#414 | The Power of Cash Value Collateralized Lending

When it comes to collateralizing cash values, there are two primary use cases in the industry – policy loans and premium financing. In the case of a policy loan, the life insurer collateralizes the cash value to provide a cash loan with terms set by the life insurer. Life insurers can charge interest at a rate set by an external index, at a fixed guaranteed rate or at a declared rate of their choosing without any sort of term end date to the loan or credit underwriting. The wide latitude for setting interest rates in policy loans is the result of the fact that the life insurer holds both the liability and the asset. Whatever the policyholder pays in interest makes its way back to policyholder in the form of an interest credit on the loan itself.

Premium financing is a completely different animal. Third party banks step up to provide funding for policyholders to pay premium with borrowed money and accept cash value as part of the collateral package securing the loan. As with any standard loan, there’s a credit underwriting process, a clear loan term end date and a defined interest rate formula, which is usually a floating rate based on something like SOFR plus a spread. The structural advantage of a premium financing loan is the ability to blend other collateral with cash values so that the loan can be used to pay premiums even though the cash value isn’t sufficient to provide full collateral coverage. It’s a way to get the policy off the ground before, as most premium financing illustrations show, the external bank financing is eventually refinanced for a policy loan.

There is, of course, another advantage to premium financing – lower loan interest rates. Bank loans are typically pegged to short-term interest rates. Floating-rate policy loans such as those found in non-direct recognition loans in Whole Life are linked to the Moody’s composite, which is a long-duration yield metric that is meant to be reflective of how the life insurer would otherwise invest the funds. In the sort of steep yield curve environment that we saw prior in the decade prior to 2022, it was easy to get premium financing loans at absurdly low costs relative to policy loans. Variable rate debt obligation (VRDO) strategies have infamously pushed this logic to the limit by financing premiums with collateralized perpetually rolling ultra-short term notes in the repo market. In the doldrums of the mid-2010s, it was not uncommon for premium financing proposals to cross my desk showing long-term assumed financing costs of less than 3%. I even saw one deal for a very high net worth client at 1.75%.

Over the past couple of years, being at the short end of the curve is not an advantage – but the times are already changing. If pundits are to be believed, the Fed is going to materially drop rates over the next 18 months to the point where being at the short end of the curve may once again become an advantage. Premium financing and VRDO vendors and promoters will be dancing in the streets. There will be no such celebrations for folks with policy loans because their rates likely won’t decline. There are times when policy loans offer more advantageous terms and times when external bank financing offers a better deal. And, as we saw from 2021 into 2022, the dynamic can shift very, very quickly.

This simple observation raises a more fundamental question – given all of the activity in premium financing and the roughly $110 billion in outstanding policy loans across the life insurance industry, why in the world aren’t banks stepping up to finance in-force policies to provide another source of liquidity in exchange for collateralizing cash value? According to the statutory filings of the 42 relatively large life insurers that I regularly track, there is a little over $925 billion in cash value in individual life insurance policies. The breakdown based on 2023 YE statutory statements is below. Companies with less than $2 billion of CSV are excluded.

Only 11.5% of that amount is currently collateralized in policy loans. It seems like that’d be a huge opportunity for banks to offer a collateralized loan product for in-force contracts.

The value proposition for consumers is clear. Collateralizing policy cash values for a bank loan allows policyholders to access their cash value without tax incidence, just like a policy loan. Third-party lenders can execute a draw on a line of credit secured by cash values faster than a life insurer will send money to your account. As I’ve written before, life insurers have the contractual right to delay payments for up to 6 months – not so for banks. Policy loan interest is clearly not tax deductible, but interest on bank loans collateralized by cash value used for business purposes may be deductible just like any other business-related debt. In those scenarios, borrowing against cash value with a third-party loan is substantially cheaper than a policy loan even if the headline rate is the same.

Cash value collateralized loans (CVCL) allow for, essentially, non-direct recognition loans on direct recognition policies at interest rates that are potentially lower than traditional non-direct recognition loans, depending on the rate environment. The ability to use CVCL nullifies the argument that Whole Life policies with direct recognition loans are at some sort of disadvantage, which isn’t true anyway and certainly isn’t true if you can use a bank loan to borrow against the cash value.

Actually, I think you could make the argument that policies with direct recognition loans have the upper hand when combined with the ability to use CVCL because the policyholder has the choice between borrowing at a fixed cost through the policy loan and borrowing at a floating rate with CVCL. That’s better than having two floating rate options, although not as good as what MassMutual offers in the form of fixed rate (direct recognition) policy loans, floating rate (non-direct recognition) policy loans and the ability to collateralize cash values for a third-party loan.

