“HOW IT WORKS” SERIES; WHOLE LIFE: “INFINITE BANKING” OR “INFINITE NONSENSE”

To understand what is communicated in this write up a comprehensive understanding of Whole Life (WL) is essential.  Anyone hoping to follow the logic discussed below would benefit from reading all of the other “How it Works” write-ups on WL.  Absent that, one might view some of what’s said as opinion, not fact.

This write-up addresses a decades old sales concept recommending the use of a WL policy as a personal “bank”.  A sales strategy first advocated in a book written long ago by a seemingly well intentioned fellow named Nelson Nash.  Mr. Nash is the father of the “infinite banking” concept.

THE BASIC IDEA

The idea is to build up funds in one’s own bank and then use them to borrow “from yourself” instead of third parties. This allows the saver to avoid the need to pay others interest.  In fact, they are actually able to pay themselves interest instead, thereby increasing the savers wealth.    

This all sounds reasonable and logical and on the surface.  And, as far as it goes, absent added exaggerations regarding the benefits gained by using a WL product, it is. 

Mr. Nash’s book takes the basic “bank” idea several steps further bringing it into the realm of an “infinite” bank.  This requires the use of a WL product to achieve accelerated levels of growth attributed to the unique design characteristics of the WL product.

All made possible by borrowing accumulated WL policy values and using those funds to purchase other assets or make added investments. 

The bold and frankly grossly exaggerated assertions being this WL borrowing approach allows for compounding ones savings.  Needless to say, in ways impossible to achieve with other types of products. 

Again, if true, this all sounds good.  The question is, does it hold up upon closer examination.  The short to the point answer is “no”.  But proving that requires quite a bit of knowledge sharing.

INFINITE BANKING BACKGROUND

As already noted the infinite banking concept itself is based on a book written many years ago by Nelson Nash. 

The book tells the tale of a seemingly fictional character; a fellow who used WL as a way to build up a large savings fund by borrowing from WL policies and “paying himself” interest on the loans.  Further leveraged by then reinvesting the borrowed funds to create even more earnings.  A cycle to be repeated again and again.  Hence the “infinite” label.

The inspiration for this book involved a real life experience of the author.  A scenario far different than the book outlines, but clearly tied to the authors own use of and fondness for WL policies.

Mr. Nash, who was himself an insurance agent working with the Equitable Life Assurance Society of the United States, fell on hard times in the late 1980’s.  The likely reason being the 1986 Tax Reform Act which gutted the commercial real estate market in which Mr. Nash was then heavily invested.

Were it not for the WL policies Mr. Nash owned at the time, and from which he was able to borrow to access cash to pay his bills and make the payments on his real estate loans, he would have been bankrupted.  The ability to borrow from his WL policies made all the difference.

While in no way did this augment or increase the returns earned in his policies, having access to these savings did make a major difference in his life.  This fact clearly made a dramatic impression on Mr. Nash. 

Mr. Nash is, to say the least, a raving fan of WL.

This in no way explains how Mr. Nash arrived at the conclusion he both earned dividends on his borrowed cash values and derived an added benefit by “paying himself” interest on his WL policy loans.  Not to mention the further pyramiding of his earnings by investing the borrowed funds to create more earnings.

While it is possible for Mr. Nash to imagine he was paying himself interest on his policy loan and earning dividends on the borrowed funds in his WL policy, the reality is this activity and those results could not be illustrated at that time.  The personal computer had only recently been created and rate books were still in use in the early 1980’s. 

Even when the first computer based illustrations became possible the scenario outlined in Mr. Nash’s book could not be produced.  A fact that would persist for several more decades.  A fact that allowed for less than accurate thoughts and assumptions regarding WL policy operations and performance. 

So, and in Mr. Nash’s defense, at the time he wrote this book there was no way an illustration system could show this activity.  Illustration software development was in its infancy and the WL product itself is impossible to dissect into its hundreds of moving parts. 

Prior to the advent of the personal computer life insurance agents used a “rate book” to piece together future cash values.  They did so on a “per $1,000 of death benefit” based on factors pertaining to age, gender, health and smoking habits specified in the rate book for each subsequent year a policy would be in effect.  The agent literally typed up numbers from the rate book to reflect future policy values, generally calculating values at five or ten year increments on a single page.

Unlike todays illustrations, at that time there were no footnotes, pages of accumulating values with multiple columns, or explanations regarding how the WL policy worked.  Agents verbally imparted there best understanding of these things. 

The reality is most life insurance agents are sales oriented people.  They are not actuaries or otherwise gifted with high levels of technical knowledge on how a WL policy operates.  Their ability to explain how the product worked to prospective clients was largely a “best case” effort on their part. 

Most didn’t have a clue and most still don’t.

Of course, Mr. Nash could always have asked the actuaries and product design folks at The Equitable to verify his thoughts were accurate.  Which would have been the end of that line of thinking.  The team at Equitable at the time was top notch and among the best in the industry.

What no doubt was the source of Mr. Nash’s confusion was the fact The Equitable WL product did not utilize what is known in the industry as “direct recognition”.  Clearly, those are the WL products Mr. Nash owned at the time since he could actually earn a commission on Equitable products he purchased for himself.  Not to mention the fact Equitable at the time had an excellent WL product. 

“Direct recognition” is a term that refers to how borrowed funds are dealt with relative to dividend crediting in a WL policy.  

A direct recognition company recognizes the fact cash values have been borrowed.  The borrowed amount is treated differently than the unborrowed amount.  A company that doesn’t use this direct recognition approach treats borrowed and unborrowed funds the same for dividend crediting purposes.

So, absent a way to illustrate its actual impact on accumulating cash values, Mr. Nash’s active imagination perceived himself “paying himself” interest on the WL loan.  No doubt believing he was having that interest increase his cash value balance in addition to the dividends that his policy was earning on all of its cash value. 

While this thought is both understandable and logical it simply isn’t the case.  Which will be discussed in great detail later in this write up.

Adding to the confusion surrounding WL the annual WL policy statement provides few if any details on what is transpiring inside the WL policy.  Very little is broken out and clearly specified.  Most just show a beginning and ending cash value and death benefit amount and not much else.

So absent a way to illustrate loans and their repayments with interest the idea dividends were being credited on the entire cash value (with a non- direct recognition company like Equitable) and interest paid was also being added to the cash value seems plausible. 

Factually incorrect, but understandably a plausible thought.

What transpired with this thought was an evolution in Mr. Nash’s mind, based on his interpretation of what transpired inside the WL policies he owned, that caused him to believe borrowing early and often was a valid way to accelerate a WL policies cash value growth.  Not only did he believe borrowing from his WL cash values saved his financial bacon, he also took it one step further by imagining it accelerated his WL policy cash value growth.

There is no doubt Mr. Nash sincerely believes this benefit exists.  Or, at least he did so at the time.  Mr. Nash seemingly is not the kind of man that would deceive people to create a benefit for himself.  Those who know him love and respect him.  His sincerity is viewed as real. It breeds faith in others regarding what he has to say. 

Unfortunately for Mr. Nash and his devotees he is sadly under informed on the actual operation of a WL policy.  Said differently, he is clearly not a technician.  Mr. Nash is a relationship oriented sales person.  Someone people feel comfortable with and enjoy knowing.  His time is not spent with actuaries attempting to tear apart the formulas and assumptions that embody a WL product.

It’s fair to say he is no actuary or self-taught product design expert.

An Equitable sales associate who knew Mr. Nash at the time, and who Mr. Nash actually invited to work with him back in those days, was familiar with what transpired in Mr. Nash’s financial life at the time.  The background info shared above is based on his recollections which are hopefully accurate.  I’ve never known him to lie or make things up.

It is fair to say the disciples of Mr. Nash’s teachings are not open to the idea the benefits of the infinite banking strategy might be exaggerated or misstated.  They are also not open to the idea other life products that did not exist in decades past might provide a far better platform for borrowing versus WL.  They are more like a cult of believers than anything else.

Moving on, at a point Mr. Nash’s personal reality clearly became tied to the strategy his book preached.  His self-image, popularity and the respect he enjoyed with those who advocated his points of view became hopelessly tied to the representations made in his book. 

Perhaps, at some point any incentive for Mr. Nash to dig deeper into the realities of how WL products actually work just faded away.  Or his conviction in his view was so internalized the thought he could be wrong never entered his mind.

There is no doubt many, if not most of the comments in this write-up border on heresy to Mr. Nash’s devotees.  Most have been trained by mentors (brainwashed if you will) to view the whole life product as if it were something truly special; almost sacred in both its design and operation.  A product that can’t be manipulated by a life insurance company to the client’s detriment. 

The fact is these sales associates have sold WL espousing this view to friends and family alike.   If they were to now question the validity of Mr. Nash’s assertions it would mean accepting the possibility they had injured, or at a minimum misled, the very people who trusted them most.   

These sales associates have every reason to want to believe every word written and spoken by Mr. Nash is absolutely true.  They have every reason to resist the idea that the ideas outlined in Mr. Nash’s book are flawed.

The error in their ways is not driven by intent to deceive.  Instead it’s a function of faith, respect and a personal need based on years of sales they’ve made. They “need” to believe what Mr. Nash had (and has) to say is true. 

The urge to dig deeper to prove or disprove the validity of his assertions simply does not exist in their world.  The very idea the strategy itself is flawed would challenge their self-image and all their prior sales efforts. 

My question for them is this. Can someone honestly say they know WL is the best possible product solution and the infinite banking strategy makes sense, absent an open mind about:

• how the state of the economy and regulatory asset reserve rules today impact WL products,
• comparing WL illustrations with the same premium flow with and without borrowing and repayments,
• the possibility the benefits of this strategy are overstated, and
• the possibility other life product designs on the market today are superior to WL.

To fully appreciate a discussion of the pros and cons of the infinite banking approach one must understand how WL actually works. This infinite banking write up would need to be 200 pages long, or more, to cover all the material on how WL works and also dissect the infinite banking concept. 

