Premium Financing: Are the Numbers Real

Speaker 1 (00:07):

Hi, I’m Bill Boersma, founder and president of OC Consulting Group. This is a follow up piece on policy crediting specifically relative to premium financing. Given the number of premium financing cases that I review, enforce 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 thing I see over and over again, and until this is taken care of, there will continue to be problems. The question is, are the numbers customers see real? 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 cuz I’m confident 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 it better than 3%. To the extent that I’m getting better than 3%, I’m effectively discounting the cost of my house. 

Speaker 1 (01:08):

Isn’t that the communicated appeal of premium finance? If I can borrow it one year, L I B o r plus 150 basis points today, let’s say that’s 2% and I can make five, six, 7% or even higher on a life insurance policy, why wouldn’t I? If I’m shown that the spread will grow cash value to the point I can pay back the loan, I have significantly discounted or even free insurance besides, that’s what sophisticated people in the know do, don’t they? That would be great if it were only true. Now, I can just about hear you saying, bill, you are not suggesting that the gazillions of dollars of premium finance business isn’t real, are you? Well, kind of of those gazillions in premium finance business, some percent is legitimate, but I’ll suggest that a lot of it isn’t. How can I say that? You might be asking because I’ve seen the misrepresentation firsthand. 

Speaker 1 (02:13):

Is that 6% whole life dividend rate or index universal life crediting rate real? Well, it depends on what the definition of real is. Is it an actual number that goes into the funnel along with all 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 finance cases built around both traditional whole life and index life in recent examples of each that I’ve analyzed. The internal rate of return on premiums to cash value over 10 years was 0%. So is the whole life dividend rate or the IUL crediting rate real? You tell me. If I’m supposedly being credited 6% and getting zero, what’s real? Where’s the 6% going? Premium taxes and charges, policy fees, mortality charges, commissions, et cetera. That’s to be expected because that’s how insurance works. 

Speaker 1 (03:21):

A recent index case on my desk had three and a half 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 returns. Where’s the positive arbitrage? That’s in the early years, so how about later over decades? The actual internal rate of return on premium to cash value is going to get better on a well-designed and well-managed policy, but we’re never gonna be at that stated or advertised rate. Is that a problem? Well, 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. It’s just not real there. I said it. 

Speaker 1 (04:17):

The gross whole life dividend rate and the illustrated index crediting rates that so many consumers buy into because that’s what they’re 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 as an internal rate return on premium to cash value that never exceeds one point something percent. I’m serious. The supposed arbitrage based on the original six and a quarter percent projected crediting rate never even hits under best case conditions. The borrowing rate, let’s review. Does your client have needs and a risk tolerance that necessitates consideration of such a plan? Or is this something supposedly sophisticated that rich people do? The advertised rate means little, 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 getting paid for what. Thanks for your time today and let me know how I can help.

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