Speaking to Clients About Premium Financed IUL Policies

June 16th, 2020 No comments

It’s important to understand the details and risks. This sample letter may help clients and advisors alike.

 

Dear Ms. Prospect:

It was good to speak with you yesterday morning about the proposed supplemental retirement plan, and I thought I would follow up with a couple of comments. As we discussed, I’m very familiar with indexed products and premium financing. I believe there are appropriate times and places to use the product and strategy, and there are times when it’s not.

Prospective consumers need to fully understand what they’re getting into on both the product and the strategy side. They need to intimately understand the variety of risks. A general rule of thumb is that they should be able to pay the full premium out of pocket but choose to finance it because they’re comfortable with the risks and have the ability to buy themselves out of trouble if trouble shows up (and it does too often). Finally, they need the policy meticulously managed until the day they die.

The proposed product is a newer policy design, and some feel it’s too aggressive. I have access to a tremendous amount of analysis regarding the policy that I’d be happy to share. One reason it’s popular in the premium financing world is because it was created to illustrate very strongly and to win the illustration wars. This doesn’t mean it’ll actually perform successfully.

As the promoter stated, it’s true that the current interest rate market makes it easier to outperform the loan rate with the life insurance policy crediting, and it may stay this way for a while. However, it likely won’t indefinitely. You’ll be signing on to significant loans over the next decade, $2.25 million, plus interest. That, in and of itself, should prove the need for some detailed analysis.

Do you understand that the loan isn’t actually gone after the 10 years? What if I told you the commercial loan was paid off after the first 10 years but it wasn’t paid off by policy values, it was paid off by taking a $3 million loan from the insurance company? And then at age 65, the projected $500,000 annual retirement stream through age 85 also wasn’t taken from policy values but was taken through loans from the insurance company? Did you realize the loan at age 85 was projected to be $32,791,478 and keeps growing to $56 million at age 95?

Regarding expenses of the policy, do you realize that of the $3.75 million in premium over 10 years, over $1.7 million is gone to fees and expenses? That’s over 45% of all the premiums and more than you’re paying out of pocket. I’m not saying that’s wrong, but that’s a bit of a hole for the policy to climb out of.

The projections are assuming a 5.67% crediting rate, and this is dictated by regulations. However, that’s the maximum allowable projection, which represents a historical average, meaning that half the time the returns would have been lower. However, your projected net cash value is growing at 11.89% from Year 11 to Year 12 of the policy. To understand how that’s possible, you need to understand the internal workings of the policy. From age 86 to age 87 the growth is 16.92% after $1.644 million in fees and expenses in that single policy year. Stress testing can be rather illuminating.

The gross cash value is projected to grow at 7.54% that year with a policy crediting rate of 5.67%. I’m not even saying this is inappropriate, I’m just saying you’d better understand it. From policy inception through age 85, there is $20 million in fees and expenses. Again, not necessarily bad, but you’d better understand what they are.

At age 85, when the loan is almost $33 million, it’s collateralized by a projected $39 million of cash value so it’s, in a sense, nonrecourse. But if the policy didn’t pan out as planned and fell off the books, and your cash value was used to pay back the loan, did you realize that you would have a $35 million taxable gain that would be phantom income taxed at ordinary rates? That means about $15 million in taxes paid out of pocket with no residual cash value available from the policy.

Do you realize there are many illustrated and projected aspects of the insurance contract that aren’t guaranteed and can be changed at the will of the insurance company? When these change (not if), the effects could be very meaningful. It might be a good idea to model the effects. By the way, this insurance company has a history of changing some of those assumptions to make more money on a book of business or to force business off the books that they don’t find profitable enough. It’s important to understand this.

Finally, for now, do you realize how extraordinarily unrealistic a projection is that assumes no variability in returns from year to year, decade after decade? It doesn’t only matter what your returns are over time, it matters when you get your returns. This is where independent modeling can be very helpful.

The internal rate of return (IRR) on your out-of-pocket cash flow to net policy value in Year 10 is negative 2.34% but is positive 4.78% by Year 15. That’s quite a swing in a handful of years. By age 85, you’ll have experienced an average annual rate of return of 9.685%. That’s pretty attractive, especially when you consider 45% of the premium went to expenses and the proposal illustrates $20 million in total expenses through age 85. Even the IRR on gross premium, including what you borrowed, is 5.82% over the same time period. When given the expenses noted above and a gross policy crediting rate of 5.67%, like I keep saying, you’d better understand how that works.

