#460 | Policy Management with Cash Value Lines of Credit
The article is written below by Paul Hanley, who also penned Cash Value Loan Optimization in April of last year. Paul is a university professor and part-time insurance agent. I have never met anyone who has become a bigger nerd for life insurance topics in a shorter period of time than Paul. He has opened my eyes more to the idea of publishing work from other bonified insurance nerds – more on that in a future post. But for now, enjoy! – Bobby
By Paul Hanley
Any agent who sells life insurance as an accumulation vehicle can probably relate to the persistent challenge in getting clients to understand that their policy cash value (CV) is a liquid asset they can tap whenever they want. One prominent agent from Northwestern Mutual says he reminds clients at every annual review of the accessibility they have to their CV (a terrific idea), just to drive home a point so easily lost on policyholders. From the client’s perspective, this perceived illiquidity is understandable. After all, with most carriers you cannot simply log into the portal and make a transfer to a bank account.
Although clients can fill out loan request paperwork and submit to the carrier, how many would feel comfortable doing that themselves? Having to contact (and wait for) your agent just to initiate the loan request—then wait another 3 to 5 business days for the funds to hit your account—are significant psychological barriers to liquidity. Procedural logistics, carrier processing lags and the typical public perception of illiquidity can give the impression the policy is a kind of black box over which the client has little or no autonomous control.
But perceived illiquidity is not just an issue in accessing loans. There may also be a psychological knock-on effect with policy funding. If clients don’t feel that CV is truly as liquid as their agent says, they may be more reluctant to dump discretionary premium into the policy. With Whole Life, the stakes of underfunding are pretty low—particularly with an all-base design. On a UL chassis, the results can be disastrous down the road when the policy lapses or requires a huge premium payment to keep it afloat. How can agents properly position a policy for accumulation if the client feels gun shy about paying additional premium into a “black box”?
Cash value lines of credit (CVLC) help to bridge the gap between client perception and reality. These are third-party lines against policy CV, much like a HELOC uses your home’s value as collateral. Once the line is initiated, the policyholder can easily log into the portal and transfer funds to their bank account with zero paperwork, headache or delay. It gives clients the CV access that many agents otherwise must reiterate until they are blue in the face. For clients to fully grasp CV liquidity, they need the ability to access it directly. After all, seeing is truly believing.
Although no direct financial incentive exists for agents to help clients open CVLC, greater perceived liquidity may certainly encourage larger discretionary premium payments. But more importantly, having loans available with a few clicks means clients are much less likely to contact the agent when liquidity needs arise. I’m sure no agent enjoys filling out loan request paperwork, getting the policyowner’s signature, and then submitting to the carrier—all with no remuneration. Plus the phone calls asking when the funds will hit their bank. And when the agent passes or retires, the client can continue making CVLC draws or repayments with no assistance. Think of it as part of their policy management succession plan.
Even for the carrier, CVLC has tangible benefits over direct policy loans. First, there is less paperwork for the back office to process, which unequivocally benefits all stakeholders. Agent production may also increase by positioning the CVLC tool at the point of sale to give clients a greater sense of real and perceived liquidity. Another angle is that life insurers can avoid realizing capital losses on bond assets when loan requests come in during times of market stress—such as in 2022 and 2023. By outsourcing the loan function to CVLC lenders, carriers diversify and ameliorate their liquidity risk.
On the user side, the sheer transfer speed and convenience of CVLC is reason enough for many policyholders to use them. But as I covered in my Guest Post – Cash Value Loan Optimization, third-party lending arrangements do not always ensure a better bottom-lineoutcome for the client—even aside from the stated loan rate. As with all financial instruments, there are upsides and downsides to CVLC which can be very nuanced and situationally dependent. That article focused quite a bit on the shorter-term economics of using CVLC versus policy loans—especially during periods of high market volatility. Below, we flesh out some other key considerations to keep in mind with CVLC, insofar as it impacts the user experience as well as policy performance and resilience.