And that’s for traditional life insurance policies where policy loans are a viable alternative, but there are a whole crop of insurance policies where policy loans are not available without jeopardizing other policy benefits. Consider Guaranteed UL, where most contracts specifically state that taking withdrawals or policy loans will adversely affect the secondary guarantee, sometimes by causing a pro-rata reduction in the shadow account value or by more direct language stating that, for example, a policy loan will void the secondary guarantee altogether. Most Guaranteed UL products have little to no cash value, but some companies – Voya and Genworth come to mind – built Guaranteed UL products with fairly rich cash value. Almost any policy with material cash value that is inaccessible to the policyholder without imperiling some other benefit is a prime candidate for CVCL. It’s a way to have your cake and eat it, too.

The same goes for hybrid Life/LTC contracts such as Lincoln MoneyGuard. Many of those policies have return of premium cash value provisions that would, theoretically, allow for CVCL. It could be magical. The policyholder could pay a premium, collateralize the cash values for a loan and still get the death benefit and LTC coverage that they need. Most hybrid Life/LTC policies are MECs and collateralizing a MEC creates immediate tax incidence for gains – but so what? Those policies usually don’t have any gains.

There are some procedural advantages to using CVCL as well. The loan is collateralized only with policy cash values, a CVCL doesn’t even show up on the client’s credit report as outstanding debt. The lender is more concerned about the carrier and product than the borrower’s credit profile. For a bank offering CVCL where the risk is really on the carrier and the product, then stable, consistent and predictable is exactly what you want. Whole Life is the most stable, consistent and predictable of all life insurance products. Hence, the reason why the vast majority of CVCL is being done with in-force Whole Life policies.

Third-party loans collateralized by cash values empower and enable a whole range of use cases and applications that don’t exist with a standard life insurance policy. The more I’ve learned about CVCL, the more that I’ve come to see that there is no reason for any policyholder with a material amount of cash value to not have an open CVCL credit line even if they don’t use it. CVCL simply expands the aperture of potential use cases for life insurance cash values. It provides a huge amount of flexibility and optionality for policyholders without negative impacts to the life insurer. Collateralized cash values are no less profitable, no less sticky, no less valuable than non-collateralized cash values.

It makes no difference to the life insurer if the cash value is collateralized with CVCL, but it does make a difference if the policyholder takes a policy loan because the life insurer (theoretically) has to liquidate investments to pay the loan and re-book the loan as the asset. CVCL is one of these rare examples where there is a clear value proposition for policyholders and a clear value proposition for life insurers. If I was an agent, I’d tell every client to open a CVCL line right out of the gate. If I was a life insurer, I’d bend over backwards to work with banks to do CVCL*.

The value proposition for banks, however, is much less clear. There are some real challenges with the CVCL business model. The bank has to understand how life insurance works and “underwrite” the policy type. That means the bank has to employ people to figure this stuff out and attach different risk profiles to different products. Indexed UL ain’t the same thing as Whole Life in terms of risk profiles, as any premium finance vendor will tell you from looking at the infamous low-point letters. There’s a certain level of expertise required to do proper due diligence on life insurance policy values used for collateralization and hiring folks with that expertise is a tall task.

The bank also has to set up data feeds or at least a data cadence with the life insurer so that they know the values that they can lend against and can protect against the policyholder, for example, double dipping with a policy loan and a cash value collateralized bank loan. All of this infrastructure costs money that has to be recouped by loan volume. In order to get loan volume, they have to hire people to go out and make producers and their clients aware of the offering. Then they have to convince the client to open a line of credit and, hopefully, put a draw on it at some point.

It’s not so different than premium financing except for one fundamental challenge – collateralizing in-force policy values doesn’t earn the agent a commission. There is no driving financial incentive for agents to talk to their clients about CVCL in the way that there is with premium financing. Agents who bring up the idea of financing premiums or using CVCL on in-force policies are doing it in spite of the direct incentives, not because of them. And as a result, there is a lot less buzz and a lot less momentum around the concept. I have been to dozens of conferences with keynote or breakout sessions on premium financing. I have been to exactly zero conferences with a session on the opportunities for CVCL. That’s an indication of the incentive structure for the agents and distributors, not the fundamental value proposition for the client.