My understanding is that this has been postured as a relatively low risk endeavor in which wealthy and sophisticated people take advantage of leverage. Leverage is perfectly fine, and most of us find ourselves doing this, most notably when buying a home. However, the old axiom, if it’s too good to be true … should be infiltrating your thoughts. I’m not sure there’s such a thing as a tax free 10% rate of return that is low risk.  I believe you need help understanding the true risk of this proposal. And recall what I mentioned about commitment; you can’t bail on this for years without taking some big lumps.

If you committed $150,000 a year to a traditional investment and realized a reasonable rate of return, you could have over $2 million in 10 years. If you realized a 0% return, you’d still have the $1.5 million. With your financed insurance proposal, even if the very attractive assumptions panned out, in 10 years, you’ll still be underwater relative to your contributions and if the assumptions don’t pan out, you could have nothing and lose posted collateral over and above the out-of-pocket premiums you paid.

Additionally, if the deal is working out fine but you have a life change and can’t, or choose not to, continue contributing to the program, don’t assume you have that option without taking a hit.

As I mentioned during our phone call, I’m not against indexed universal life or premium financing, but my history in the market of analyzing proposals and existing programs as well as my experience in the litigation support and expert witness world leads me to understand that an abundance of caution is beneficial and the fees I related are quite minor relative to what’s at stake and the potential consequences. Remember, I’ve been through the looking glass. It’s what I do.

Bill Boersma

Bill Boersma is a CLU, AEP and LIC. More information can be found at www.OC-LIC.comwww.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.comwww.LifeLoanRefi.comTheNAPIC.org, www.LifeInsExpert.com or email at bill@oc-lic.com.

Life Insurance in the Coronavirus Era

June 2nd, 2020 No comments

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Coronavirus-Related Life Insurance Considerations

May 12th, 2020 No comments

Things to keep in mind.

While some insurance carriers are implementing virus-driven underwriting changes, I’ll focus on other issues to think about during the COVID-19 pandemic regarding life insurance. Most, if not all, of these issues are applicable during normal times, but it might be easier to get attention now.

Cash Flow

I recently read a statistic about the percentage of people feeling a cash flow crunch as a result of layoffs and the disruption of business. It’s to be expected, even for the most responsible of us. Even those not in a real crunch now are choosing to delay mortgage payments and discretionary purchases simply because there’s too much uncertainty moving forward.

What should policyowners keep in mind now? If they’re in a cash crunch and life insurance premiums prove an undue burden, there may be

options, but they need to be understood and enacted appropriately. Many life insurance policies can handle not having premiums paid for some period, but policyowners better be sure, and often they don’t know if that’s the case. Also, and this might sound strange, depending on the kind of life insurance, they better not pay the premium the right way.

Whole life (WL) and term premiums work very differently than universal life (UL) based products. One might be able to simply not pay the premium on a UL policy and be fine for some period of time. On the other hand, not paying on a WL policy might result in it flipping to a reduced paid-up contract or extended term, which is likely a permanent result.  Automatic premium loans and using policy dividends or paid-up additions might be in the cards, but all of these options, and the ramifications, should be analyzed and modeled.

It’s times like these that many look to their cash value life insurance as a source of funds. This may be a good choice, or it may not be. Some policies have very favorable loan features, while others don’t. Some have low interest rates, while others are very high. Taking out a loan meaningfully affects the policy performance on some contracts, while it’s negligible on others. Is borrowing money out of a contract the best thing to do, or might it be better to use the policy as collateral and borrow from an external source? What options have been presented? How have they been analyzed? Have the various options been objectively compared? Please don’t let your clients take action without doing so if you have any influence.

Policy Loans

Speaking of life insurance and loans, many life insurance policies already have loans, and too many policyowners don’t understand the terms and the effects of the loans. In many of these situations, the loans are crushing the policies, and in some, the policyowner is coming out of pocket for the loan interest to keep the policy alive.