For instance, let’s assume you wish to take a loan directly from your Whole Life carrier since the rate is lower than CVLC. In my own policy, the current variable loan rate is “only” 5.3%, compared to a typical CVLC at around Prime (currently 6.75%). At first glance, the policy loan looks like a better deal by a mile. But my carrier uses direct recognition which, at current, reduces the Dividend Interest Rate (DIR) on loaned funds by 135bps. If we assume a 30% marginal tax bracket, the pre-tax equivalent “cost” in forgone DIR is close to 200bps. If we add that to the headline rate, the effective loan cost is around 7.25%—about 50bps more than current Prime via CVLC. Of course, these rates aren’t etched in stone and the favorability of using one option over the other can and will change over time.
But the moral of the story is that initial optics can be very misleading.
There are other practical benefits of CVLC besides mere access to cash on demand. The credit line also gives the policyholder a highly viable funding tool for making Paid-up Additions (PUA) payments. Strategically this can be really key, especially since many carriers have a limited window when PUA payments can be made for a given contract year. If the client does not have the cash on hand for a PUA dump-in, the CVLC provides the means to stay on track with the desired level of policy funding until, ideally, the credit line can be paid down. Even if there is a net loan cost (keeping in mind the headline rate and any DIR adjustment on loaned funds), a slight negative spread is a small price to pay to have flexibility in maximizing payments.
There are arguably even greater potential impacts—both positive and negative—of using CVLC when collateralized by a Universal Life chassis. As discussed recently in #459 | Rethinking Life Insurance for Income, heavily loaned Indexed and Variable UL policies are inherently more sensitive to fluctuations in the crediting rate on unloaned values allocated to indexed accounts. This could potentially lead to an unexpected lapse in a zero year, particularly when it coincides with high interest costs and skyrocketing Annual Renewable Term (ART) at later attained ages. By using a third-party lender, you are essentially decoupling CV access from the policy values themselves, turning a CVLC draw into a de facto participating loan. This is not just a matter of semantics. Crucially, it means that using CVLC eliminates the option of a wash loan or even having guaranteed net fixed-loan costs.
The impact is twofold. First, the overall policy value will be subject to greater fluctuation since the collateralized cash values in indexed accounts have a much wider range of interest crediting outcomes compared to a fixed loan. The policyholder is also exposed to significantly higher potential net interest costs. Even though CVLC is similar to carrier loans in that the owner can choose to capitalize accumulated interest charges each year (instead of paying them out of pocket), there could be a problem if the outstanding CVLC balance exceeds the credit limit. If the owner doesn’t pay down the loan, the lender could terminate the line and transfer the remaining balance back to the carrier. If policy values cannot support the debt, a large payment may be required to avoid the risk of lapse.
A sensible course of action may be to use CVLC for IUL/VUL liquidity in the years before the loan amount grows too large relative to policy CV—or at least while the owner still has the ability and willingness to pay down the balance. When the time comes to pull in the reins and tamp down the crediting/lapse risk of a highly levered policy, we could opt to terminate the CVLC and revert to fixed carrier loans with little or no net cost. It greatly limits the range of potential outcomes by reducing loan arbitrage risk, but obviously requires someone to execute the pivot. Just because a policyholder has a CVLC doesn’t mean they have to keep it forever, especially if policy integrity is on the line.
The name of the game with any UL contract is vigilant policy management—regardless of how we access loans.
Although third-party lines are most commonly collateralized by Whole Life, there is a whole spate of compelling reasons why VUL arguably stands to benefit the most from CVLC. The most straightforward angle is that VUL products typically do not pay a persistency credit on loaned values. Outsourcing loans to CVLC helps secure that extra bump in policy crediting. This is analogous to circumventing reduced DIR on direct recognition loans. But without Whole Life’s robust guarantees, VUL must actively secure protection through smart design and policy management—including a thoughtful strategy on how to best access CV.
To that point, consider the opportunity cost of liquidating cash from VUL investment subaccounts to take carrier-direct loans. Many would understandably find it undesirable to lose out on average equity gains of 10% or more per year just because they need short-term cash. Much as we saw earlier, the CVLC participating loan structure offers liquid access to policy values without having to sacrifice CV growth by drawing collateralized values out of investment positions for fixed loans, or out of indexed accounts for participating loans. In this case, however, the external loan clearly works in the client’s favor if the policy is not too highly levered—a point we will revisit shortly.
