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The Most Important Thing to Understand Regarding Premium Financing: Are the Numbers Real? By Bill Boersma

September 16th, 2020 No comments

Given the number of premium financing cases that I review, in force and proposed, I’ve seen much of what’s out there and have a good grasp of the level of understanding in the consumer market. There’s one overriding commonality I see again and again, and until this is taken care of, there will continue to be problems: Are the numbers customers see real?

As I’ve written before, I’m not against premium financing. If I was, I wouldn’t have a mortgage on my house. I don’t pay off a 3% mortgage because I’m confident that I can do better over time in the market or invest that money back into my company, other real estate or whatever I believe I can invest in at better than 3%. Returns elsewhere that are better than my mortgage rate effectively discount the cost of the house.

The Appeal

Isn’t this often the communicated appeal of premium finance? If I can borrow at 1-year LIBOR plus 150 basis points today, let’s say that’s 2%, and I can make 5%, 6%, 7% or higher in a life insurance policy, why wouldn’t I if I’m shown that the spread will grow cash value to the point it can pay back the loan and I have significantly discounted, or even free, life insurance?

That would be great… if only it was true. Now wait a minute Bill, I can hear you saying, you’re not going to say that the gazillions of dollars of premium financed business aren’t real, are you? Well, kind of. Of the gazillions in premium financed business, some percentage is legitimate but I’ll suggest bazillions aren’t. (Sorry for the technical terms. I’ve defined them at the end of this piece.) How can I say that, you ask? Because I’ve seen the misrepresentation first hand.

This isn’t about the realism of the AG 49 regulations or the future performance of the stock market or legitimacy of proprietary indexes or performance of more realistic sequencing of returns or the efficacy of indexed loans or numerous other things we can argue about regarding modern life insurance and the financing of premiums. No, this is about something very simple… are the numbers consumers see real?

What Rates are Real?

This is where we can start getting into the area of Clintontonian parsing of language. Is that 6.2% whole life (WL) dividend rate or indexed universal life (IUL) crediting rate real? It depends on what the definition of “real” is. Is it an actual number that goes into the funnel along with all of the other contract variables? Yes. Does it bear much resemblance to the product coming out the other end? No. At least not in the sense that policy owners understand.

I’ve seen plenty of premium financed cases built around both traditional WL and IUL. In recent examples of each that I have analyzed, the internal rate of return on premium to cash value over 10 years was 0%. Let’s go back to the earlier question; Is the WL dividend rate or IUL crediting rate real? You tell me. If I’m supposedly being credited 6.2% and getting 0%, what’s real? Where’s that 6.2% going? Premium taxes and charges, policy fees, mortality charges, commission, etc. That’s to be expected because that’s how insurance works. A recent IUL case on my desk had $3.5 million of premium in the first decade and $3.7 million of expenses during the same period. That’s bound to put a dent in the returns.

That’s in the early years, so how about later? Over decades, the actual IRR on premium to cash value might be 3%, 4% or 5% based on current dividend rates and reasonable market returns, but we’re still not at the 6.2%. Is that a problem? It depends on how the deal was postured to the policy owner. What I can tell you is that over and over I see a deep misunderstanding on the part of the consumer that’s a result of misrepresentation. The arbitrage these deals are consistently built around is between the gross crediting rate and today’s borrowing rate. Moving into the arena of Trumpian language, there is almost no understanding that this is a fake spread.

It’s not real, people. It’s just not real. There, I said it. The gross WL dividend rate and the illustrated IUL crediting rate that so many consumers buy into, because that’s what they are sold, doesn’t mean much relative to the net rate after all expenses. I’m not saying this is typical of all cases, but one I’m working on right now, based on the actual original sales ledger, that has an IRR on premium to cash value that never exceeds one point something percent. I’m serious! The supposed arbitrage based on the original 6.25% projected crediting rate never even hits, under best case conditions, the borrowing rate. It’s a perpetual negative arbitrage that the client bought into because of how it was sold to him! It didn’t even have anything to do with the opportunity cost of any of his other assets.

What Can You Trust?

But what about the spreadsheets showing is all working out? Ask yourself how well you comprehend those spreadsheets. Do you really understand all the variables built into them? How realistic are the assumptions? Maybe it’s being built on an insurance carrier’s illustration system that’s being outlawed as we speak. Are you familiar with options pricing and how that affects cap rates and where they can go? When do you want to discover that? Maybe it was built off a baloney, nonetheless “real” dividend rate that someone who actually understands the markets, the industry and how life insurance works, would absolutely know is going down. Wouldn’t that be valuable and more so today than down the road after millions are sunk into it?

