Key points:
- Wealthy individuals often choose to park their wealth in family businesses or in investments to capitalise on market returns.
- But stocking up on illiquid assets comes with risks, as the need for cash often coincides with turbulent markets.
- Universal Life Insurance is growing in popularity as a source of liquidity, as it can generate liquidity without compromising on risk mitigation and protection aspects.
Wealth is a lot like a river – it gathers speed when it is allowed to flow. This is why wealthy individuals often choose to grow their wealth by investing it in the market or into businesses that accumulate value over time.
But this strategy of keeping funds illiquid comes with a caveat. When markets go belly-up, sometimes overnight, cash becomes a safe haven – bad news for asset-heavy individuals who may find it difficult to convert their assets back into cash.
In 2022, reports by a consulting firm1 and a large private bank2 found that family offices and high net-worth individuals around the world keep only 9% to 24% of their wealth in cash. The rest are stored in assets such as equities, fixed income, real estate, and alternative investments.
Ensuring that there is a balance between having the funds you need to tackle emergencies and continuing to grow your wealth is crucial. One way of doing this is to consider Universal Life Insurance (ULI), which helps you unlock liquidity and greater flexibility to stay nimble in times of crisis.
The risks of insufficient cash
During times of market turmoil, cash is king. It offers liquidity and allows for opportunistic purchases when company valuations decline to attractive levels.
However, it is precisely when the market is turbulent that it becomes difficult to sell illiquid assets, such as real estate and private equities. Such assets can take a long time to convert back into cash, which limits investors’ flexibility to seize opportunities.
Think of illiquid assets as ice floes on a rushing river. Too many ice floes may impact your ability to direct the river’s course and “go with the flow” of the market.
This situation is exacerbated by the fact that wealthy individuals are known to multiply their wealth by borrowing against their assets to pay for new investments. Such an approach allows the wealthy to capitalise on market opportunities, but could also mean becoming heavily leveraged, especially when market turbulence is prolonged.
In negative market scenarios, the value of collaterals can also decline so sharply that lenders require borrowers to cough up cash, either to top-up the value of the collateral or to pre-pay the loan. Borrowers who have insufficient cash in their pockets will then be forced to sell other assets at a loss – a situation which may have been averted with proper liquidity planning.
Coping with unexpected tax bills
Wealthy individuals also have to contend with the uncertain regulatory environment. One clear example of this is changes in taxation rules. When a wealthy individual has assets in different countries or jurisdictions, their vulnerability to changes in tax rules increases.
This sudden outflow of cash – akin to encountering an unexpected waterfall – is often time-sensitive as well.
In 2021, for example, Indonesia moved to raise the wealth tax3 in a bid to boost state revenue and mitigate the effects of a Covid-19 induced recession. High net-worth individuals with earnings of more than five billion rupiah (S$466,550) a year found themselves having to pay personal income tax of 35% when previously, they only had to pay tax of 30%.
In times like these, a large, liquid emergency stash could help to avoid unnecessary hassle.
How Universal Life Insurance can help
The difficulty is in the balancing act – storing your wealth in illiquid assets that can profit from positive market conditions, and retaining enough cash in times of emergency without losing out on growth. Often, this involves building up the agility to convert wealth from liquid to illiquid and vice versa as and when market conditions require it.
This keeps your “river of wealth” nimble, that is, capable of staying the course – or changing direction in short notice.
This is where Universal Life Insurance (ULI) comes in. A form of whole life insurance, ULI gives policyholders the opportunity to build cash values which can be borrowed from or withdrawn. Its primary selling point is the flexibility it offers.
With ULIs, policyholders can adjust premiums and death benefits within certain limits. They can also benefit from cash value growth, which can be tagged to minimum interest rates set by insurers or market indexes. Earnings are also tax-deferred while the policyholder is still living.
Once cash value is accumulated, policyholders can subsequently take out a portion of the cash value in the form of partial withdrawals or loans, in addition to borrowing against the accumulated cash value if they wish to take a loan.
Such features will be helpful in events such as a sudden tax expense. But the perks don’t end there – the policyholder’s ability to leverage the ULI policy is further strengthened by the fact that it is easier to qualify for a policy loan since the policy already exists. As the policy loan is based on cash value, the policyholder is also shielded from collateral calls due to adverse market movements.
As long as policyholders ensure that their cash value does not fall to zero and that their premiums continue to cover the cost of insurance, ULIs can function as a “converter” of sorts by shifting wealth from its illiquid state, in the form of policy, to its liquid state, in the form of cash. At the same time, policyholders can continue to be assured of lifetime coverage.
Customise the perfect blend
The upshot of a ULI is that it allows you to customise your insurance policy to your needs. Think of it as being able to find the perfect balance to your drink – to add as much ice, or illiquid assets, as you want, and choose whether to convert them into liquid depending on your environment and your needs.
Whatever you choose, ULIs offer you a way to go with the flow and grow your wealth using the cash value component. But they can also benefit those that come after you.
In fact, many affluent individuals use ULIs in their legacy planning and as a way to transfer wealth effectively to the next generation.
That said, ULIs may not be the answer for everyone. While they are undoubtedly a useful tool in unlocking liquidity, they are only one way to balance liquidity needs against achieving growth returns. Whether ULIs are for you depend on your own unique circumstances and risk appetite.