We should also consider the reinvestment risk when policy loans are repaid. In a perfect utopia, we would only take loans at a market peak and buy low when paying them back to the VUL subaccounts. At best this is a slippery game of roulette, where the baseline opportunity cost gets magnified when repayments are made in a down market. It’s almost impossible to predict potential reinvestment losses, which can drag heavily on policy performance. CVLC helps to mitigate this risk (and attendant heartburn) by creating a stabilizing liquidity buffer.
Interestingly, CVLC has another trick up its sleeve to help optimize for long-term accumulation and contract integrity. In #453 | Searching for Certainty in All the Wrong Places, we saw a highly compelling argument for de-risking VUL by aggressively funding it to hit CVAT corridor as early in the contract as possible. The basic premise is that sharp investment losses in the subaccounts will not destabilize policy longevity or integrity while the Account Value (AV) is in corridor, since in that case the Net Amount at Risk (NAR) is attenuated proportionally to the continuously fluctuating AV. Think of this as the ultimate VUL hedge against market volatility.
The flip side to this is that if there is an outstanding policy loan, it will depress AV and could cause a significant lag in hitting corridor. By outsourcing the loan function to CVLC, any outstanding balance is effectively invisible for the purposes of determining corridor status. As a result, CVLC can further enhance contract performance by reducing COI drag that would otherwise result from outstanding policy loans—thereby minimizing NAR and helping push AV to corridor. (As a side note, #453 spells out the specific VUL case design parameters for hitting CVAT corridor as quickly as possible.)
The above scenarios certainly make a good argument for CVLC having the greatest risk-mitigation value when collateralized by VUL.
However, this is not to say VUL is immune from risks with a third-party line. While CVLC collateralized by Whole Life often has a loan-to-value (LTV) ratio upwards of 95%, it may be as low as just 50% with VUL. This is understandable, considering a steep downturn in the market could potentially reduce policy CV perilously close to (or even below) the outstanding CVLC debt. When the lender does its periodic review of policy values, the borrower may be required to pay the line down below a reduced credit limit.
It may surprise some that a similar dynamic can occur with IUL when there is a confluence of low policy crediting with high ART costs and CVLC interest charges. With indexed accounts on a UL chassis, the idea that “zero is your hero” belies the nature of the underlying COI risk over time. The good news? Credit lines backed by IUL can have LTV up to as much as 90%—which could help insulate against a sharp drop in AV if the outstanding CVLC balance is low enough. The bad news? Whether with IUL or VUL, the client may not have the means to pay what effectively amounts to a CVLC margin call.
Fortunately, there are practical measures which can be implemented to reduce this risk. With VUL, it is advisable not to exceed a 50% LTV, even if the lender will approve a higher ratio. And with either VUL or IUL, it would behoove the owner to leave a significant buffer of available credit as protection against market downturns and/or zero interest crediting. These dynamics only underscore the importance of our earlier discussion on optimizing VUL case design to hit corridor as soon as possible. Once that happens, any decline in AV due to poor investment performance will actually cause NAR to contract—with a commensurate reduction in COI. Although this may not single-handedly prevent a CVLC “margin call”, it can certainly help reduce the risk.
In taking everything in from a satellite view, we really have two different elements at play when it comes to third-party CVLC. On the one hand, it is an undeniably invaluable tool for policyholders by providing liquidity and flexibility to empower financial decision making on their own terms. This alone arguably makes the product a must-have for anyone with policy cash value. For the CVLC owner, the streamlined process of its platform certainly adds valuable transactional simplicity by untethering from the logistical constraints of agent and carrier.
But under the hood, CVLC can both aid or hinder policy performance, while adding significant complexity in the dispersion of potential outcomes for the contract—particularly on a UL chassis. This requires the financial professional to be cognizant of the potential long-term implications (often obscured and counterintuitive) when aiming to mitigate policy risks.