The average reader would die of boredom, or mental fatigue, long before they ever finished reading it.  As it is, this write-up is far too long for most people to endure.

Those who “read on” without first reading all these WL write ups will have to just have faith each statement made is backed by facts.  At least until they are inclined to devote a great deal of time to reading all the other “How it Works” WL write-ups. 

THE SOURCE OF THE CONFUSION

It would be a gross understatement to say WL is a poorly understood product. 

This reason relates to its design which embodies a “bundled” approach.  A problem further exacerbated by how WL products are administered by the companies that sell it.  Made worse yet by the fact formulas and the myriad of assumptions making up a WL product are never disclosed. Further exacerbated by the fact no comparisons are ever made pertaining to original assumptions versus subsequent actual results.

The “bundled” design approach precedes our computerized world.  It dates back to a time it was economically impractical to tract a products multiple individual moving parts when tens of thousands of accounts (policies) were involved.  A time when multiple formula’s dictated allocations of pooled results into individual policies. All of which were were netted together totally obscuring all the individual moving parts. An approach that technical limitations required be used at the time. An approach that no longer was required in product design after the advent of the computer.

The bottom line, explained later in far greater detail, is WL is an utterly impossible product to dissect.  A function of its design and the fact disclosures are never made regarding the assumptions and costs embedded in its design.  Further complicated by the fact actual experience disclosures are never made in subsequent decades as actual investment and expense results occur. 

This clearly leaves ample room for confusion regarding how WL products actually work.  Ambiguities that allow plenty of room for bold assertions and wide ranging interpretations pertaining to WL products.  Such is the world of WL. Financially speaking, a dinosaur product dating back to a time long past.

Confusion which is all made possible by the obscure nature of the WL product itself and the confusion this creates. Not by ill intent.

STARTING ONE’S OWN BANK

Of course, to become one’s own banker there must be savings on hand to fund a bank.  After all, a bank can’t loan money it doesn’t have. 

This means the average person hoping to activate the infinite banking strategy must first forego purchasing the items they need (or want) in order to build up a savings balance to fund their bank.  The proverbial average person is in fact the target market at which Mr. Nash’s book is directed.  Not that those presenting it are averse to marketing the concept to those with sufficient wealth to just open said bank on day one. 

The “infinite banking” approach itself requires paying premiums into a WL policy to activate the strategy.  The WL policy warehouses the accumulating savings (representing the bank) which becomes the source for subsequent borrowing going forward.  Borrowings to be made by the owner of the WL policy “bank” allowing them to compound and accelerate their wealth.

At least that’s what is represented to occur. Which is not at all accurate.

THE LIQUIDITY PROBLEM & SOLUTION

WL policies are highly illiquid in their first decade.  The typical “base” WL policy will have a zero cash value for all (or most) of the first three years.  After which the cash value grows at a snails pace for a decade or two.

This means only marginal levels of cash value as a percentage of premiums paid are reflected in the base policies cash value.  A reality that slowly improves in the second and third decade.

This lack of liquidity dramatically impacts the policy owner’s ability to borrow a meaningful sum from their WL policy. And it does so for a considerable length of time.  A situation that must be addressed for the infinite banking scenario as its marketed today to work.

There is a solution to this problem. It involves layering on what is known as a “paid up additions” (PUA) policy rider on top of the base WL policy.  PUA riders feature a far higher level of liquidity on the additional PUA premiums paid into a WL policy.  The PUA premium amount itself must be substantial for it to create sufficient cash values to allow for borrowing a meaningful amount.

PUA premiums are paid above the base policy premium level.  

PUA riders come with a number of constraints imposed by IRS rules. Companies deal with these limitations in various ways, a few of which are discussed below.

The first reality is that a PUA rider must be added at the time a base WL policy is purchased.  They can’t be added later on. Or increased. 

A classic approach is to illustrate an added PUA premium equal to the base policy premium.  It is also not unusual to illustrate PUA premiums in multiples of the base premium.  The larger the illustrated PUA premium the greater the cash value amount that will be available to borrow in early policy years.

The liquidity aspects of PUA premiums clearly differ dramatically from that of the base policy premium. 

Their are three key differences allowing for this liquidity. 

One is the fact each dollar of PUA premium creates only a minimal amount of death benefit. A typical ratio multiple ranges from one to five times.  Contrast this to each dollar of base premium paid where the typical multiple might be 100 times or more.  Therefore PUA rider cash values have a minimal mortality cost impact as opposed to base WL policy premiums. Which in turn requires far less in reserves be set aside to support PUA rider death benefits versus those required for base WL premiums.

A second difference pertains to the commission amount paid on PUA rider premiums. It is very small compared to that paid on base WL premiums;  usually on the order of 2% to 4%.  The commissions paid on base WL premiums range anywhere from 40% to as much as 115%. 

The payment of high commission levels on base WL premiums is a major reason very little of the base premium is credited to cash values early on. It takes many years (decades n fact) to amortize this up front commission cost. Only after the amounts advanced from the companies capital are recovered can cash values be made available to the policy owner for either borrowing or policy surrenders.

NOTE:  The commission is actually advanced from the capital base of the life insurance company.  However, the company is well aware it will take many years for it to recover the amount paid out in the first year of the policy on that base premium.  Which is why base premium cash values are suppressed for many years until the capital amount advanced to pay these commissions to be fully recovered. 

The remaining major difference pertains to how the PUA premiums are invested in the general account versus how base WL premiums are invested. Base premiums are typically invested in longer term maturity instruments while PUA premiums are invested in shorter term fully liquid fixed interest instruments. 

Historically shorter term maturity bonds and T-Bills pay a far lower yield than longer term maturity financial instruments.  The shorter life of PUA investment instruments make them far more liquid. Unlike longer term maturities purchased with base WL premiums, the investments supporting PUA cash values can usually be traded out of without triggering penalties that would result in losses in the general account. .

That said, there is a second consequence to investing PUA rider premiums in shorter term maturities. Shorter term maturity instruments historiaclly earn less than longer term maturity instruments. This means cash values supporting PUA riders generally earn less than base premium cash values. The result is a far lower dividend crediting level pertains to cash values applicable to PUA riders as opposed to base premium cash values.

The combination of these factors allow WL companies to make far higher levels of liquidity available for PUA rider premiums than is possible with base WL policy premiums in early policy years.  Again, the availability of cash values is essential to allow illustrating infinite banking scenarios with early policy year borrowings and loan repayments.

THE IRS COMPLICATION

Adding a PUA premium rider of any material amount will also require the addition of a “term” insurance rider.  This second rider is needed to create additional death benefits.  The added death benefit levels are needed to meet IRS stipulated ratio’s that must exist between total WL policy death benefits and premium amounts paid.

These IRS required ratios must be maintained if the policy is to qualify as life insurance under the tax code.  Which by definition any life insurance policy sold must.  No life insurance company will knowingly allow a life insurance policy to be issued that fails to meet IRS requirements that effectively represent the legal definition of what is and what isn’t life insurance for tax purposes.

Life products that meet IRS requirements enjoy three very attractive tax advantages. 

The first being the death benefit will be tax free when paid.  The added good news is the cash value build up inside the life policy, including gains above premiums paid, is tax deferred like an IRA.  Finally, loans from the policy will not be taxed so long as the policy remains in force. Which allows untaxed gains to be accessed and spent with no tax consequence.

If IRS definition of life insurance is not complied with the policy will not qualify as life insurance. All three tax advantages will be lost.  The result would be litigation were a policy holder sold a non-complying policy.  Not to mention massive fines and penalties assessed by regulators.

There is a secondary life policy test that also must be complied with. It was added a couple years after the initial test criteria was added to the tax code. It’s called the Modified Endowment Contract test, or MEC test. Essentially, this second test sets a ratio that must exist between premiums and death benefits. Failure to meet its requirements would result in policy loans being taxable.

Needless to say, if a WL policy is to be used in the infinite banking scenario it must qualify as life insurance under initial IRS test criteria and it must also pass the MEC test. Obviously, if policy loans were taxable the entire infinite banking strategy would fall apart.

So, the fact a PUA rider must be added creates a problem. The larger the PUA rider, the greater the problem. Each dollar of added premium requires a certain amount of added life insurance. The formulas are complex and not practical to disect here. The good news is all WL software used in creating illustrations takes all required testing into account.

To create the rquired additional amount of death benefit the industry uses another rider. It’s called a “term rider”. The negataive is the term rider has a very real cost. A cost substantial enough that it erodes cash values.  The cost of this rider therefore reduces a WL policies ability to produce a meaningful level of dividend fueled earnings and resulting cash build up.

NOTE:  Read the WL PUA/Term rider write up if not familiar with this rider.  It isn’t practical to discuss this topic in detail for purposes of this write-up.

Without a PUA rider, which itself is an outgrowth of the much older “dividends to additions” dividend option, the infinite banking concept cannot be implemented.  The reason being it would take fifteen to twenty years, or longer, before a material amount of base policy cash values would be available to borrow.  

Which is not the scenario envisioned and expoused by those who tout the infinite banking concept. They want the borrowing to occur sooner than later. One reason is “sizzle” in nature. The other is the supposed ability to magnify and accelerate cash value growth and wealth building.

THE NEED FOR SIZZLE

Those who sell WL understand the average person, when considering a major purchase or investment, would prefer to have a near term benefit they can utilize sooner than later.  There is no “sizzle” in suggesting someone wait decades before they can benefit from an expensive savings program. One of the reasons IRA’s and 401K’s feature an up front tax dedcution as an incentive for people to save. Most people prefer an up front tax benefit to a longer term tax advantage.

The fact is the infinite banking devotee is selling a “plan” that involves aggressively borrowing from WL policy cash values as soon as possible.  Which they explain will allow for dramatically increasing savings and earnings. Which is why near term liquidity is needed.  This is the key to making the approach appeal to potential buyers.

The infinite banking scenario most often illustrated involves a repeating series of borrowings and repayments during the first two or three decades the WL policy is in effect.  The representation is this will “create” a dramatic acceleration of cash value growth and overall wealth accumulation.  The first borrowing is typically illsutrated in the fourth or fifth year.

