#145 | Financed IUL Update
In Quick Take #2, I surmised that higher interest rates would put a clamp on new financed IUL proposals and the squeeze on in-force designs, particularly the ones where the client planned on accruing interest forever. But just as cockroaches are said to be able to withstand a nuclear war, so too have premium financing promoters found a way to keep marketing their wares despite the fact that interest rates have turned against them.
In the days of yore, financing promoters would show clients accruing interest forever and reaping the illustrated benefits of financial arbitrage for eternity between the financing loan cost and the illustrated rate. That no longer works because loan rates have significantly increased but, fortunately for them, cheaper financing is now available – policy loans. Now, the strategy is to pay interest out of pocket and then refinance the bank loan with a policy loan. The risk, of course, doesn’t change. Policy loans are still debt in the same way that bank loans are. But optically, it looks much cleaner. The client sees their bank loan being “paid off” via policy values. What they probably don’t understand is that they’re simply swapping one loan for the other. Take a look at this proposal and this proposal.
The Vietnamese have a saying – same same, but different. That’s modern premium financing. It’s the same as the old stuff but, now, bank loans are substituted for policy loans. Mercifully, clients usually go into deals these days expecting to pay something out of pocket. Take a look at this proposal, which requires a lump sum payment in year 1. If you think that makes the economics of the deal are worse, think again. These new financing promoters are quick to point out that paying interest has its advantages – namely, that refinancing the bank loan principle with a policy loan shows that there will be significantly residual value left over in the policy.
And what, pray tell, do these premium financing promoters plan to do with that residual value? Why, lever it up, of course. Most of these new premium financing proposals show a lifetime income stream being disbursed from the policy, courtesy of policy loans, beginning after the bank loan refinancing. The pitch is that the client just has to pay the carry on the loan for 10 years or so and then get a stream of income from the policy thereafter. Check out this financing proposal (which was presented at a major industry conference from the main stage) – and this one – and this one. I mean, what could go wrong?
These strategies are not real. They are simply creatures of the illustration and nothing more. Financing promoters, despite what they say, have done barely any real financial analysis of what they’re selling – which is actually a very complex short-term/long-term fixed income swap with a derivative overlay where all of the pertinent variables are controlled by the insurance company. It’s going to about as well as when premium financed UL (yes, UL) policies from the early 2000s that were also sold as free insurance because the crediting rate exceeded the projected loan rate. If you don’t recall, those collapsed in a heap of lawsuits. Or maybe this will go as well as when hybrid financing deals from the mid-2000s suffered the same fate. Come to think of it, when has premium financing under the assumption of long-term financial arbitrage not resulted in a wave of lawsuits, carrier payouts and policy rescissions?
Real, quality financing groups – and yes, there are a few of those out there – scoff at these types of financed IUL programs. True premium financing is a way for the client to keep their money at work in their own business earning better returns than anything in the public markets while ensuring that they have liquidity to pay estate taxes. The only requirement is that the client has something better to do with their money than buy life insurance, even though they need it. It’s not based on some artificial, unproven, precarious, cavalier and often deceptive projection of long-term financial arbitrage – it’s just prudent and smart financial planning. But financial arbitrage? Please. If you get pitched a long-term financial arbitrage strategy from someone who hasn’t even passed their Series 7 and doesn’t manage a few billion dollars with a decades-long track record of outperformance, then run.
I would also be remiss if I didn’t mention the fact that this type of arbitrage-based premium financing isn’t limited to just Indexed UL. Some folks have also decided that Whole Life is a suitable place to employ financial-arbitrage projections. This is every bit as foolish as doing it with Indexed UL, but at least it’s less risky because the variability of returns is lower. One could also conceivably make the argument that using a Whole Life policy might actually work for accrued interest premium financing if dividends paid by the company are sufficiently boosted by other business earnings. But it’s a stretch and I wouldn’t make that bet and neither should your client. Whole Life works well for premium financing when the client is paying out of pocket and wants a collateral offset from very stable cash value growth. You’d be hard-pressed to find a better vehicle than Whole Life for those cases.