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Effect of Loan on Life Insurance Policy

December 12th, 2019 No comments

Question:

Please help me out with the effect of a loan on my policy.  What happens to policy crediting and am I focusing on the cash value or the cash surrender value when looking at COIs (Cost of Insurance).

Answer:

The effect of loans on life insurance policies is a source of common confusion and frustration.  There are potentially multiple effects a policy loan can have but regarding mortality charges we have to focus on the cash value and not the cash surrender value.  The reason is because of how life insurance loans actually work which is different than most people understand based on what agents tell them.

When policy owners take loans they aren’t actually “borrowing from themselves” as is common vernacular.  The insurance company is issuing the loan just as a bank would but without the financial underwriting because you are “pre-approved”.  And why wouldn’t you be?  I think any financial institution actually holding assets of yours for greater than the loan amount would be fine issuing an on demand loan.

The cash value of the policy is collateralizing the loan which is why there is a different cash value and surrender cash value.  It’s no different than a line of credit collateralized by your investments.  Your total investments are there but your net available assets are lowered by the amount out on your line of credit.

The reason it matters that your cash value is still in the contract is because the insurance company only charges mortality charges or COIs on the spread between the cash value and the death benefit.  If ones death benefit is $1,000,000 and cash value is $200,000 then the COIs are on the $800,000 spread because you are basically self funding $200,000 of the insurance.  That’s why we like to see a growing cash value in most life insurance policies.  As the insured individual gets older the cost per thousand of coverage gets higher but theoretically it is on a smaller and smaller amount.  (Though this depends on what kind of policy we’re talking about.)

When a policy owner takes a loan, the cash value is still there but can get credited a different amount.  The “amount at risk” doesn’t change immediately due to the loan.  However, over time the effect of the loan could be meaningful or even devastating.  Lets’ say for sake of (a very simplistic) example that we have a variable life securities based policy and the policy cash value would have grown at 8% but the cash value collateralizing a $500,000 loan balance is put in a fixed account at 4%.  Over 20 years the account value at 4% would have grown to $1,095,000 versus $2,330,000 at 8%.  Over 30 years at 8% it would have grown to $5,935,000, a $3,410,000 difference over the $1,621,000 it would have grown to at 4%.  Now imagine the difference in mortality charges on $3.4 million for an insured individual at age 85.  It could be astronomical; hundreds of thousands of dollars a year.

The sinister aspect of this is that the cash value that doesn’t materialize due to the cash value collateral being reined in results in greater mortality charges which itself reduces the cash value which results in greater mortality charges which reduces the cash value… it’s a death spiral of sorts.

On the flip side, if one happened to be doing this prior to a market crash, the collateral moved to the fixed account could actually benefit the policy as the cash value wouldn’t have been hammered.

Regarding whole life contracts, some policies change the dividend crediting based on loans and others don’t.  There is an ongoing “discussion” regarding the benefits and costs of direct recognition and non-direct recognition policy loans and this is something to pay attention to but beyond the scope of this Q&A.

 

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Bloomberg – What the Non-Insurance Advisor Needs to Understand to About Indexed Universal Life Insurance by Bill Boersma & Henry Montag

November 13th, 2019 No comments

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Don’t Forget the Value of Life Settlements

November 7th, 2019 No comments

Policy owners can benefit greatly from a simple concept

Back in the day, the life settlement market was as crazy as the Wild West. Funders were making insane offers on anything you’d throw in front of them. A dozen years ago, with the financial collapse and significant changes in life expectancy calculations, things changed dramatically, and the market largely dried up.

Fortunately, for policy owners, the market is still alive and well. I’m currently working on a couple of situations in which policy owners have been well served by the existence of a currently thriving life settlement market.

Recent Cases

In one case, a trustee called me because a $2 million trust owned policy was collapsing, and the insured had made the decision to surrender it for its cash value of $85,000. This was a Transamerica policy that was subject to terribly dishonorable tactics. When Transamerica decided it didn’t want to pay death benefits on a certain book of business, it simply jacked up the mortality expenses dramatically even though it didn’t realize adverse mortality experience. This was also a strategy to make the policies less attractive to the life settlement market. For full post, click here…

Categories: Life Settlements, Success Stories Tags:

Introduction to Premium Financing by Bill Boersma

October 29th, 2019 No comments

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Success Story: Life Insurance Loan Refinancing

October 14th, 2019 No comments

A gentleman has a $2,000,000 mutual whole life policy with an $800,000 loan.  He and his wife weren’t even aware of the loan until recently because his agent wasn’t helping manage the policy and the trustee didn’t understand what was going on.