This early borrowing is explained as being absolutely essential to deliver the infinite banking advocated benefits. 

The key points for now, relative to making it possible to implement the infinite banking advocated strategy itself, is the a PUA rider must be used to creates the added early cash values.  And, in order to use a PUA rider a very large term rider is also needed..

WHICH BEGS THE QUESTION

Which perhaps would all be fine if borrowing from a WL policy actually does have a positive impact involving accelerating cash value growth or overall wealth building.  Which it doesn’t. 

Which is the reason this write-up exists. 

The purpose of the write up is to refute the alleged benefits touted by infinite banking devotees.  Allowing those who read it to avoid becoming victims of a complete misunderstanding as to how WL actually works.

Sadly, the entire premise supporting the infinite banking idea is the result of a total confusion regarding how WL policies work.  Confusion tied to something referred to as “collateralized confusion” in the rest of this write-up. 

There will be more (much more) on that later.  For now we still need to build up a bit more of a base of knowledge.

PUA PREMIUM EARNINGS ATTRIBUTES

A valid question is does adding a PUA rider, with the dramatic increase in premiums it requires, enhance earnings in the WL product. 

The short and to the point answer is “no”. 

PUA riders only work because there are no surrender charges imposed on withdrawing or borrowing the cash values they create and they are invested for the short term, not the long term.  This is the exact opposite of what occurs with “base” WL policy premiums. 

The reasons for this have previously been outlined.  They are also discussed in far greater detail in the separate PUA/TERM rider write up. These two factors, along with a low premium to death benefit ratio, account for why PUA rider premiums are more liquid than base WL policy premiums.

The point being, with a short term maturity investment focus, there is no actual earnings benefit gained in a WL policy by using a PUA rider.  The actual fact is using a PUA rider reduces the level of earnings inside a WL policy.  And worse, the term rider that must be addedto allow the PUA prmium to be paid into the policy has even a far greater negative impact on cash value accumulations due to its cost.

Which brings us back to the idea of sales appeal. 

Anyone who has worked in financial sales knows with most people complicated products tend to lack buyer appeal.  While everyone likes to understand what they are buying, most people have no interest in spending endless hours in that effort.  So the more complicated the product, the less likely it is the potential buyer will buy it since they have no interest in digging down into all the messy details needed to fully grasp how it works.

The average buyer prefers a simple conceptual story as opposed to a detailed education effort.  Only accountant and engineer types crave that level of knowledge.  Pretty much everyone else is repelled by any effort on the part of a sales associate to impart high levels of detail. 

Most people only want to hear “the bottom line”.  Successful financial sales associates understand this. They behave accordingly.

WL; A MIRACLE OF SIMPLICITY (NOT)

Many of those who sell WL portray the WL product as a miracle of simplicity. 

WL is often presented as a product so clean and simple it can’t be manipulated.  Often stressed is the fact its benefits are guaranteed.  Never mentioned is the fact base WL premiums must be paid for life of the policy for guarantees to apply.

While this “it’s guaranteed” line of thinking is overblown nonsense when one digs deeper, its music to the ears of a potential buyer.  Paying premiums for life is never illustrated or discussed because it would alienate potential buyers and require complicated discussions as to what occurs and how quarantees are impacted if they are not paid for life. 

What is always illustrated is non-guaranteed dividends being used to pay premiums at a point in time. That point in time is calculated by the illustration software.  Many decades ago this was referred to in illustrations as the “vanish” point. A term subsequently outlawed by the nations regulators, since premiums never actually vanish.

The reason this “vanish” point may or may not arrive is because dividends, as illustrated, may or may not materialize in the future.  This is dictated by subsequent actual economic realities versus the myriad of undisclosed assumptions buried in illustration software formulas.

If a buyer has no intention of paying premiums for life, which no one ever does, the touted guarantees cease to exist.  As noted, a fact that is never mentioned, never illustrated and never expressed in sales presentations. 

WL is not a simple product. 

It is, in fact, the most complicated life insurance product ever developed.  Which is why selling it requires gross levels of over simplification.  Rare would be the buyer willing to spend the many hours needed to grasp the complexities of WL.  Even rarer is a sales associate with the knowledge needed to impart that understanding.

SINCERITY

Sincerity is a powerful force when it comes to making a sale.  The sincerity of the typical infinite banking devotee, albeit it based in ignorance and or blind faith, is none the less compelling in a sales situation. 

Potential buyers, especially those about to commit to paying large premiums for a decade or more, want to feel the person selling them sincerely believes the benefits being discussed will be delivered.  There is no doubt the vast majority of those who sell the infinite banking concept fall into that category. 

Sincerity and exuberance in making a sales is a far more powerful force than an in depth WL product education.  Presentations made by a more technically inclined sales professional are most often compared to watching paint dry. 

Right or wrong, simplicity and sincerity sell. 

Complex detailed explanations don’t.

INTENT

Most of those who sell WL are not doing so with ill intent. The opposite is more often the case.

Those selling the infinite banking strategy are typically just repeating what they have been told by those who hired and or trained them.  They respect their mentors who they trust implicitly.  Mentors that themselves were hired and trained by others like themselves.

People blessed with complicated minds and technical leanings are rarely sales managers.  Sales managers hire new sales associates.  Sales managers are usually people blessed with warm and fuzzy people skills.  Naturally, most look to hire people like themselves. 

The truth is those with a more technical bent only annoy most sales types. They are viewed as wasting time belaboring useless details that will be of no help in making a sale. Which also accounts for why most techical types fail when hired to sell life insurance.

Adding fuel to the fire is the fact those who sell WL genuinely like the infinite banking story they’ve been told.  And, why wouldn’t they.  It makes them feel good about what they do.  Who would’t want to sell a miracle product that will help people pyramid their wealth. Hence the popularity of the infinite banking story.

The fact is, many if not most, of those who sell this concept lack the curiosity needed to drive them to dig deeper.  They are just not internally motivated to gain a technical understanding of the products they sell.  Instead, they are focused on the benefits they’ve been told it can provide.

Rare is the recently hired financial sales person motivated to spend endless hours in study and research trying to unravel the WL puzzle.  Few of that ilk are hired.  Those that are, who spend their time in that regard, usually make very few sales early in their career.  Instead of perfecting ways to go out and meet with people as their managers constantly urge them to do they instead sit in the offide and study the products they are being asked to sell. Disfunctional behavior in the eyes of those that hired them.

The end result being most technically inclined people hired to sell financial products fail.  While they may fail with a better understanding of the products they were hired to sell than those who go on to succeed in the sales career, they still fail most of the time. 

It does not mean those less technically inclined are “bad” or being “deceptive” by intent.  It just means they are not technically inclined and they have little or no interest in details.  They tend to believe what they’ve been told by those who hired them.  It’s just the way it is. 

This leaves the public at risk relative to the level of knowledge the person selling to them may or may not possess.  It’s easy for a sales person to project the image of being knowledgeable, but all too often it’s just an image. Again, its just the way it is.

BORROWING FROM A LIFE PRODUCT

So on that note let’s get back to the boring facts.  One of which is the fact borrowing from a life product, including WL, is nothing new. 

It’s actually been incredibly popular for decades to illustrate borrowing.  The reason being the IRS tax code allows borrowing as a non-taxable way to access gains that have accumulated in cash value above premiums paid.  Gains that have been carried inside the policy on a tax deferred basis.

So borrowing allows untaxed gains in a life policy to be taken out via loans and spent for any purpose one desires with no tax being due at the time.  That’s a very big deal.  What was never illustrated in a sales illustration was the repayment of these policy loans. 

NOTE:  Only a ROTH IRA offers similar tax treatment relative to the ability to access deferred gains (by withdrawal, not loans) so they can be spent with no tax being due.  ROTH IRA’s did not exist when WL was created, the tax code was written and for a great many decades thereafter.

But when it comes to borrowing from a life product theirs even more good news.  The reason being the borrowing transaction literally becomes tax free later on.  That happens when the loan balance is repaid at the demise of the insured party by the tax free death benefit proceeds. 

Loans are not technically considered tax free when taken.  It becomes tax free when the loan balance is repaid at the death of the insured party.  The reason being death benefits are tax free.  The death benefit remaining above the repaid loan balance is then paid to the policy beneficiaries.

Humorously stated, the bad news is one literally has to die to benefit from tax free death benefit proceeds repaying the loan balance.  On the other hand, the good news is everyone dies.  A fact even the IRS understands. 

So the question is why not benefit from death.  And why not benefit while one is still alive and able to spend the tax deferred gains accessed by borrowing from the life insurance policy. 

Which explains the popularity of life insurance with those that understand the tax code.  It can be used to build up tax deferred wealth, which can be borrowed and spent without taxation.  After which, at a point in time, the loan making that possible will ultimately be discharged (repaid) when one passes away.

What many people realize, when allowing someone to explain this to them, is If you’re going to buy term insurance because you need the death benefit to protect your family or business, why not wrap it around a savings account and reap the tax free gains and benefits noted above. 

Which is why a great many high income or wealthy people own large amounts of cash value life insurance.  ROTH contributions are limited in amount.  Life premiums are not.

CLASSIC LOAN BALANCE CONCERNS

When first explained it is not uncommon for a potential buyer to fret about the effect all this borrowing will have on the policy.  They worry about how large the loan will become. 

Prospective clients, and even their legal and accounting advisors, often express a concern the loan balance will ultimately exceed the death benefit amount.  The worry being this would leave a loan balance their family may have to repay at the time of their death.

The short answer to this concern is this cannot happen.  The mechanics of a life policy won’t allow it to occur.  The reason being the IRS made it possible to be sure it can’t.

The more complicated answer is life policies eventually enter a phase where IRS testing is confined to the ratio between the death benefit versus total cash value.  Total cash value for IRS purposes includes the loan balance (borrowed funds).  Cash value being divided into borrowed and unborrowed funds.

