What a UL of whole life insurance policy loan isn't, what it is, and how to explain it to your clients

By Jeffrey Reeves MA

EUREKONOMICS[tm]


First, it is imperative that you, as an agent and financial advisor, realize that the term policy loan is insurance speak and a bit of a misnomer. Agents, advisors, and even insurance company personnel use the term policy loan extensively, with the understanding that it defines a specific removal of cash values from an existing policy. That is not exact and is not correct.

Insurance companies, like banks, do not maintain physically separate accounts that hold specific amounts of money for specific policy owners.1 Insurance companies pool the money of all policies in their general account. Therefore, since there is no separate bucket from which a policy owner can borrow, there can be no direct loan from a specific policy.

In "Tools and Techniques of Life Insurance Planning," Stephan Leimberg and Robert Doyle describe a policy loan this way:2
    "When a policy owner borrows money directly from the insurer what is actually happening is something other than a `loan' in common parlance. The difference is this: In a true loan the borrower must agree to repay the money. A policy loan does not require repayment. It is more like an advance of the money the insurer will eventually pay out under the contract. The policy owner is receiving an advance -- of his own money."
An analogous way of looking at a policy loan is to view it as a line of credit against the cash values -- equity -- of the policy. Using this construct allows you to relate an insurance policy loan to the more readily understood and more commonly discussed home equity line of credit.

Using these two analogies -- an advance and a line of credit -- adds credibility to a discussion of what a policy loan is and isn't, but also give you the opportunity to open a discussion of the power, flexibility, and versatility that policy loans add to cash value life insurance policies.

The policy owner may, at any time while the insured person is living:
  • Take a policy loans for any amount that is equal to or less than the net cash value of the policy (i.e., the total tabular cash account value minus any outstanding loans and loan interest), and -- in the case of UL policies -- minus also any unpaid expense, fees and/or surrender charges.

  • Repay all or any part of a policy loan while the policy is in force.

  • Take and repay policy loans as often and for whatever amounts available

  • Borrow from the policy without completing an application or having to be approved.

  • Use the cash values of the policy as collateral for a bank or other commercial loan, although the terms available from the policy itself are usually better than the terms a policy owner can obtain from a commercial lender

    • Policy loans can often be made at net zero interest, since the interest charged by the insurer and the interest and/or cash value increases within the policy offset each other.

    • As whole life policies age, the combination of guaranteed cash value increases and non-guaranteed dividends often creates a significant gain over the cost of borrowed funds.
There are, of course, ancillary benefits to using policy loans that are not intrinsic to the policy loans themselves. Perhaps the most stunning of these ancillary benefits is that the interest paid to the insurance company -- and offset by the internal growth of the policy -- represents a gain over having paid the same interest to a commercial lender or having paid cash.

Here's an example I use to illustrate this benefit. Suppose your client is debating how to pay for a big screen plasma TV that costs $1,000. S/he might consider several alternatives:
    1. Pay the 18 percent or 24 percent interest charged by the big box store or the credit card. In the end, that makes the cost of the TV anywhere from $1,100 to $1,800, depending on how long it takes to repay the loan.

    2. Take the one-year same-as-cash deal from the big box store where s/he is buying the TV, then deposit $100 per month in the savings account for 10 months, thereby assuring that there would be $1,000 in the account before the one-year same-as-cash deadline would impose the penalty of interest. In the end, s/he has the original amount in her account and it would have earned a small amount of interest on the monthly deposits and a full year's interest on the original $1,000. However, that would be offset by the $100 discount s/he lost by not paying cash.

    3. Pay cash by withdrawing money from a savings account. This would likely motivate the seller to discount the cost by as much as 10 percent -- that's being generous -- thereby letting your client buy the TV for $900. However, your client would lose the interest s/he might earn by leaving the money in the savings account. However, s/he could then replenish the savings account by depositing $90 per month to the account for 10 months. In the end, s/he would have the TV, $900 back in her account, and a small amount of interest on the monthly deposits, as well as the $100 that remained in the account for the entire year.

    4. Borrow the money from a cash value life insurance policy, receive the same $100 discount and repay the policy loan in 10 $90 monthly installments as above, and pay the interest in a single extra payment. What's the difference? In the end, the policy cash value continues to grow as if the client had taken no policy loan and the interest charged by the insurer is offset or eliminated by that growth. Although this may not be a huge difference in one year, it adds up to tens of thousands of dollars over time.
All in all, policy loans can help you help your clients with the innovative solutions to everyday problems that cash value life insurance provides.

1Variable UL policies do maintain separate accounts -- akin to mutual funds -- based on the options chosen by the policy owner.
2Tools and Techniques of Life Insurance Planning, 4th Edition, Nat'l Underwriter, Cincinnati, OH


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