The concept of refinancing a high-interest policy loan should be evaluated. I’ve helped many policyowners save tens or hundreds of thousands of dollars of interest annually by favorable refinancing policy loans. An additional benefit is strengthening of the policy and preventing nightmarish income tax consequences.

Life Settlements

I wouldn’t run to a life insurance settlement on the secondary market just to satisfy a liquidity crunch, as the policy may be very important over the long term. However, there are many policies out there that have been riding on a thin edge for a long time, and the current circumstances we find ourselves in might be putting some policyowners over the edge.

Maybe they were wondering if they could afford to increase the premiums, and now that decision has been made for them. Maybe selling a policy with $100,000 of cash value for $500,000 didn’t look attractive enough before, but it does now. Whatever the reason, the life settlement market is more aggressive now than it’s been for a long time so it may be worth some attention.

Term Insurance

Given the typical term insurance premium, there might not be a lot to gain from evaluating term coverage, but I’ll suggest there’s more to it than many understand.

Many term insurance policies on the books remain competitive, but many aren’t. I often see drastically overpriced policies in which the insured individuals have been squandering money for years. Use this as an opportunity to review your client’s portfolio to make sure his money is working the best it can be.

Many people also have their term insurance through professional associations and group term through their employers. While this is better than nothing and valuable for those who can’t otherwise qualify for life insurance, it’s also some of the most expensive and poorest quality insurance out there. The potential money saved with individually underwritten life insurance with dramatically better contractual features and rights would surprise most policyowners.

A Diversified Estate Portfolio

A recent teleconference with some advisors and their clients brought back to the forefront a piece I wrote a handful of years ago. It’s about the attributes a well-designed life insurance portfolio can bring to an estate. We all will eventually die with “pots of stuff,”  including personal assets, business assets, traditional investments, qualified plans and real estate.

But let’s focus on the unique attributes of life insurance. Life insurance has unique income tax attributes that can make it attractive. Unlike almost everything else in a portfolio, it has an inverse relationship to time. It has very low, if any, variability. Life insurance is a noncorrelated asset, which is one reason life settlements as investments are attractive to some portfolios. What if your client dies during uncertain times like we have now, when most of the other assets are severely depressed? Life insurance comes in at full value regardless of housing starts or jobless claims, the exchange rate of the yen or the euro, who’s in office, what war or geopolitical issue is going on or … pandemic.

Need for Premiums

Though much of my work involves rescuing underfunded life insurance policies that need more of a cash infusion, sometimes it’s the other way around. It’s not uncommon to meet with policyowners who want to reduce or terminate premiums and express disappointment at not being able to. They’re surprised when I tell them they don’t need to keep paying. Many WL policies are funded well enough for dividends to cover premiums with an analysis showing out-of-pocket premiums can safely be stopped. Even though guaranteed UL is often notoriously susceptible to rigid premium requirements, I’ve seen situations in which premiums can be terminated for a number of years with no adverse effect. In the latter, unnecessary premiums are simply a waste of money.

As mentioned earlier, every one of these points is as pertinent at any other time as it is today, but maybe the issues some are currently facing will garner renewed attention. Not only will education and expert guidance help many of your clients when they need it, but also without it, too many will make poor decisions that won’t best help them now in addition to having deleterious consequences over time.

 

Bill Boersma is a CLU, AEP and LIC. More information can be found at www.LifeLoanRefi.com, www.oc-lic.comwww.BillBoersmaOnLifeInsurance.info and www.XpertLifeInsAdvice.com or email at bill@oc-lic.com.

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Coronavirus, Preppers and Life Insurance

May 4th, 2020 No comments

Can the current situation help us focus on priorities?

I don’t think of myself as a prepper, but not everyone agrees. My truck has a toolbox, fire extinguisher, jumper cables, flares, extra oil and antifreeze, a medical kit, tow straps, a water filter and more. Some might roll their eyes, but when something is on fire, literally or figuratively, they tend to look in my direction. Yes, my Wrangler looks like an apocalypse response vehicle, my basement has its share of home canned goods, and people joke about heading to my house during a disaster, but it’s only a joke until it isn’t.