This ratio test, when applied, is referred to as the policy being “in corridor”.  A reference to the differential the IRS dictated must exist at different ages between the cash value and the death benefit.  When applied its referred to as the policy being in a “cash value corridor” (CVC).  Literally, that is the name of the IRS test rule.

The further and more complicated additional news is the CVC ratio (the corridor between the cash value and death benefit total) gradually declines as the insured person ages.  Picture it as paralleling the insureds age.  At age 40 cash value can equal 40% of the death benefit.  At age 50 it can equal 50%.  At age 60 it can equal 60%.

While not exact, the above percentages are very close to the IRS imposed limits.  The IRS understands that the cash value is part of the death benefit being paid out at the insureds demise.  They also understand there is a very real cost associated with paying the excess amount. 

If the IRS rules didn’t allow the required amount of death benefit above cash value (the ratio percentage) to decline as a person ages the mortality cost factors would eat up all policy cash values long before the insured persons likely mortality age.  Conversely, the IRS is not about to allow the cash value in a policy to exceed the death benefit total and still grant the three major tax advantages cash value life insurance policies enjoy.

Most important is the fact the CVC ratio reaches zero at older ages (95 and beyond).  Which means the cash value and death benefit can literally are allowed to become equal at that age.  Which means there is a point in time when there is no longer a need for the life insurance company to pay more in death benefit than the cash value total.  Meaning at that point in time there is no longer a need to charge a mortality cost factor against policy cash values.

Which brings us to the added fact the IRS also allows insurance companies to automatically increase the death benefit amount to allow the policy remain within the legally required ratio as cash values increase.  Which in turn means the loan balance (which is part of the cash value) can never exceed the death benefit.  Never.

CLIENT LOAN INTEREST CONCERNS

Which leads to the next “fretting” subject often expressed by potential WL buyers when loans are illustrated to access cash values in later policy years.  Which is the concern the policy owner will have to pay interest on the loan.  Amounts that could be very large as the loan balance grows. 

The life insurance industry, once again with the IRS’s tacit blessing, long ago put in place added mechanisms to address these concerns. 

The first being the fact loan interest can also be paid by taking out additional policy loans.  This means the borrower does not have to pay the interest “out of pocket”.  It can literally be paid internally within the policy using accumulated cash values.

However, this still leaves an added concern.  A thought that may or may not occur to the average life insurance purchaser.  But it does occur to some. 

The concern is what happens if the interest rate payable on the loan balance exceeds the rate being credited into the policy on the borrowed funds?  If a larger amount than is being earned must be borrowed to pay the loan can this cause the cash values to be eroded over time?  If so, the result could be a policy lapsing before the insured party passes away.

After all, even a 1% net earnings differential can result in a tremendous negative impact on cash values when seven figure digit loans exist.  Loans of that size are the norm with policy designs that involve borrowing to fund supplemental retirement income needs.  The reason being when added borrowings are made to pay the loan interest the borrowed amount literally compounds for decades.  The result is extremely large loan balances in the later policy years. 

Clearly, absent any solution, the result of even a minimal differential between loan interest rates charged and the rate earned credited into the policy on borrowed funds could cause many policies with large loan balances to lapse long before the insured party passed away.  Which, if no solution existed, would be a very valid concern.

The industry addressed this concern decades ago.  They created what the industry refers to as a “net zero” interest rate loans.  This occurs when the interest rate charged on borrowed funds is exactly the same as the rate credited into the policy on borrowed funds. 

With Universal life (UL) policies this works extremely well.  The plus in earnings and minus for loan interest are totally transparent and easy to identify.  “Net zero” loans have been the norm with UL policies for several decades.

Relative to the typical UL scenario, the norm is for this feature to kick in ten or twenty years into the life of the policy.  Loans taken prior to that time frame incur a haircut, typically ranging from 1% to 2%.  Meaning the earnings credited on the borrowed funds is that much less than the rate charged for loan interest. 

But that is not the case with most WL policies.  Two different methods have been used with WL policies for the last fifty plus years.  Both are far less transparent and provide no certainty that loan interest rates charged will be equal to or less than earnings credited into the policy on borrowed funds.    

The fact is a “net zero” cost loan only recently became available for WL with one company.  Since it eliminates any mystery relative to how loan interest can eat into cash values, it is likely to be adopted by other WL companies if they wish to remain competitive.  

The historical treatment of borrowed funds with WL is discussed briefly in the segment below and in greater in a separate write-up.

WL BORROWING DIVIDEND FACTS

With WL the dividends paid on borrowed funds have historically been structured in one of two different ways.  One is referred to as “direct recognition”.  The other, by default, is referred to as “non” direct recognition. 

The “direct recognition” approach recognizes a loan exists.  The dividends credited on borrowed cash values are calculated in a different manner than the dividends credited on unborrowed cash values. 

The “non” direct recognition approach simply ignores the existence of the loan.  Meaning the same dividend levels are credited on borrowed cash values and unborrowed cash values.

Devotees of the infinite banking strategy have mistakenly decided the method a company employs makes a major difference.  They believe direct recognition companies are incompatible with the implementation of the infinite banking concept.  Conversely, they view only “non” direct recognition companies as compatible with the strategy they advocate. 

These topics are discussed in far greater detail in another WL “How it Works” write-up.  The discussion is both complicated and confusing, as with all things WL.  A fact that helps foster the confused belief noted above.

As noted earlier, at least one company that sells WL has adopted a “net zero” loan cost feature for WL borrowed funds.  Meaning the interest due on borrowed funds and rate earned in the policy on them is identical.  Meaning borrowing has absolutely no impact on policy cash values either positive or negative.

If borrowing is intended from any type of cash value life insurance policy its best to seek a company that offers “net zero” cost borrowing.  The advent of its becoming available with WL products also puts an end to the need to belabor the two historically confusing methods historically utilized with WL policies. 

Wonderful news it and of itself.

IMPACT OF A LAPSE WHEN LOANS EXIST

The key point to always keep in mind is any policy that has even a minimal difference between the loan interest rate charged and the rate credited on borrowed funds creates a risk the policy will lapse before the insured passes away.  Which can be a taxation disaster.

The really bad news is if a policy did lapse before the insured party passes away all, or most of, the loan balance outstanding at the time will become immediately taxable at ordinary income tax rates under IRS rules.  The added bad news is when a policy lapses it means there are no cash values remaining in the policy.  Which means there are no funds from the policy available to help pay the taxes. 

The fact is long term borrowing strategies with added borrowing used to pay interest creates extremely large compounding loan balances over the life the policy.  Large seven figure loan balances are the norm.  Meaning the tax due can easily be in the millions of dollars.

To avoid the risk of lapse It is imperative that interest charges on borrowed cash values not exceed dividend or interest crediting rates into the policy on those borrowed funds.  If they do, over time this differential can and often will eat up all cash values and ultimately trigger a policy lapse.  At which time the loan balance then outstanding becomes taxable.

Only a true “net zero” loan feature guarantees this can never occur.  It’s that simple.

OVERLOAN PROTECTION RIDERS

Which brings us to a second rider created to help avoid policy lapses while large loan balances are outstanding.  These are referred to as “overloan protection” riders, or by similar names.  This rider addresses the risk mortality costs applied within a life policy will cause a life policy to lapse.  

As noted earlier, the insurance amount that a company provides isn’t the total policy death benefit.  With WL the amount that the insurance company pays out of its own capital or reserves is the difference between the policy cash value amount and the death benefit total.   So the cash value covers a portion of the amount being paid when the insured passes away.

The “at risk” amount is the actual amount of life insurance a life company is at risk of having to pay (above cash values) at any point in time. 

The point being the total WL policy death benefit payable at all times includes the policy cash value.

The cash value itself is actually an asset of the policy owner, not the life insurance company.  The life company views the cash value amount as a liability due the policy owner.  It’s available to the policy owner upon policy surrender or as part of the death benefit proceeds.

NOTE:  With UL policies under one option (called either Option A, or Option 1) the cash value again is considered to be part of the death benefit.  However, under Option B, or Option 2) the cash value would be paid above (in addition to) the policies total specified death benefit. 

Most people don’t think about the cash value in their policy as lowering the actual amount of insurance a life company must pay out of their own pocket upon the insured’s demise.  The fact is with WL it always does.  The formulas that govern WL policy calculations of dividends and cash values takes this into account.

A related critical point is the fact that as cash values grow over time and the death benefit amount stays the same, the actual insurance amount “at risk” constantly declines.  That said, it must stay within certain ratios that change (decline) with the insured party’s age.  This was discussed earlier relative to the IRS “cash value corridor” (CVC) rule. 

With WL it must also be noted that PUA riders and with the dividend election where dividends are converted to additions, there is a nominal corresponding increase in death benefits.  However, it is also true that as those “additions” are surrendered later, either to pay premiums or to fund policy distributions during retirement, the nominal increase in death benefits they created is cancelled out.   

The point here is the differential between cash values and death benefits represent the actual amount the company selling a life policy must pay from its own reserves or capital base.  To the life company it is the amount they are “at risk” of paying and they must charge for. 

Relative to the CVC corridor noted above (the difference between total cash value and total death benefit) a mortality cost impacts the dividends credited and therefore the resulting cash value build up inside a WL policy.  As one would logically expect, the cost per thousand of dollar of death benefit increases as the insured party ages. 

The offsetting good news is as the cash value grows and the death benefit remains level the number of thousands of dollars of death benefit is always declining over time.  Meaning the “at risk” amount that represents the actual amount of insurance the life company is providing above the cash value declines over time. 

The way this works with UL versus WL policies is completely different and extremely clear.  The actual cost for the mortality risk assessed in any given year (or month) is clearly stated on the policy statements.  There is no mystery.

But, as is true with all things WL, it’s impossible for anyone who owns a WL policy to nail down the impact of the “at risk” mortality cost on the dividends credited and resulting cash value growth.  The reason being it’s tied to a factor built into the formulas that govern dividend calculations. 