Let’s review. Does your client have needs and a risk tolerance profile that necessitates consideration of such a plan, or is this something “sophisticated” that rich people do? The advertised rate means almost nothing so your client should never make a decision based on the “arbitrage” or “spread” between the advertised dividend or crediting rate and the borrowing rate because it isn’t real; it’s a fake spread. Seek objective counsel from someone who understands the financial markets, the industry, the products, the programs, what’s driving these deals and who’s paid for advice.

Once again, I’m not saying premium finance is bad or can’t work, and I’m not saying to get out of what’s currently in force. What I’m trying to say clearly is that anyone who’s in a deal or considering a deal absolutely needs to understand what is real and what isn’t real. Is that so crazy an idea? The good news is that this is possible. All that’s needed is some objectivity and a calculator. If they move forward with something that isn’t as real as it’s understood to be, things fall apart, disillusionment prevails and they end up at my door. After I dive in and untangle things and show them what was real from the beginning, they tend to pay attention and get engaged. If only they were that engaged from the outset.

* Gazillion – A lot.
Bazillion – A lot but not quite as much.

Bill Boersma is a CLU, AEP and LIC and the founder and principal of OC Consulting Group. More information can be found at www.OC-LIC.com, BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com.

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Do Life Insurance Dividends and Crediting Rates Mean Anything?

September 8th, 2020 No comments

It’s time to separate fact from fiction.

If I hear another policy owner touting the rate of return he’s getting on his policy cash value, I might scream.

Few policy owners have any idea what they’re talking about. All they’re saying is what the agent told them, and they haven’t even taken out a calculator to check the numbers.

Let’s look at a recently run traditional mutual whole life (WL) policy presented to me. The carrier is a big name and respected company with a

current dividend rate at better than 6%. The internal rate of return on the premium to the cash value at 10 years is negative 3.2%. At 15 years, it’s about 0%. At 25 years, or age 70, it’s 3.5%. It never hit 4%.

Expenses Need to Be Considered

There’s nothing wrong with this, and it’s a perfectly fine policy. However, don’t tell me you’re getting 6% on your cash value because you’re not. That’s not even how WL works. The cash value, let alone your premium, just doesn’t grow at the stated dividend rate. I mean, seriously, where do you think the expenses are paid from? Of course, not everyone thinks this and not every, or even most, agents misrepresent it, but enough do so it needs to be talked about. For full post, click here…

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Indexed Universal Life: Back Testing and Cap Rates and Averages, Oh My!

July 30th, 2020 No comments

In a recent engagement, an agent trying to convince a client to enter a premium financed indexed universal life (IUL) transaction was touting returns on his own IUL policy over the past decade or so.  I found a number of aspects of this peculiar.  One was that he was touting the average interest rate on his own policy, which has happened to be in force during the longest bull market in U.S. history.  This was supposedly a reason the product was so great and could/might actually outperform the crediting rate of the sales ledger, which I already deem to be too aggressive based on significant objective data.

Another oddity is that he evidently doesn’t understand the difference between an average interest rate and the internal rate of return (IRR), which is the difference between an arithmetic mean and a geometric mean.  The geometric mean will generally be lower, and it’s the number any sensible person would use when evaluating an investment.  As an example, what if you get a 0% rate of return for three years and then a 40% return in the fourth year?  The average rate of return is 10% but the IRR is 8.78%.  It’s respectable but not accurate.  No one would reasonably look at the track record of this product as 10%.

Next, the agent was sharing past rates of return that are higher than currently possible due to falling cap rates.  In an IUL product, the cap rate is the highest crediting rate possible regardless of the actual index return.  On the flip side, there’s a minimum, often 0%.  Therefore the product is postured as having upside potential with downside protection.  This is not untrue but rather misleading without a full discussion of internal policy fees and charges and what’s going on with caps. For full post, click here…

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Video: Funding a Buy-Sell Agreement with Life Insurance

July 28th, 2020 No comments

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Woes of a Fee-Based Life Insurance Consultant

July 21st, 2020 No comments

Why are policy owners so reluctant to pay for these services?

I’ll admit it.  I get frustrated at times.  I’m a fee-based consultant brought in by attorneys, CPAs, trustees, financial advisors and family offices to review, create, fix and do whatever else is needed regarding life insurance products and concepts.  I’m approached to analyze policies and programs already in force for years or even decades, and sometimes it’s new proposals that I’m retained to opine on.

History Can be a Guide

I’ve been around long enough to say “I told you so” a lot.  When I first started doing “policy audits” 20 years ago, which was already 15 years into declining interest rate markets, most policy owners and their advisors hadn’t seen many, if any, examples of underperforming whole life (WL), universal life (UL) and variable life policies.  Few people understood how modern life insurance worked and how the interest rate markets affected it, so few even looked to monitor, let alone manage, life insurance policies and portfolios. For full post, click here…

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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. For full post, click here…

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. For full post, click here…

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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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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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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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