Fixed, variable or participating loans — Which is best for your clients?
By Jeff Reed
Kestler Financial Group
When is $1 million not $1 million? When it's in a life insurance contract.
It could be more; it could be less. The challenge lies in knowing how to best manage the income stream; and like so many other topics in our business, this one is filled with landmines:
- Increasing loan interest rates
- Indexes that may or may not perform
- Client expectations based on flawed sales illustrations
Using historical performance is flawed at best, based on the assumption that cap rates will remain static, and all of the illustrations we run involve a level rate of return, along with a level loan rate.
Reality is just not that neat and tidy.
The good news is that we can investigate these last two items without having to debate the underlying assumptions. The simple fact of the matter is that stress testing these two variables is the only way to get a handle on how likely the assumptions are to end up meeting client expectations set at the time of the sale.
Gone are the days when taking withdrawals to basis followed by a wash loan was the only choice for taking income out of a life contract. Now, we have three basic flavors to choose from in the IUL market:
1. Fixed loans: Loan rate and crediting rate are fixed
2. Participating loans: Loan rate is fixed, crediting rate is variable
3. Variable loans: Loan rate and crediting rate are both variable
- Male age 45, Standard Nonsmoker
- $50,000 annual premium, 20 pay
- Distributions for 20 years, assuming default crediting rate and the following loan rates:
The real question we should be asking isn't who has the most income on the illustration, but which product is most likely to meet expectations.
Unfortunately, the decision isn't that simple, as there are cap rates, illustrative rates and policy expenses that all impact the income stream a particular product can produce.
However, if consumer sentiment is any indication, most clients will care more about what could happen if things change for the worse versus how great it will be if everything is sunshine and roses.
Our challenge is to make sure we know the type of loan the income stream in the illustration is based on, and what the ramifications of our recommendations could be in a period of rising interest rates.
One last point: The real differentiator is not the loan rate, but the delta between the loan rate and the crediting rate. Push the crediting rates down from their default rates, and you'll see the same story play out.