The key point here is mortality cost factors can impact dividends to the point there is a risk the policy’s cash value will be depleted to the extent there are no longer funds available to absorb those costs.  At which point either the policy owner must again start paying premiums to keep the policy in force, or it will lapse.  The lower the yield on general account assets, the greater the likelihood this might occur.

When the policy owner is unable or unwilling to once again pay premiums out of pocket a WL policy will lapse.  If a lapse scenario occurs with a loan balance outstanding then both the premium amount and the loan interest would have to be paid.  If the loan balance is large the interest payment might be a very large amount.

The really bad news is when a policy lapses a loan is outstanding the IRS considers the loan balance to be fully taxable.  Even worse the tax code treats this as “ordinary income” (like salaries, interest, and dividends).  Ordinary income is taxed at far higher tax rates than are long term capital gains, the less penalizing classification the IRS places on other types of longer term investments. 

Making matters even worse is the fact at the time a policy lapses there is no longer any cash value left in the policy.  It’s all been withdrawn, loaned out, used to pay premiums, or used to pay loan interest; or all of the above. 

With no cash value left in the policy to help pay the taxes then due, and with a seven figure loan balances being the norm, the ordinary income tax due on the loan balance can be catastrophic.  Literally in the millions of dollars.

As noted earlier, the good news is under the CVC rule the actual “amount at risk” declines with age.  This is critical since the cost per thousand for the “at risk” death benefit increases dramatically with age.  The CVC rule is intended by the IRS to allow the “at risk” amount to decline as the insured party ages. 

Generally, this means the impact of the mortality expense risk on policy cash values declines over time.  If it didn’t every life policy ever issued would lapse long before its maturity date.  The IRS understand this.  Hence the CVC rule being built into the tax code as pertains to life insurance.  This is all embodied in Section

7702 of the tax code for those inclined to study the matter further.

The added good news is at very advance ages (95 and above) the CVC ratio declines to zero.  Meaning per the IRS rules the insurance company no longer required to have an “at risk” exposure for the product to remain defined as life insurance under the IRC.  This also means the life company no longer must factor in a charge for mortality expenses. 

This “zero” CVC ratio at advanced ages is very good news for the owner of a life policy that manages to live to a ripe old age.  It allows the insurance company to simply keep their policy in force until they die at no expense to either the insured or the life company.

The bad news is not every life insurance company allows that to happen.  Some instead leave a small amount of actual insurance in force above the cash value.  This allows them to continue to apply a mortality cost factor that reduces dividends and therefore cash value accumulation even at these much older ages.

The point being it is not mandated by the IRS that life insurance companies bring the amount at risk to zero at those ages.  It’s just allowed by the IRS.  Any company selling WL policies (or UL policies for that matter) not building this IRS gift into their product offerings should be avoided.

Which brings us back to the topic at hand.  At the ages where the IRS CVC rule still mandates an “at risk” amount be in effect a properly structured “overloan protection” rider is an absolute essential.  

A properly structured rider of this type will not allow a policy lapse triggered by internal policy costs.  This is critical when the buyer’s intent is to borrow out cash value gains to supplement their retirement income needs.

Unfortunately, many of the riders of this type made available by various insurance companies are poorly structured.  Several very large companies have riders so poorly designed, seemingly with intent, that they are unlikely to eliminate the risk of a policy lapse.  These companies seek only to give the appearance this risk is protected against; when it’s not. 

A poorly designed overloan rider may list eight, nine or more requirements that must exist for their rider to be triggered.  Some of which are utterly incomprehensible mumbo jumbo not even an actuary could explain.  Some of which are seemingly mutually exclusive, meaning they can’t exist at the same time. 

Poorly structured riders of this type require all the obtuse and obscure conditions exist simultaneously.  They also require the policy owner (usually the insured) identify this fact and contact the insurance company asking them to trigger the rider.  Keeping in mind the insured party is usually in their 80’s or 90’s when these conditions would exist.  

So not only is the typical policy owner/insured expected to be a master scholar on life insurance able to divine when all these terms are met, they are expected to have retained their cognitive skills as well.  They dare not be victims of dementia as they age. 

A properly written rider will have just three requirements.  All being the conditions that would likely exist at older ages if policy cash values were accessed by borrowing to fund non-taxable supplemental retirement income distributions.  The properly structured overloan rider is also trigger automatically when the three conditions exist without any action required on the part of the policy owner. 

The three requirements being:

• A loan balance of at least 90% of total policy cash value exists,
• The policy has been in force for at least 15 years, and
• The insured is over age 65 (or perhaps 75).

Again, there are companies that almost a dozen specific and incomprehensible criteria exists.  There is no need for this.  Those are the deceptive companies.  They are to be avoided.

As noted above, there are also companies with properly structured riders that still require the insured to instruct the company to invoke the overloan rider.  They typically intend to mail the policy owner a letter telling them the conditions exist that would allow them to exercise this rider. 

The problem with this is the fact the policy owner is unlikely to have any idea what this notice is about. They would have to have an extensive knowledge of how policies are structured and the tax code to know why it is important for them to exercise the rider immediately. Even fully cognitive oldsters would be baffled by the need to make a decision of this nature since most will have no idea how life policies work and the rules the IRS imposes. 

The same is true for the clerical staff who answer the 1-800 customer service calls for these companies.  If a reasonably mentally acute policy owner were to receive this letter and call with questions, the people manning these lines would have no idea why this is important.  They are little more than clerks provided with simple scripts to handle the most basic questions people might ask. 

Which is important because the agent that sold the policy will likely be long dead by the time this situation occurs.  Which means the policy owner has no one else to call.  The point is any company requiring the policy owner to notify them to activate this rider, or make an election it be activated should be avoided.

LIFE INSURANCE PER THE TAX CODE

Products that meet the IRS definition of life insurance by complying with Section 7702 of the tax code enjoy tax favored status.  Tax advantages that have long been the primary reason people buy cash value life insurance policies; including WL. 

The tax code allows for the tax deferred buildup of gains above premiums paid in the cash values inside a life policy.  It also allows for those tax deferred gains to be borrowed out and spent without triggering tax liability.  Lastly, the death benefit proceeds are tax free.  At death a portion of the tax free death benefits repays the outstanding loan balance.  Completing the tax free circle that allowed for the accessing and spending of the deferred cash value gains.  

That said, the way loans are discussed and utilized under the infinite banking concept is totally outside the norms relative to how loans have been structured and illustrated in decades past.  Until recently it was literally impossible to illustrate the type of WL loan activity advocated by infinite banking devotees. 

The classic WL illustration shown to prospects since the 1980’s showed a far different cash value borrowing scenario.  A classic retirement oriented illustration showed:

• Premiums being paid for ten, fifteen or twenty years.
• Cash values, including dividends, built up for two, three or even four decades. The longer they grew the greater the amount of gains they included.
• Cash values were borrowed out during retirement; usually from age 65 to 85.
• Loan interest was paid with additional policy loans. 
• Tax free death benefit proceeds paid off the loan balance at the insured demise.

This was an IRS compliant approach to using life insurance to create additional supplemental tax free retirement income using a life policies accumulated cash values.  It was for decades the primary reason people “in the know” would buy cash value life insurance. 

As long as longer term market interest rates were in the high single digits or greater WL illustrated a very favorable overall IRR result under this scenario.  Meaning when comparing premiums paid vs. borrowings out the dollars out vastly exceeded the dollars paid in.  A ten to one “out to in” ratio being the norm. 

The result being attractive enough to induce people who had a need for life insurance protection to use a cash value product (like WL) as opposed to far cheaper term life insurance.

INFINITE BANKING BORROWING

The infinite banking approach to borrowing is entirely different.  It has nothing in common with the classic loan and ultimate repayment scenario discussed above. 

Think of it as borrowing on steroids.  Also, think of it as borrowing the premiums recently paid into the policy.  Not the growth on them.

The justification for infinite banking based borrowing is threefold.  Theoretically it will dramatically accelerate cash value growth in a WL policy.  The borrowing is also supposed to multiply the growth of one’s investment wealth as the same premium dollars fund multiple investments.  All with the added plus created by eliminating the payment of interest to outside 3^rd parties as one pays them self instead.

Unfortunately, all three benefits noted above are illusionary.  They don’t really exist. 

Let’s first address the idea it magnifies the growth of cash values in a WL policy.  This benefit is entirely imagined.  No such added growth in policy cash values occurs when borrowing is utilized.  This is now easy to prove today, but was impossible to prove not so long ago.  

The crux of the infinite banking thrust is the borrowed funds are still earning dividends inside the WL policy.  Adding to that is the interest being paid on borrowed funds by the policy owner.  The thought is this literally double up the rate of cash value growth in a WL policy.

The second benefit is the opportunity then use the borrowed premiums from the WL policy to make a second investment.  This could be the purchase of another WL policy or it might be any other possible type of investment.  The representation being the original policy is still paying dividends on the borrowed funds and the second policy or investment is also earning dividends. 

This is represented as the same premium dollars that were paid into the first WL policy being able to also fund the premiums to be paid on the second policy (or investment).  This is alleged to double up on the resulting wealth building.

All of this would be quite compelling if any of it were actually true.  Sadly, all of the above imaginary interpretations of what is transpiring are based on misunderstandings as to how a WL product works relative to borrowing, interest payments and the crediting of dividends. 

Anyone who has read the various other WL “How it Works” write-ups already can see the holes in the infinite banking story starting to form.  All of which are discussed in seemingly infinite detail below.

CLASSIC INFIINITE BANK ILLUSTRATION

The classic infinite banking illustration shows a series of multiple repeating borrowing and repayment cycles.  Usually starting around the fourth year which is long before any earnings have accumulated. 

The idea being these loans allow premiums paid on the original policy to do double, then triple, then quadruple duty.  Hence the “infinite” label.

The loans are to be used to either purchase additional WL policies, make other alternative investments or purchase other needed items. 

The initially paid premiums from the first WL policy are viewed as still creating dividend fueled cash value growth inside that first policy.  And, compliments of the borrowing strategy, they are also viewed as either creating a new income source in the second and subsequent WL policy or alternative investment, or as eliminating the payment of interest to third parties and instead “paying oneself”.

