Premium Financed IUL

Speaker 1 (00:07):

I’m Bill Borsema and I’m talking about what’s happening in the premium financed I U L market. Premium finance life insurance can appear to have a compelling narrative, your rich and sophisticated. So naturally you want to do what other rich and sophisticated people do. Why use your own money to pay for insurance when you can use other people’s money at historically low interest rates to buy a policy that has upside market opportunity without the downside risk? The primary marketing hook of an index contract is a fact that it has a floor such as 0%, so the cash value crediting cannot experience a negative return. These contracts also have a capped limit to the upside potential. Let’s say 10% regardless of the s and p 500 index return for the period. This is in effect a collared return. Why not forfeit some upside in the good years to avoid experiencing loss in the bad ones? 

Speaker 1 (01:04):

The opportunity to realize 10% while facing no negative return risk can be quite attractive when the s and p 500 projects to grow your cash value handsomely. Over time, you can withdraw or borrow some of that cash value tax free to pay back the loan. Your life insurance rides the remaining cash value for the rest of your life. And if you’ve beaten the market based on my experience, this is often the story used to market financed I U L policies. Is this the whole story? Of course not. Premium financed I U L transactions are frequently so complicated. It’s difficult to know where to begin, and prospective policy owners do not have an appreciation for the level of complexity deaths involved. In fact, many believe these programs are rather simple and straightforward and most of this confusion centers on the I U L product itself. Though many are drawn by the equity style returns, most clients never realize that their premium dollars are not going into the s and p 500 or any equities for that matter. 

Speaker 1 (02:09):

IUL contracts are not securities and the contract’s cash value is a part of the general account of the insurance company that is largely required to invest in high quality bonds. This is often where expectations in reality start to diverge because clients expect equity returns even though the premiums were not invested in equities to begin with. So where did those projected returns come from? The carrier uses a small bit of the premium in income from their bond portfolio to purchase derivatives to credit the upside gains to cash value. The carrier doesn’t need to limit downside losses because the client’s money is never in the market, so there can’t be a loss. From an investment perspective though this is very different from experiencing a loss in cash value, and we’ll come back to that. Let’s look at a real life case study that I’m reviewing for a client right now who borrowed significantly from a bank to buy into one of these contracts. 

Speaker 1 (03:07):

This client purchased a 5 million index universal life policy in 2015, and the policies premiums were a little over half a million a year for seven years. The final payment is due a few months. The money was all borrowed from a bank with the policies, cash value, and other assets pledged as collateral for the loan. This policy was built particularly skinny, meaning there’s no room for error. It couldn’t account for the reduced cap rates and the reduced crediting and realized rates. So something has to give. The client will either have to put more premium in pay, more interest, expect to reduce death benefit pledge more collateral, expect less income out of it, or a combination of some or all of the above. Two plus two can’t equal four when one of the twos is actually a one. The original 5 million policy was expected to last through age a hundred with a 5 million death benefit after paying off over 3.6 million in loans, but now it’s projected to collapse after the loan is paid back and no death benefit will be paid out. 

Speaker 1 (04:14):

In addition, about 2 million of interest will have been paid along the way and the illustration assumed an unsustainable low loan interest rate that was projected to continue indefinitely as well as the highest regulatorily allowable policy crediting rate. That itself was built on unrealistic assumptions. It will all more likely than not be worse. So what’s it gonna take to get this thing back on track, especially considering the lower crediting rates and the potential for increasing loan interest rates? What are his bailout options? Does he know any of this? Does he even know he should be asking these questions? It’s gonna take seven figures of additional and unexpected premium for this thing to have a chance at working, and that’s under the best case scenario. Realistically, we’re talking about significantly more plus additional interest on the loans and possibly losing the posted collateral. The circumstances of this case are ideal for illustrating how the original projections of a premium financed I U L product compare with the policy’s. 

Speaker 1 (05:27):

Current reality equity markets have run hot and borrowing rates have remained very low on the loan since the policy was purchased. The s and p 500 annualized return during the period, this policy has been enforced. It’s 14.53% without dividends that aren’t included in the s and p 500 index products. In question. To many people’s surprise, the return is 12.47%. If a policy cannot succeed under one of the most successful market runs in history while using a premier carrier while loan rates have stayed unexpectedly low, then how could it ever be expected to work? You can also read the full article that was originally published on LAMB services. It is also posted on my LinkedIn page and my blog. Thank you and enjoy your day.

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