Since he didn’t realize there was a loan he wasn’t paying loan interest so it has been accumulating.  Additionally, his agent told him years ago he didn’t have to pay the premium out of pocket and that the policy values would pay it for him.  This turned out not to be true and his policy is in danger of collapsing with over $900,000 of gain at ordinary income tax rates.

The policy premium of $25,000/yr is being added to the loan annually while $56,000 of dividends are buying additional insurance (paid-up additions or PUAs).  We changed the dividend option to pay the premium so the loan wouldn’t keep growing.  Since the loan has an interest rate of 8%, this left $64,000 of loan interest of which $31,000 could be paid by the remaining dividends.  But who would accept an 8% loan?  Most insurance policy owners, that’s who.  They would refinance an 8% home mortgage but they don’t realize they can refinance a ridiculous policy loan and no usually one tells them.

We ended up refinancing the loan for 3.75%, collateralized by the policy itself, that reduced interest to $30,000, saving him $34,000 in interest annually.  This was enough to pay the interest on the new loan with a little bit left over to start paying down the loan.  As the policy dividends grow the loan principal can be paid down more.

The policy is now performing better than it was, has a full $2,000,000 tax free death benefit, has a much lower debt service and hundreds of thousands of taxes have been avoided.  It almost seems too good to be true but it is because someone paid attention.

 

 

Do you have a client with a policy loan?  It might be a good idea to talk.

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Whole Life Dividend Options and Policy Management

October 9th, 2019 No comments

Manage policies in your clients’ best interests.

Even though whole life (WL) insurance is one of the most traditional forms of life insurance, there’s an abundance of misunderstanding regarding how it works and the available dividend options. For the purposes of this piece, I’m referring to actual WL, not just permanent, cash value life insurance that many consumers generically refer to as WL. Universal life, indexed universal life, variable universal life and guaranteed universal life aren’t to be confused with WL.

Additionally, I’ll be referring to classic dividend paying WL, often referred to as “participating (par)” WL. It’s important to understand WL dividend options so you can make sure the policy is managed in the client’s best interest. Because I see so many problem policies, I understand why they’ve become problems; lack of understanding and lack of management. For full post, click here…

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Life Insurance: Told vs. Sold: Part 3

October 2nd, 2019 No comments

What policyowners are actually buying isn’t always necessarily what they think.

Part 2 of this series dug a bit deeper into the details of whole life and premium financing as it pertains to what policyowners are presented and what’s reality.

After highlighting the facts and figures that show this doesn’t really work as presented, I get the response “But Bill, that’s why we have the client pay loan interest out of pocket. It makes the program more conservative.” Frankly, that’s true, but how does that help relative to the misrepresentations I regularly see? All it does, it makes the policy look like it’s working on arbitrage, allow it to pay its loan off and keeps the collateral requirements lower. It doesn’t actually change the important dynamics of the transaction. If you add a couple hundred bucks to your mortgage payment every month, it’ll be paid off earlier, but it doesn’t change the deal. Putting more money down on a real estate transaction doesn’t improve the return on the property. The return is the return. Extra money down may make it less risky, but it absolutely doesn’t change the return. For full post, click here…

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Hybrid Life Insurance and Pension Protection Act 2006

September 30th, 2019 No comments

 

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Giving Life Insurance to Charity

September 25th, 2019 No comments

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What CPAs should understand about premium financing By Bill Boersma and Henry Montag

September 19th, 2019 No comments

Premium financing has been around for many years but it became more popular when LIBOR rates plummeted after the recession and perceived crediting rates on indexed universal life (IUL) insurance and whole life policies were relatively high.

Originally, the concept of premium financing was not much different than why one might not pay off a home mortgage, even when the money is available. If one thought that money deployed elsewhere would be more productive than paying down a mortgage, then why not do so? If I’m confident I can make more in the market or my business, financially it would be silly to pay down my mortgage any faster than necessary. Read More…

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