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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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Letter of Explanation – Premium Financing

December 20th, 2018 No comments

Following is an email I recently received:

Over this past year I have been contacted several times (by parties that I respect) asking me to get involved with Premium Financing…    The pitch is compelling – that Indexed life insurance is great (a game changer); that some carriers offer immediate surrender free CV of 100% of the premium deposit(s); that super large banks are happy to do the lending…   on and on…

I just read your take on this and I respect your opinion…     Could I ask you, if I was to get involved, what insurance companies or financial firms do you think are respectable and experienced (and doing the best job) in this specialized arena? For full post, click here…

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Letters Of Explanation – Policy Funding Options

September 24th, 2018 No comments

Dear Mr. Client:

It was a pleasure to speak with you last week and I appreciate the opportunity to review your life insurance policy. Per our discussion, this note is intended to be a follow up summary of our conversation. If there is any additional information you were looking for which I have forgotten to include, or if you have questions about what I have written, please do not hesitate to get back with me.

Your $1,000,000 was originally an Alexander Hamilton policy which was acquired by Jefferson Pilot and subsequently merged with Lincoln Financial. Though I do not have the original sales ledgers, the original premium of $13,750 was likely calculated to maintain the policy indefinitely given the interest crediting and expenses assumption in play at the time the policy was issued in 1995.

Since that time interest rates have come down significantly; probably 300 basis points or more. For full post, click here…

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Letters of Explanation: Donating a Policy to Charity

August 16th, 2018 No comments

Good Afternoon:

It is my pleasure to be introduced to you.  Your accountant referred you to me because of the frustrating, yet required process when donating a life insurance policy to a non-profit.  I understand it is not pleasant to hear you won’t be getting the deduction you were expecting for your policy donation to the school but the process I will bring you through will get you everything you are entitled to.

Unfortunately, your cash value is not the number the IRS looks at when taking donations into account.  To think about it in a simplistic way, they aren’t eager to let you take a deduction for something you have never paid tax on.  In other words, the special rules which allow your life insurance cash value to grow tax free is what is preventing you from fully deducting that same cash value. For full post, click here…

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Letters of Explanation – Trustee Liability

July 31st, 2018 No comments

This letter is to the management of a law firm.  Multiple attorneys act as trustees for clients.  There has been no program of management regarding these policies and I was called in to suggest a plan.  I was also able to look at redacted policy information and could see at a glance that many policies are underperforming and headed towards failure.  A decision was made that the attorneys deal with it on a case by case basis as they see fit.  I see this as a grave mistake.

Dear Firm Management:

It’s been a while since we’ve talked and the last time we did you mentioned the attorneys who are acting as trustees will be deciding independently on how to proceed.

I understand this but as we discussed earlier, if things go wrong (which they have and will) and result in a lawsuit, case law has shown that an independent third party is critical to a successful defense.  I am currently involved in four litigation support and expert witness cases, some going after trustees and some defending trustees. For full post, click here…

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Letters of Explanation: Whole Life Term Blend

July 25th, 2018 No comments

This letter is to a client explaining why the term blended whole life policy on his mother is failing:

Dear Mr. Client:

Unfortunately I still do not have what I requested from XYZ Life but I was able to do some work anyway.  Also, what I requested may end up being sent directly to the policy owner, which is you as trustee, at the address of record.

You had asked about potential income tax consequences regarding this policy and I believe there would be none as it looks like the gross cash value is less than what I calculate the basis to be in the contract.  I am waiting on a formal basis and gain calc from the company. For full post, click here…

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