Relative to the loan from the initial WL policy, repayments (with interest) begin immediately after the loan is taken.  The loan is shown as fully repaid within four or five years, after which another loan is immediately taken out and the borrowing and repayment cycle repeats itself again and again over the next decade or two.

The infinite banking devotee believes this repeating loan cycle creates accelerated wealth building results and added wealth building by “paying oneself” interest on the policy loan instead of paying it to third parties.  

This occurs in three stages.

First and foremost they hold the view dividends are still being earned on the initial WL premiums irrespective of the fact the funds have been borrowed out of the policy.  This delusional belief is a function of the “collateralized confusion” mentioned previously.

They go on to suggest an added benefit is occurring because the policy owner now able to “pay themselves” interest on the policy loan. The thought being the interest being earned in the policy on this loan is in addition to the dividends still being earned.  Which is not the case and instead is simply a function of the above noted misunderstanding. 

After which they view the second (and subsequent) WL policy purchase or investments made with the borrowed funds as creating added sources of wealth building income. 

This triple combo of earning dividends while “paying oneself” interest and making added investments with the same premium dollars is viewed as dramatically accelerating the building of wealth. 

While this all sounds pretty good it’s absolutely not what is occurring.  Misunderstandings all of which are made possible by the aforementioned collateralized confusion.

DEBUNKING MISUNDERSTANDING #1

Relative to WL, and for a nice change of pace from most things pertaining to WL, it is now easy to prove no such acceleration in cash value growth in the initial WL policy is occurring.  Proving beyond any doubt borrowing does not result in both dividends and loan interest adding to cash value growth.

That is the sole actual benefit of the updating of WL illustration software by some companies to allow for illustrating the above noted infinite banking repeating borrowing and repayment scenario.

If the policy owner’s payment of interest on policy loans adds to cash values, then the values in the infinite banking illustration would be far greater than the cash values reflected in the same WL product illustration without loans.  The infinite banking illustration would in theory benefit from both dividends and the interest paid on the loan.  The illustration without loans would not. 

Oddly enough, at least in the eyes of the infinite banking devotee, both illustrations show identical cash values in all policy years.  Exactly the same.  Not one added dime of growth is reflected in the infinite banking illustration.

This is proof positive there is no acceleration of cash value build up by borrowing from the initial policy when loans are taken.  This result is true with both the “direct recognition” and “non-direct recognition” loan regime. 

What is truly odd is the fact it never occurs to the infinite banking devotee to make this simple test.  You would think it would, since they could then show prospective clients the advantage they are saying will occur. 

Logically, they should be anxious to show the prospective buyer “here’s what you get if you don’t borrow and repay the loans in repeating cycles and here’s what you get if you don’t. 

Of course, since the two illustrations have identical cash values all that would happen is the proposed buyer would wonder why they were being encouraged to borrow in the first place.

Which brings us to the other alleged benefit to be gained by borrowing from a WL policy.  That being the ability to pyramid the original WL policy premium to further build added wealth. 

DEBUNKING MISUNDERSTANDING #2

As one reads Mr. Nash’s book, if they have an accounting background, they will have a constant sense of rampant “double counting”.

The term itself exists because it is not at all uncommon for double counting to occur in a range of business situations.  The more obscure or disconnected the pieces of any given economic puzzle are, the easier it is to have a double counting situation evolve. 

As often mentioned in the “How it Works” WL write ups, there is no financial product more obscure than WL.  As such, it’s an ideal playground for double counters to thrive in.  The lack of detail available to clarify facts allows for erroneous assumptions to be made.

Eliminating the likelihood of double counting is one of, if not the major reason for double entry accounting.  Double entry accounting is the foundation of today’s accounting systems and is the method required by the AICPA to be used in all bookkeeping and financial reporting. 

The foundation of this system is a two sided entry, one a plus and one a minus, for each individual transaction recorded in a company’s books.  The end result is always a net of zero. 

Think of this accounting system as represented by a single page, divided down the middle with a line.  For each entry on one side of the line there must be an equal and offsetting entry on the other side of the page.  Positive numbers are referred to as “debits” and negative numbers are called “credits”.  

Every transaction entered in a company’s books is represented by one or more debits on the left side of the page and an one or more offsetting “credits” on the right hand side.  The added complication being there are many pages (called accounts) and the debits and credits are made on different pages (accounts). 

At all time the net result of each transactions entries must always be zero for the books to be considered “in balance”.  The fact their might be dozens of debits and credits involving dozens of accounts further complicates matters.  Which is why it can be challenging to identify where a possible posting or transposition error has been made causing the accounts to be “out of balance”. 

The idea behind double entry accounting is every plus is offset by a minus and every minus is offset by a plus.  When a company’s books are referred to as being “in balance” it means the net of all entries and resulting account (page) balances is zero.  If not the books are considered “out of balance” indicating an error of some type in the numbers exists.  The AICPA will not certify the accuracy of a financial statement unless the books balance “to the penny”.

Double entry accounting is the foundation for all financial reporting the world over.  Its use is absolutely essential to avoid the possibility of double counting.  A scenario which can result in the overstatement of income (or expenses).  As it does with the infinite banking devotees view of what transpires when WL policy loans are used to make additional policy purchases or investments.

When borrowing occurs the cash values in a WL policy actually becomes collateral supporting the loan.  If the loan is defaulted on (payments are not made) the policy cash value is taken to repay the loan. 

The loan itself is made to the policy owner by the WL company.  The source of the funds loaned to the policy owner is the companies own assets from its capital base.  The loan is not made directly from the owners policy.  Instead, a portion of the policies cash value is flagged as “collateral” which is not accessible to the policy owner until the loan is repaid. 

This “flag” is represented in a policy statement as a portion of the cash value total as “borrowed funds”, which causes a great deal of confusion since it implies the loan was taken from the policy cash value.  This confusion would be eliminated if the reference instead said “collateral withheld to repay insurance company loan to policy holder”.  Which is not how the industry evolved to label policy loans on a policy statement.

The fact the whole life policy cash values are treated as collateral supporting the loan creates an element of “fuzzy math” that lends itself to double counting.  The appearance of “total” cash value on a WL statement further lends itself to allowing for that confusion.

On the WL statement the total cash value number includes both borrowed and unborrowed funds.  The borrowed portion is actually the collateral amount being restricted.  The loan balance itself is shown separately as an offsetting reduction.  The resulting “net” cash value (total cash value minus the loan balance) may also be shown.  The “net” is what remains available to the policy holder.

When someone ignores the loan balance as offsetting the total cash value they are in effect “double counting”.  They may conclude they still have a cash value equal to the total cash value amount that appears on their WL statement, when in fact they do not.   

Mr. Nash and his small army of infinite banking devotees are victims of this “fuzzy math”.  Which is in turn the result of “collateralized confusion” resulting from putting a “total” cash value amount on the WL statement.

BORROWING TO MAKE AN INVESTMENT

It’s now time to take a slightly different look at the “fuzzy math” confusion made possible by this “collateralized confusion”. 

Let’s look at the math when borrowed WL cash values are used to make a separate unrelated investment. 

The Infinite Banking enthusiast sees this as a win, win.  Not only does the policyholder earn a return on the new outside investment, they are also viewed as continuing to earn a dividend on their initial WL cash values. 

As such, some Infinite Banking advocates are encouraging WL borrowing.  They see a doubling of returns being earned. 

The WL borrower is told if they do this they will enjoy this doubling of their earnings growth only possible when using a WL policy.  Possible because dividends are still being earned on the cash value. 

All the sales prospect needs to is buy a WL policy, pay premiums for a few years creating a he cash surrender value they can then borrow from and then take loans from the policy.  Once they do, they’re off to the races” and able to “pyramid” the earnings on their savings.

NOTE:  The use of the word “pyramid” is never good in conjunction with any investing opportunity. 

The classic Infinite Banking devotee will tell you this pyramiding would not be possible for those who foolishly save using other investments like money market, bank or brokerage accounts instead of a WL policy.  The reason being, they would have to liquidate out of those types of accounts in order to make another separate investment.  

Of course, with a WL policy they are able to borrow. As such, they do not have to liquidate a portion of their initial savings plan (the WL policy) to make a second investment.  They can instead leave their cash value in the policy and just use it as collateral to support a WL policy loan. 

Which all sounds great.  If, in fact, it works that way.  No wonder the Infinite Banking concept has such tremendous appeal when that’s how the potential results are viewed!

If only that fuzzy math held up under further review.  Which, of course, it doesn’t.  It doesn’t hold up for much the same reason as the “buy a car” logic fell apart.  So yes, this is yet another case of double counting made possible by “collateralized confusion”. 

Let’s look at why this is so. 

To make things simple we can use an assumed 5% return in a WL policy and a 5% return in a second possible separate outside investment.  To make this work the infinite banking devotee says we must borrow from the WL policy.  When we do, we incur a loan interest cost.  Which we are encouraged to make “out of pocket” so we are “paying ourselves”. 

To keep things really simple let’s also assume the loan interest rate we will pay is also 5%. 

To hear the infinite banking devotee tell the tale, if we are still earning 5% in the WL policy in dividends, and now we also have another added 5% being earned on the new investment; the illogical conclusion is we are now earning a total of 10%.  Which is part of the story.

The other part of the story is the idea we are “paying ourselves” the interest.  We are told to look at it as an addition to our savings.  It’s not being “earned” since its coming out of one of our pockets (a bank account) and going into another (the WL policy).

The infinite banking devotee’s recap of the “deal” therefore is an earnings amount of 10% in total and a further addition to our savings plan (the WL policy) in the form of the interest paid. 

That’s the result if we use “fuzzy math” with some double counting sprinkled in to sweeten the pot. 

Absent “fuzzy math” the fact is we really only will earn a net of 5%. The reason being we had to pay the 5% WL loan interest.  We are actually paying it to the insurance company.  It is not going into our policy.  The insurance company is a lender like any other. 

So yes, while we now have total earnings of 10%, we also have a new cost of 5% since we borrowed the money to make the second investment.  And borrowing has a cost.