With nearly a trillion dollars in cash value in the United States, it would seem like banks would be falling over themselves to market lines of credit on the cash value that their clients already have. But the hurdles to the market are real. Building a CVCL business is a daunting task, but some banks have given it a shot. The most visible participant is Valley National Bank, which you’ll occasionally see sponsoring a booth at industry events. TriState Capital Bank, Ameris Bank, Provident Bank and The Bancorp are also floating around the space. The fact that these banks aren’t exactly household names – far from it – is an indication of the specialization and investment required to build a viable CVCL business.

But it’s also an indication that the space is ripe for disruption. Enter Inclined, a non-bank firm that is trying to solve the challenges of the CVCL market from both angles. For banks, Inclined serves as a centralized platform for banks to enter the CVCL market without having to build up their own infrastructure, expertise and marketing. Inclined can make the investments in the business that any bank entering the CVCL market couldn’t justify making on its own.

For consumers and agents, Inclined addresses some of the common complaints about the cumbersome and fragmented nature of traditional banks providing CVCL. The website is super slick. The process for opening what Inclined calls an Inclined Line of Credit (iLOC) is incredibly easy. Drawing on an iLOC puts money in the customer’s bank account the next day. Compared to a life insurer’s policy portal, Inclined’s interface is from another galaxy – one where getting a loan secured by your cash value is as easy as clicking a button and doesn’t require calling your agent or the insurer.

I was first connected with Inclined through a mutual friend who was the head of product at a major mutual company. I immediately saw the appeal of CVCL in general, which I knew embarrassingly little about, for expanding the accessibility and liquidity of policy cash values. My first impression was that CVCL makes policy cash values come alive. If a client can get a loan by clicking a button and see the money in their account the next day, then policy cash values suddenly feel real in a way that they usually don’t for many clients. That’s also one of the specific benefits of Inclined as a modern, standardized and simplified intermediary for CVCL lending with a simple, digital experience for consumers. I liked it so much that I took out iLOCs on my Whole Life policies even though I don’t have any plans to actually use it – just because it’s cool and I knew as soon as I saw Inclined that I wanted to write about it.

And, in full transparency, partially because they asked me to be on the Board for Inclined and I agreed. I’ve been asked to be involved in different organizations at various levels in the past and I almost always turn down the opportunity because these organizations, in one way or another, take sides on both mundane and controversial issues. Being on the Board of Inclined was an easy decision. Cash value collateralized lending isn’t an issue with sides – it just flat out makes life insurance better by making cash values so much more accessible in a way that doesn’t damage life insurers. It’s one of these rare instances in our industry where people benefits without anyone having to lose. Banks make secured loans at competitive rates. Life insurers get stickier cash values. Policyholders get near-instant liquidity. What’s not to love?

Despite the fact that CVCL offers incredible benefits and has been around for many years, the market is still in its infancy. CVCL is generally only available on Whole Life, but it should be expanded to the full suite of product types, potentially even all the way to Variable UL. There are banks leaving the CVCL space due to the high fixed cost and low take rate of policyholders for loans. Part of the solution is simply awareness. Top-end agents at Northwestern Mutual and Guardian – both direct recognition companies – are generally aware of CVCL, but it’s not a part of the usual discourse in the industry. Another part of the solution is a better experience for agents and policyholders in opening up CVCL lines, including more active participation and datasharing by life insurers. Banks need to be able to be in the CVCL space on a variable rather than fixed cost model. Inclined, in my view, is in an enviable position to solve all three of those problems.

What it can’t solve, however, is the problem of incentives. Who is going to pay agents for having clients set up and draw on CVCL lines? Probably no one in the same way that no one incentivizes agents to tell clients to take policy loans. The only way CVCL becomes mainstream is if agents can be convinced that it helps sell more life insurance – and I think it can. The simple fact that CVCL exists is proof that life insurance cash values are “real” and that clients can use them for more than just emergencies. The CVCL lender doesn’t ask why you need the money. They just put it in your account in the same amount of time it takes to move money from your brokerage account to your bank account. CVCL turns cash value from a theoretical concept to a practical store of capital. And if more people looked at life insurance that way – the way life insurance actually works – then I have no doubt that we’d sell more life insurance in the process.

*The counter argument is that policy loans are a fantastic asset class and that is true. Policy loans offer high quality corporate bond-like yields with no life insurer capital requirements. That’s true, but there are tradeoffs. Policyholders who take loans when rates are low are also forcing more portfolio turnover and diluting the overall yield of the portfolio but they are less likely to take loans when rates increase. CVCL allows the carrier to be more agnostic to the effects of clients accessing cash values.