I’m not racing to the store now to stock up on anything, and that’s a nice feeling. What does this have to do with life insurance? Quite a bit. Why am I thinking about it now? A year ago, an executive I met started asking me about his life insurance as his term policy was close to expiring. Life gets in the way, and I didn’t hear back from him for quite a while. After he reestablished communication, I learned he was prompted into action after his 50-some-year-old brother-in-law, a professional himself, died suddenly leaving a wife and three children at home … and no life insurance. I see this more often than I care to say. For full post, click here…

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Corona Virus, Preppers & Life Insurance

April 27th, 2020 No comments

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Insurance Policy Loan War Stories

April 24th, 2020 No comments

Why it makes sense to understand what’s going on when refinancing.

After writing a few pieces on loan refinancing, I’ll now share some examples. Over the years, I’ve seen many situations in which policies have significant loans. These include whole life (WL) policies, universal life (UL) policies and others. Some are modest, and the policies can handle the loan, while others are overwhelming and will drive the policies into the ground. Some have reasonable rescue strategies, and others are all but loss causes.

These situations often involve a lack of understanding about how the policies fundamentally work, how loans affect the contracts and how to manage the policies over time. In some situations, the initially chosen policy management features, which have caused the problems to escalate over time, have never been changed. Sometimes I’ve been able to simply make a dividend option change, and a failing policy can be self rescued with the trajectory of the cash value, loan and death benefit reversing itself over time. For example, when a policy has an 8% loan interest rate in today’s market, why would a dividend option be set to buy additional paid up insurance while ongoing premiums are added to the loan and loan interest accrues? Again, it’s a lack of understanding and too often an abandonment of the policy owner by the agent. What may have been true a number of years ago may not be true today given the meaningful changes in the financial marketplace and policy crediting. Policy management is an ongoing responsibility. For full post, click here…

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Refinancing Life Insurance Loans – Scenarios

April 20th, 2020 No comments

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Refinancing Life Insurance Loans by Bill Boersma

April 1st, 2020 No comments

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A Different Kind of Premium Financing

March 18th, 2020 No comments

Concentrate on the spread between borrowing rates and opportunity cost of money.

In certain markets, premium financing is all the rage and has been for some time.  The basic pitch is that wealthy, sophisticated clients should borrow money at low rates to buy life insurance and let their money grow at a higher rate and over a number of years. The results of this spread or arbitrage can pay back the loan so they’re not out of pocket for the entire cost of the life insurance.

This is perfectly legitimate, but I also believe there’s right way and a wrong way to do it.  I’m not a fan of much of what I see in the market because I feel, or have proof in many situations, that it’s based on misrepresentation and a severe lack of understanding.  The disasters that end up on my desk are almost all based on the perceived spread between borrowing rates and life insurance policy crediting.  Unfortunately, in too many situations, this isn’t real or sustainable, and few consumers and advisors understand how it really works and the risks involved.

The real opportunity with premium financing is on the spread between borrowing rates and opportunity cost of money rather than the policy crediting.  It’s the same reason I don’t pay off my home mortgage.  If I’ve borrowed at 3.5% to buy my house,  I believe I can do better than that over time in the market and I understand and accept the risks and have the wherewithal to deal with the results if things change, why would I pay down my mortgage any faster than I have to? For full post, click here…

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Life Insurance and Policy Loans

March 4th, 2020 No comments

Bill Boersma, Jason Kurchner | Mar 04, 2020

A match definitely not made in heaven.

As a life insurance consultant, I see just about everything imaginable out there. My desk is littered with cases for which I’ve been called in to pick up the pieces after the wheels fall off. In fact, litigation support and expert witness work is the fastest growing part of my practice. There’s a lot of good work, but there are also a tremendous amount of lousy plans. Advisors are regularly bringing me their client’s non-performing policies and structures and I like to use these real life cases to educate as many advisors as possible.

I urge the advisor community to address these issues before clients are dissatisfied and angry. Proactive action can prevent problems and save a ton of money. There’s a common problem that few are aware of that has an obvious and simple solution.

Large Policy Loans

There are a handful of current files on my desk with large policy loans. The loans on these policies range from $500,000 to $3 million. In some of these contracts, money was actively borrowed out, and in some, the loans are a result of borrowing premiums to fund the policy. In others, the policy owners didn’t even know a loan existed. Imagine the shock when they learned this. For full post, click here…

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