The bottom line is we net the same 5% we would have earned if we just owned the WL policy alone and never borrowed in order to make a second investment.

NOTE:  To make this really clear, picture the 5% earned on the second investment as the source of the money used to pay the WL loan interest.

So, the fact is the 5% earned on the second investment is totally offset by the 5% paid on the WL loan for interest expense.  Meaning there is no benefit gained by borrowing from the WL policy to fund the second investment. 

That’s the actual math, instead of the fuzzy math that results from collateralized confusion and inaccurate double counting.

The only way one could come out ahead is if the outside investment made with the borrowed funds generated a higher return than the loan interest we are paying.   If that were the case taking money out of the WL policy to make a second added investment would generate a true gain; albeit only the difference between the interest amount paid and the second investments return above the interest rate.

NOTE:  If we can earn 6% in an outside second investment and only pay 5% on the WL policy, a net gain in earnings of 1% could be achieved.

Of course, the above analysis would be viewed as heresy by the infinite banking devotee. 

Before outlining how the loan interest and dividends on borrowed funds actually work or interact, let’s first let’s digress and lay a bit more groundwork on the infinite banking strategy and Mr. Nash’s book and background.

MAIN STREAM CONCEPT OR CULT

LIKE FASCINATION

The average person being presented with this sales concept has no idea the infinite banking scenario is not a “main stream” sales concept. Meaning it is not a concept embraced by all, or even most life insurance sales professionals or life companies. 

This is especially true for the larger companies because they have very deep pockets would be at risk should class action lawyers get wind of this silly sales scheme and descend on them.

The fact is only a relatively small number of Infinite banking devotees are selling whole life by illustrating this repeating loan scenario.  Some of whom do sell a great deal of WL. 

No doubt their success in doing so is the result of the level of enthusiasm they project when presenting the infinite banking strategy.  Most of these folks happily provide prospective clients with a copy of Mr. Nash’s book as further proof supporting the benefits they tout.

The fact the company selling the WL product produces and illustration of this scenario adds further credibility.  The logical conclusion is the company endorses the concept.  After all, they are illustrating it.

The truth is only a handful of small to midsize life insurance companies have made these software modifications.  It is fair to say these companies are totally dependent on the sale of WL to fund their overhead and operating costs. 

Still, even these companies will not openly and publically tout the infinite banking concept.  For them to do so would require they provide the State regulators with copies of their printed materials used in that sales process.  Instead, they tacitly, not actively and openly, support its use. 

Some of these smaller companies actually host Mr. Nash’s as a speaker at their producer meetings.  Clearly, in doing so they are encouraging the concept to be used by those who sell their products. 

These are the companies that have modified their WL illustration software to allow for showing the repeating borrowing and repayment loan scenario.  Another fact documenting they are allowing the strategy to be used in the sale of their WL products.

Still, these companies do not want their deep pockets exposed to the risks associated with touting the strategy.  So they don’t “train” those who sell their WL products how to present the infinite banking strategy.  Nor do they even acknowledge in their printed sales materials that they support or endorse the strategy. 

REGULATORY STRUCTURE

State regulators allow a fine line or two to exist between companies that manufacture and sell WL policies and the individuals the State’s license to sell WL “fixed” insurance products. 

The fact is, for whatever reason, most of the companies willing to illustrate the repeated borrowing scenario do not have a “captive” sales force.  A captive sales force is one where those who sell a company’s products actually work for that company.  Meaning they are employees. 

That becomes an important distinction that separates the sales associate from the company whose products they are selling. 

Further, State regulators actually approve the sales illustration software a company uses to sell its products.  The State regulators literally review the types of illustrations prepared and the language and numbers that result when illustrations are run. 

Clearly, when a State approves the software a company uses to illustrate the use of its WL product it must be aware of what is being illustrated.  Clearly, when the repeating cycle of borrowing and loan repayments are being illustrated the State must be aware this is being done. 

At a minimum it should prompt the State to ask the insurance company why a scenario that produces no benefit is being shown to prospective clients to sell their WL products.  Yet it clearly has not had that effect.

The section below outlines why both situations above persist. 

REGULATORY GAP

It’s fair to note that if WL were deemed by the nation’s securities regulators to be a securities product, which it isn’t and never will be, anyone using Mr. Nash’s book to induce a sale would be violating the rules imposed on the entire securities industry.  Rules that require only facts, not fiction, be used in the process of making a sale. 

They would lose their license. And be fined.

When it comes to the sale of any product deemed to be a security, misrepresentations, exaggerations and overblown assertions about results are strictly forbidden.  Draconian penalties await anyone violating these rules. 

Which is not the case with fixed products, those not deemed to be a security.  These are typically interest sensitive products that offer contractual guarantees benefiting the product owner of one nature or another.

The point being the book itself and the concepts it preaches would not withstand the scrutiny of experts.  As a result, security regulators would deem it unacceptable for use with clients. 

Generally speaking, securities are products directly or indirectly tied to the stock market.  These include stocks, bonds, options, REITS, commodities, futures, mutual funds, real estate partnership shares, limited liability company memberships and a host of other products. These types of products have no downside guarantee protections for those who own them.

As noted, the rules pertaining to the sale of these products are draconian in comparison to those applicable to fixed products.  And, they are rigorously, if not excessively, enforced.

Fixed products are those whose performance may be tied to interest sensitive instruments, but those investments are owned by an insurance company, not the client.  The performance of that company’s general account, or a segment of it, effectively supports the growth of cash values and guarantees offered in any given fixed product. 

The key distinction being the fact the insurance company owns the instruments (bonds, CD’s, T Bills) that produce the returns subsequently allocated into the product a client owns.  More or less like a bank owning bonds and T-Bills that support its CD rates.  The client owning the product has no direct interest in the investment instruments themselves. 

The SEC and FINRA regulate the securities industry. The State’s regulate fixed insurance and annuity products via their Insurance Departments.  Each State also has a Securities Regulation Department that approves or denies the right of a FINRA licensed associate to sell securities in their respective State.

As opposed to typically overtly aggressive and fine happy securities regulators State insurance regulators are deaf, dumb and blind in virtually every way imaginable.  This seemingly harsh statement its easily verified as true simply by reviewing fifty years or so of glaring State Insurance Department regulatory failures. 

State bureaucrats rarely if ever rise to the occasion until massive media driven articles and exposes dissect a problem situation for them.  Absent that, they remain clueless and dormant.  

State regulators, and it is the State’s alone that regulate fixed insurance products like WL and their sale, are oblivious to the fact some insurance associates they license are using this  book to facilitate their sales efforts.  They have no idea infinite banking devotees use it to sell WL.  If you called and asked for their opinion on the infinite banking strategy they would have no idea what you are talking about. 

They shouldn’t be unaware of these goings on, for reasons noted below, but they are.  Which is just another classic failure scenario typical of State insurance company regulatory bodies.

Clearly, to any informed individual familiar with how WL products work, the misrepresentations and overblown assertions made by infinite banking devotees are inappropriate for use with clients.  Even if well intended on the part of the under informed sales associates making them, the damage being done is all too real. 

Sadly, it doesn’t take unethical intent to do damage.  With or without ill intent the damage done is every bit as real.

State regulators do have rules pertaining to sales materials allowed to be used in the sale of fixed life insurance products (those not deemed to be a security).  However, these rules only seem to be imposed “after the fact” after the “shit has hit the fan”.   And, they are easily sidestepped when the sales associate is not an actual employee of the insurance company whose products are being sold.

These rules require life insurance companies to submit sales materials for review and approval prior to use by their sales associate employees.  They also require companies to be familiar with the sales practices of their sales associates. 

So most large companies voluntarily conduct periodic audits of their sales associate’s files.  They actually have to do so since most fixed product sales associates are also securities licensed and the securities regulators have intense rules requiring annual audits of sales associates. With securities regulators massive fines are imposed if the rules are not followed.

Bottom line; since the overwhelming majority of financial sales associates are both insurance and securities licensed their files must be audited.  Companies the employ financial sales associates take these rules seriously because they know the SEC and FINRA delight in fining large companies. 

To be honest, the way the SEC and FINRA operate is akin to organized crime.  They can put any company they wish out of business simply by suspending their ability to sell securities products.  Their departments are staffed by an army of lawyers who devote their every waking moment to making mountains out of molehills.

Even the most minor clerical and technical failings result in massive multi-million dollar fines.  Fines that securities firms have no choice but to pay.  Essentially, the SEC and FINRA black mail these large companies at will.  Should one of the companies dare to fight back these regulators will destroy them.

Getting back to State regulators there is really only one area where they use their muscle on the companies approved to do business in their State.  This pertains to the resolution of client complaints which must be addressed to the satisfaction of State regulars. 

This actually does help protect those buyers of “fixed” insurance products who complain to the State.  When the State becomes aware of a problem via a complaint the State will require corrective action to be taken. Companies may be compelled to offer solutions they otherwise would be forbidden by other State rules to utilize.  Which can be most helpful.

Of course that’s of no help whatsoever to those who remain blissfully unaware a problem exists with a product they own.  As is the case with those victimized by infinite banking devotees.  They are unlikely to complain since they remain largely clueless how their WL policy operates and there are no details ever provided to them to help them sort out what is transpiring.

Which brings us to the real problem, or gap, with State regulations.  It’s the fact most licensed insurance agents don’t work directly for the companies whose fixed products they sell. 

Instead, the norm is they are either totally independent or they are affiliated with one or more brokerage companies that offer them access to the products of multiple insurance companies.  Even the independent agents that fail to meet production standards required to affiliate with those brokerage companies will often be appointed with multiple life companies whose products they can access and sell.   

Independent sales associates largely do as they please.  This is true whether they are plugged into large brokerage firms or not.  This is especially true if they have elected to forego securities sales licensing, meaning the likelihood their files would ever be audited is nil. 

