benefits-of-inequality
So it's more a function of profiting off inequality and an inefficient system based on poor policyholder behavior. Novices make foolish choices and mistakes, and sophisticated/wealthy individuals benefit as a result of it.
It's not really comparable to trading in an efficient market with equally capable parties on both sides of the trade.
It's more comparable to a multilevel marketing scheme where you sell everyone on a dream so that a lot of people buy in and quit so that a few at the top can redistribute everyone else's earnings to those few who stay in.