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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?

Premium financing can be a powerful tool for a slice of the market that can afford to bear the risks, but it’s being mass marketed to the mass affluent, most of whom probably shouldn’t get involved. “Non-recourse loans” is a term that’s being bandied about with abandon but isn’t really addressing the actual risk.  Just because a client has a non-recourse loan doesn’t mean he can’t lose his tail plus a whole lot more.  For many of these deals, sure, the insurance company is limited to what’s in the insurance policy because it will never allow the loan to become greater than the cash value that’s collateralizing it.  But Uncle Sam may still have his hand out.  If that policy is in a gain position (and don’t your clients certainly expect to be, or why else would they be involved?), there could be millions owed to the government on phantom gain. That part certainly isn’t non-recourse.

There are other more common and practical times to think about insurance and financing, and it all goes to the idea of best utilizing money.  Let’s say your client is a business owner and is making 15% on his money in the company.  Let’s further say he has a life insurance policy for estate tax planning, business succession planning and liquidity.  For purposes of this example, we’ll assume the premium is $100,000/year.  Furthermore, let’s assume the internal rate of return on his premium to death benefit at actuarial life expectancy is 6%.  It may be a conservative product or even guaranteed, and it’s tax free and provides him the funds precisely when needed.  That’s not bad but let’s look closer.

How much does anyone like taking 15% money out of the game to exchange it for a 6% return?  Also, this probably means taking $150,000 out of the game to net $100,000 after taxes.  What if that money could be borrowed at a dramatically lower rate while productive capital stayed in the game?

Let’s Look at the Numbers

I’ll make up some numbers and assume a 35% tax bracket and a 4% borrowing rate over 10 years and, to compare apples to apples, I’ll accrue the loan interest.  The rough numbers are that borrowing $100,000 a year will result in a $1.25 million loan.  On the other hand, leaving $150,000 in the business at 15% will grow to $3.5 million over the same 10 years.  To pay off the loan at that time will mean distributing about $2 million to net sufficient funds to pay off the loan while leaving $1.5 million of value that otherwise wouldn’t have existed.

The tax rate, insurance return, borrowing rates, loan rate and so forth can all be different, but the fundamental point is that if there’s leverage to be had, why not have it?

Sure, there are a number of intricacies unique to a given case; the type of policy, is it in an irrevocable life insurance trust, do we need external collateral, etc.  But I see policy owners pit agents against each other or make other decisions based on the smallest of issues or spreads of cost, so why wouldn’t they pay attention to an idea that could fundamentally reduce the cost of their insurance by far more than any other single issue?

How Is This Different?

What are some things that make this different than the premium financing barrage out there?

  • Your client already decided he needs life insurance, and this is a strategy to fund it rather than using an insurance funding strategy as a reason to buy it.
  • Your client isn’t dependent on the insurance policy performing as predicted or illustrated.
  • There are no games being played regarding paying back the loan.  Everyone knows what it is, and it can be paid back when wanted or needed.
  • Your client can bail at any time with no loss.
  • Your client doesn’t need to die to pay back the loan.
  • The life insurance policy itself never has a loan.
  • The efficacy of the plan isn’t dependent on the insurance company not changing the rules.
  • Works with any kind of insurance.

Unlike other financing pitches, this is straightforward and understandable.  It’s based on the same metrics and decision making that a business owner and his advisors would use on virtually any other deal or proposal.   The numbers speak for themselves, and they can’t be manipulated like so much of what I see out there.  They’re provable and able to replicated without a shadow of a doubt, and an advisor can independently vet them.

Another Angle

One of the predominant points of selling whole life and other cash value plans is the ability to borrow from them.  Whether it be planned or for an emergency, there may a true benefit to having a source of capital at the ready.  However, just because one can, does that mean one should?

Let’s say your client has easy access to a 6% loan to buy a new car.  Does that mean she should?  My mother-in-law just got a car loan at 2.99%.  Wouldn’t that be better in almost every situation?  Then why automatically take a policy loan if a better loan is available that can be collateralized with the policy cash value?  Many people who compare the price of gas and groceries on a regular basis don’t think to look for a better loan rate when eyeing the life insurance policy for cash.

Many of the consulting cases on my desk are a result of whole life policies with very large loans that are threatening the very survival of the policies.  Most of these loans are at 8%, and the accruing interest is unsustainable.  If I’m helping them salvage these policies by refinancing these loans at dramatically lower rates than they’re currently paying, why take out a higher rate loan to begin with?

Misunderstandings

I’m borrowing from myself, you say?  Nope.  Since my cash value is still being credited, my loan rate is really only the spread between borrowing and crediting and is very small, you’ve been told?  Not really.

First, a policy owner isn’t borrowing from herself, regardless of what she’s been told. The insurance carrier has stepped in as the bank.  The loan is separate, and the cash value of the policy is simply collateralizing it.  If you had $500,000 of securities that were collateralizing a bank loan for real estate or plant and equipment, even if it was with the same institution, are you really borrowing from yourself, or do you have a separate securities account with $500,000 in it and a $500,000 loan that happens to be now tied at the hip?

If the life insurance policy is being credited at 5%, and the loan interest is at 6%, or even if it‘s a wash loan and the crediting and lending rate is the same, wouldn’t a 3.5% loan rate be better while the policy continues its normal crediting?  There may have been a time when the line told by the agent was more accurate than it is now, but the world changes and things need to be questioned on an ongoing basis.  Different contracts work differently so to be sure, let’s run all the numbers.  The numbers are what they are, and no decisions should be made without independent calculations.  The point is, don’t take anything for granted, ignore conventional wisdom and let’s not start leaving common sense by the side of the road just because the words “life insurance” have entered the conversation.

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

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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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An Unfortunate Conversation Regarding a Life Insurance Policy Loan

February 12th, 2020 No comments

What your client doesn’t know certainly can hurt him

Life insurance policy loans trip up more people than I thought could ever be possible.  It’s not because they’re so complicated but because they aren’t properly explained to most policy owners.  Worse yet, many policy owners don’t even know they have loans on a policy and when they do, don’t understand how they got there.  This sounds so ridiculous it defies belief.

Consider this: A policy owner recently called me after his attorney sent him a copy of something I’d written about policy loans.  “This story could be about me.” he exclaimed.  I asked him to send me what he had and explain what he was trying to accomplish.  Included was a list of questions he had for his agent, of which the agent answered the simple and inconsequential ones and ignored the balance.  It was easy to understand why, as the balance of the questions had no answer that any agent would want to share with a client.

Here was one of the questions: “When I first talked to you years ago, you indicated that I could borrow my own funds at a 1% to 1 1/2% interest rate, so how did the loan get to over $700,000 when I only borrowed about $175,000 and paid back $225,000 at one point.”  I imagine that would be a good question.

It’s fortunate but sad that I knew the answer before I opened the attachments because this isn’t the first or last time I’ll see this.  I’ll recreate the conversation: For full post, click here…

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WSJ Article: It’s the Hottest Thing in Life Insurance. Are Buyers Aware of the Risks?

January 7th, 2020 No comments
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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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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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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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Life Insurance: Told vs. Sold

September 17th, 2019 No comments

Over the course of my life insurance consulting career, it’s been much more common to be called in to fix things that are already in place than to be called in to help understand and build something right from the get go. For full post, click here…

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