In the final analysis, we have seen several plausible examples showing that the way in which product specifications and dynamics interact with the external lending vehicle often have a much greater impact on policy performance than mere differences in loan rates between carrier and third-party lender. As life contracts mature and situations evolve, agents must be vigilant of the various mechanics at play to proactively pivot to a different liquidity strategy when it supports overall policy management to protect client interests.
When looking out across the CVLC landscape, unfortunately we see only a small handful of vendors lending in the space. There is good reason for this, as their platforms are typically plagued with operational inefficiencies and cumbersome application and line-maintenance procedures. This is primarily due to the lack of costly data-feed infrastructure with carriers, causing a reliance on clunky manual reviews of requests for credit line increases, in-force illustrations and policy value statements. Ultimately this places more demands on agent and borrower, and leads to lethargic processing times by the lender’s back office.
Fortunately, the financial technology startup Inclined provides a highly streamlined and user-friendly platform for both clients and advisors with their self-branded iLOC (Inclined Line of Credit). I was recently approved for the line and was immediately impressed at the efficiency of the process, which is quite seamless and intuitive. The agent does need to provide the Policy Summary Page both before and after line approval to verify account values and collateral assignee, as well as a one-time in-force illustration. But after line initiation, the iLOC user is generally free and clear of any dependence on the agent to maintain or increase the line—which is “evergreen” and never needs renewal. Both client and advisor have separate accounts for managing policies, with two-factor authentication conveniently bypassing the need for any login credentials.
I found their communications to be very clear and proactive in updating the status and next steps in the application process, but what impressed me most was when I clicked the email link to access the policy collateral assignment agreement. Not only had Inclined secured the carrier form on my behalf, but it was already pre-populated with all my policy information and only required a quick electronic signature. (I think my mouth literally dropped open.) In just seven business days from submitting the initial application, Inclined had both approved my line and initiated the wire to pay off my existing carrier loan.
There are several things that really make Inclined’s iLOC stand out from the rest of the pack. The first is an extremely low minimum credit limit of just $5000 in most states—the lowest in the industry—compared to $65,000+ among many of its competitors. This truly democratizes third-party loans for the masses. Second, clients can stack different policies and product types across its approved carriers. For example, if you have two Whole Life policies with Guardian, or Whole Life with MassMutual and IUL with Penn Mutual (or all of the above), you can combine them into a single line—including policies with different owners. This is a clear indication of how technologically sophisticated Inclined’s data-feed integration is, as manual administrative demands of maintaining such cross-collateralization would likely be untenable.
Another big advantage of having the iLOC over the competition is that a credit limit review is done automatically on each policy anniversary and then again six months later. But what if you make that big premium dump-in at some point in between? You can contact customer support and request a manual credit limit review at any time. I have been in contact with several members of the Inclined team, and can say that their accessibility, product knowledge and service is second to none. Their website (Inclined.com) and mobile app are intuitive and easy to navigate, and you can even instantly link your bank accounts to the iLOC using Plaid—as opposed to a manual ACH Authorization form. Transfers should hit your bank in one business day.
This is a company that puts technological accessibility at the center of their platform, and they clearly are on a mission to disrupt the CVLC space.
Inclined’s currently supported carrier line includes Northwestern Mutual, Guardian, MassMutual, New York Life and Penn Mutual. Other carriers are in the works as the company is seeking to expand across the space. The team advises that they are even in the process of building out support for adding VUL in coming months. Applicants do need a FICO score of 620 or higher, but there is no income verification and the line is never reported to credit bureaus since it is fully cash secured. There are no fees whatsoever to apply for, open or maintain the iLOC, and interest payments are optional as long as there is room on your credit limit. (Though as we mentioned earlier, in some cases it may be best to keep the loan balance well below the line’s limit.)
As we have discussed at length, third-party lines certainly do have their pros and cons when it comes to raw economics and impacts on policy performance. But the tool is so potentially empowering for the user’s personal finance that it seems like a no-brainer for anyone with policy cash value not to have one.
Fortunately, Inclined makes the decision even easier.
