Letters of Explanation: IUL Premium Financing Risk

June 17th, 2019 No comments

Dear Mrs. Client:

Last week I promised you some numbers to put into perspective my thoughts that premium financed Indexed Universal Life isn’t what you think it might be.

The spreadsheet you showed me some time ago assumes an annual loan of $700,000 for 13 years.  This is used to purchase a policy that assumed roughly a 7% annual crediting.  This may sound conservative for an S&P 500 Index return but it isn’t if you understand how Index funds work.  A significant issue is that the dividends aren’t included in the return and historically dividends make up at least a couple hundred basis points of the return and sometime 500 basis points.  There are entire decades where the dividends are greater than 50% of the return of the S&P 500.

When you take dividends out, a reasonable return is much lower.  There is independent modeling that suggests that to credit 7% on an Indexed policy the Index would have to actually return 10%-12%.  Also, the insurance ledger assumes level returns year in and year out.  We know that isn’t going to happen and the inevitable variability in returns may dramatically affect the performance of a policy.

Finally, we’re now at the tail end of the longest bull market in history.  Is this when you really want to go into an equities based contract?  If we model a policy with a few years of down or flat numbers, the policy performance will look dramatically different.

Finally, to put some numbers to it, the ledger you were provided shows a return on premiums to cash value at negative 2.34% after year 5.  It’s 3.65% at year 10 and 4.88% at year 13 when premiums are scheduled to terminate.  This is all assuming the policy is actually crediting at 6.96% every year from year one.  This shows how steep the early expenses are.

Per the ledger, if everything works out perfectly, which it won’t, in 20 years the cash value will be $21,395,000 and this will be used to pay back the loan of $20,156,000.  That is a pretty tight margin.  Furthermore, the commercial loan is paid back by a $20,000,000+ loan from the policy so you still have a loan but it is from a different place. And it keeps accumulating at interest.  10 years later the policy loan has grown to $32,833,000.  If the policy didn’t perform as projected and it collapsed with that loan on it, which is a possibility, you would own ordinary income tax on $23,733,000 of phantom gain.  This is money (forgiven debt) you would have to pay income tax on when the policy has $0 of net cash, hence the term “phantom gain”.

If everything doesn’t pan out as expected, your interest expenses and collateral requirements could increase as well.

This is what I promised to relate and I’ll move forward on some other ideas now.

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The Bastardization of Premium Financing

June 10th, 2019 No comments

What you see isn’t necessarily what you get.

Wealthy people and business owners have always leveraged money and assumed risk but starting about a decade ago, after the 2008 crash, premium financing has been driven by very low London Interbank Offered Rate (LIBOR) based borrowing rates and aggressive return assumptions on insurance products that are easy to manipulate.

Indexed Universal Life (IUL) made a strong showing marketed by a particularly attractive story, if not altogether accurate.  Upside potential of the stock market without the downside risk sounded great with the memory of 2008 still fresh in minds.  These products can be illustrated at unrealistically high rates while appearing to be modest because few understood how they work.  Abuse is rampant even after the regulatory action of AG 49. For full post, click here…

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Q&A: Opinion of IUL Policies

May 24th, 2019 1 comment

Question:

I am curious as to your opinion of IUL policies? They seem to me to substantially overpromise, and they are too complicated for me to understand! Would love to hear what you think.

Answer:

Regarding IUL, I say “There’s not bad insurance as much as there is insurance done badly.” For full post, click here…

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The Tragedy of Group Term

April 30th, 2019 No comments
Steer clear unless it’s the only option.

For full post, click here…

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Understanding the Flaws in a Premium Financing Policy

April 16th, 2019 No comments
Convince a client without opening your mouth.

At the courthouse, the judge looked to the other guy and asked his story. After hearing the guy’s side, the judge ruled in my favor. I never opened my mouth. You can imagine how ridiculous the situation was when I didn’t even have to present my side of the story.

I’ve written at length about how little the typical consumer understands about premium financing. A part of my job has been to vet deals and fix problems. But even I was surprised earlier today when I had a scheduled phone call with a client who retained me to review his deal.

The phone call consisted of the insured individual, the premium finance guys, myself and my associate. In a way, the client was the judge, and respectively, the agent and I were the defendant and plaintiff, though I didn’t mean for it to be adversarial. That being said, I didn’t think it was a good idea for the client to move forward based on what I understood as his goals relative to what I was seeing. All I proposed to do was to bring objective information to the table. For full post, click here…

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Premium Financing is Great… Except When It Isn’t

April 10th, 2019 No comments

Digging into the numbers is exceedingly important.

More and more premium finance deals and proposals are making their way to my desk. Most have some common characteristics. First, they probably aren’t going to work, and second, consumers don’t understand them. When I say “don’t understand,” I don’t mean they simply don’t understand the details but that they have a misunderstanding of how the transactions will play out.

I’m a proponent of premium financing, when it’s done right and for the right reasons. Real-estate owners and developers have used OPM (other people’s money) very effectively because they’re often able to prove mathematically that the leverage makes sense. I’m doing the same thing when I don’t pay off my low interest home mortgage and keep my money in the market. However, when it comes to financing life insurance, I have an issue with much of what I see out there. First of all, I firmly believe that finance deals built around the arbitrage For full post, click here…

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Vetting a Premium Finance Deal

February 25th, 2019 No comments

A family office called me in to review and analyze a proposed premium finance deal. After gathering the details of what the family was trying to accomplish and requesting presentation materials, insurance ledgers and financing term sheets, I dove into it.

The advisors let me know that one of the primary things they wanted to understand was what their “bail out” option would be in 10 years. In other words, they wanted to understand their options in a worst case scenario, which is an important thing to get one’s arms around.

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This plan was built around a 10 pay whole life contract and the collateral for the policy was to be an existing whole life contract on the same individual, the matriarch of the family. A part of my analysis was a historic comparison of whole life dividend, and how they move in relation to the interest rate markets, to LIBOR rates. An important and revealing aspect of this for the advisors was how the policy dividends really work and how they are applied. For full post, click here…

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Is Association Term Insurance Really a Good Deal?

February 20th, 2019 No comments

Young professionals don’t stay young forever.

If your client is in his 20s and is a young lawyer, accountant, doctor or member of any association, he’s no doubt been offered the opportunity to purchase inexpensive term insurance through his association. He gets all the benefits of easy enrollment and no lengthy forms nor medical questionnaires to complete. He may not even have to pay a bill as everything might be done electronically through his payroll department. Then, to top it all off, he receives a dividend/refund check making the price even lower. He’s convinced association term life insurance is the best and only way he should ever buy term insurance for his family—after all, the members of his profession are clearly a better risk than the public at large. The only problem is those automatic five-year increases become very expensive once he hits age 40.

For full post, click here…

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Testing and Modeling Life Insurance by Bill Boersma & Marty Shenkman

February 12th, 2019 No comments

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Life Insurance Reviews Don’t Always End in Disappointment

February 7th, 2019 No comments

Just as with routine physicals, a “well visit” can identify opportunity.

Sometimes I think my job is basically giving people bad news. As a consultant, yes, I see more than my fair share of sick policies just as the number of patients that come through a doctor’s office in the course of a day who are sick is likely greater than the population at large. Sick people congregate at the doctor’s office and sick policies congregate on my desk.

The main issue with educating the advisor market on sending sick policies to me is that they don’t always send policies to me that aren’t obviously sick. Often times, sick policies don’t look sick and when one waits long enough to see the sick, they’re terminal. Hey, just like with people.   For full post, click here…

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