State regulators do not view the firms that broker the products of multiple insurance companies as responsible for the actions of the non-employee sales associates that affiliate with them.  Therefore, these brokerage firms are not responsible for training these independent sales people.  Nor are they required to monitor their actions, audit their files or approve the sales materials they use. 

Instead, these brokerage firms are viewed as simply putting products on a shelf for properly State licensed insurance sales associates to access and sell.  If they make any sales material available to their affiliated sales associates at all, it’s usually material provided by the insurance company whose product the sales associate is attempting to sell. 

This is a giant, gaping hole in the regulatory framework pertaining to the sale of fixed insurance products.  A hole that leaves the buyers of those products not deemed to be securities to fend for themselves. 

The average person approached by an infinite banking devotee has no idea the infinite bank approach has only a small but devoted cult like following.  After all, how would they know?    

There are at least two possible reasons why companies decide not to have a captive sales force.  The first being a captive sales force is very expensive to maintain.  The second being it creates a direct link between the company offering a product and the licensed agent who sells it.  It opens their “deep pocket” to class action attorneys and to the public at large.

A direct employer/employee relationship means the company is responsible for the actions of its captive sales associates.  A direct link creates both supervisory and training responsibilities, in addition to a great many other mundane and expensive things like benefits and payroll costs. 

More to the point, as noted above, it invokes direct financial risk pertaining to the actions of said sales associates.  A risk best avoided if the product being sold has problems, or the manner in which its being sold may be inappropriate.

To avoid a direct link most of the companies involved in selling WL broker their products. They have no captive sales force.  This means they have no direct link to those who sell their products. 

These companies are viewed by State regulators (and the courts) as simply putting products on a shelf for any properly licensed agent, regulated by the State, to access and sell. 

The sales associates themselves are classified as “independent contractors” for both legal and tax purposes.  They work for themselves even when they are affiliated with a brokerage firm in order to gain access to a broader range of products (on the shelf).

This distinction totally separates the brokerage firm providing access to multiple companies fixed products and the companies themselves from those who sell these products.  They provide no training, they don’t monitor sales practices, and they don’t review or approve materials they may be used to make a sale. 

Most important of all to them is the fact this separation means the “deep pockets” of the brokerage firms and the companies whose products they make available, are not exposed.

Which brings us to the singular reason these companies tacitly, but not actively, support Mr. Nash’s infinite banking strategy.  They know there are sales associates using it to sell the fixed WL products companies manufacture and brokerage companies make available.  But, they don’t want there to be any direct link between said companies and the strategy itself.

On one hand we have a handful of companies that need to sell a great deal WL products to cover their overhead.  On the other hand we have a great deal of potential financial risk pertaining to the fact the strategy being used by many sales associates selling WL is all smoke and mirrors, nonsense and illusory.  

The clear and obvious fact is, at this point in history, the only reason anyone with a grain of knowledge relative to how WL really works would manufacture and sell this product is to survive.  This is a topic addressed in a separate “How it Works” WL write-up.  It is far too involved to delve into here. 

The bottom line is it’s no one’s fault WL can’t work in a low interest rate environment.  It’s just the way it is.  And that’s the environment the United States is in as of this writing and for the last two, going on three, decades. 

The companies devoted to the sale of WL guessed wrong years ago.  They felt interest rates would return to historical levels.  And, at those levels WL can work.  And even work well in spite of the fact its less than transparent nature makes it ripe for manipulation by those companies selling it.

Most, if not all, of these companies desperately need to sell the WL products they have chosen to hang their future financial well-being on.  Most need to increase their market share to reach the sales volumes needed to stay in business. 

These are the companies that modified their sales illustration software to allow for showing the repeated borrowing and repayment scenario preached by Mr. Nash.  Something WL software dating back two, three or more decades never was able to do. 

The only reason to make this modification is to facilitate the presentation of this concept.  Yet, the concept itself is never mentioned in the illustrations they produce.

Clearly, any company that modifies its illustration software to allow for showing the infinite banking repeating series of borrowings and repayments is supporting that sales strategy.  Common sense tells us that is so. 

Common sense should also alert State insurance regulators this concept is being presented to those who are being shown these illustrations. 

Yet, as is ever so typical of past failures, the very same State regulators that approve illustration software before it can be used never think to ask why the software is being modified to allow for showing this type of activity.  A question that clearly should be asked since it can easily be shown it produces no economic benefit.

Yet the very same State regulators who must approve the illustration software before it can be used to sell a WL product never ask “why”.  The sad fact being this is the only point in time when the State regulators are being put on notice about what prospects considering a purchase of WL are being shown.   

The reason WL illustration software for decades didn’t allow for illustrating repeating borrowing and repayment scenarios is it made no sense whatsoever to do so.  Which is why for decades WL illustration software programmers and the actuaries that managed them had no reason to design an illustration system that would allow for this to be shown.  

After all, if this borrowing and repayment activity produced no additional cash value growth why would anyone in their right mind want to show that activity in a sales illustration intended to be shared with prospective clients. 

Obviously, they wouldn’t.

Which brings us to the question State regulators should be asking these WL companies. Which is why they have modified their illustration software to show a strategy that makes no sense to utilize? 

Duhhh!

Sadly for the public they are supposed to protect State regulators have no clue why the companies they regulate would make this modification.  Nor do they ever think to ask what the reason for this might be. 

After all, the average person logically assumes if a scenario can be illustrated the company selling the product must feel it makes sense.  The saddest fact of all is how easy it is to prove it doesn’t by just running one illustration with that borrowing and repayment activity and another without it. 

So what we have once again is a glaring example of classic State regulator ineffectiveness.  They are just too ignorant to even wonder how the products they regulate are being sold.  They wouldn’t know who Mr. Nash was if they fell on top of him.

The silver lining here, and the only really good news about this illustration software updating, is it does allow for showing the repeating borrowing scenarios produce no benefit at all.  The results clearly prove future cash values remain exactly the same with or without the borrowing and repayment. 

Again, in defense of the clearly well intentioned Mr. Nash, this type of comparison was never possible in the past when Mr. Nash wrote his fantasy tale.  He had no way of knowing what he imagined was a fantasy, not a fact. 

But now he and those who follow his preaching’s can know the facts.  But no one selling the concept ever shows a prospect both types of illustrations.  And you would think they would want to since they say one out performs the other. 

Who wouldn’t want to present black and white proof of this by showing both types of illustrations?  Perhaps only someone who knows there is no added benefit, but prefers to ignore that fact.  Or someone so dim intellectually that they never even think to do so.

If only the average unsuspecting prospective buyer knew enough to ask for this to be done.  Which clearly they don’t.  Which is why the regulators should be insisting if the repeating borrowing scenario is illustrated the second illustration without that activity must also be presented at the same time.  But alas, ignorance and dim intellect are not limited to those who sell WL products, those attributes clearly extend to those who regulate their sale as well.

The regulators are the ones who are supposed to be protecting the public.  Something they have chronically and historically failed miserably to do.  This simple requirement would put an end to WL sales promoted by infinite banking devotees.  Even those who are infinitely oblivious to the facts couldn’t help but notice the cash values were the same.

So the good news is it now can be proven this aspect of infinite banking makes no sense.  The bad news is no one is bothering to require or share this with the prospective clients who are being misled.  By intent, or not, the results are the same.  The public is deceived.

What this “proof” also does is call into question all the other representations made by those who embrace the infinite banking concept.  If this representation, central to the concept, makes no sense at all, it clearly calls into question all of the other inane representations; doesn’t it? 

Of course it does.  A fact that no one, including the companies actively or passively encouraging this sales concept by modifying their illustration systems for the infinite banking devotees selling their products ever seem to focus on. 

Leaving one to wonder why.

ENTHUSIAM VERSUS FACT

At best Mr. Nash’s writings are 50% enthusiasm and 50% fact.  Truth be known, the book itself is more like 90% enthusiasm and 10% fact but that sounds a bit to unkind to say about such a nice fellow.  Still, this does not discount the author’s good intentions. 

What is lacking in his book is a high level of product knowledge relative to how a WL policy actually works.  Instead, facts are replaced with fanciful exaggerations pertaining to the benefits that can be derived by using a WL policy as a personal “bank”.

The average buyer has no real understanding how the WL product works or what can go wrong.  Largely because those who sell it don’t understand it and prefer to turn a blind eye to macro-economic trends (like decades of abysmally low interest rates) that impact the WL product design.

A “TRUST ME” PRODUCT

WL is at its very core a “trust me” product, meaning those who buy it and those who sell it will never have access to facts on earnings and costs incurred within the product. Ever.

Part of the problem, if not the very cause of the misunderstandings inherent in the infinite banking story, is the fact the WL product itself cannot be dismantled into its parts.  This fact alone creates an element of mystery, allows flights of fantasy and without a doubt lends itself to misstatements. 

Were it not for the fact we can now finally illustrate the fact repeated borrowings and loan repayments with interest have no impact on cash value build up it would be impossible to prove the infinite banking strategy doesn’t work as advertised..  There would be no way to absolutely debunk the infinite banking strategy.

The lack of factual information on the internal workings of the WL product and myriad of assumptions and formula’s that govern its operation simply are not available to review. And never will be.  All that is available are illustrations showing premiums due, cash values accumulating over time and the applicable death benefit amount being put in force.

While the percentages of enthusiasm vs. fact can be debated, there isn’t any room for debate when it comes to the fact side of the infinite banking equation thanks to the software updating that allows the repeating borrowing to be illustrated.

The truth is the book is a disaster of implied and/or grossly exaggerated benefits and multiple examples of wishful thinking.

BUILDING WEALTH

Aside from technical failings and its biased focus on WL’s imaginary benefits the main thrust of the infinite banking book is; “saving money builds wealth”. 

Clearly it does.

The book constantly stresses those who save will have more money later in life than those who don’t.  Which is not “news” to anyone. 

They will.

The book goes on to stress the power of leveraging ones savings by using them to buy things, as opposed to borrowing and incurring interest payable to a 3^rd party.  That is also true.  If you don’t waste money paying interest to third parties you can add the amount saved to your subsequent savings. 

Again, on this point the book is on solid ground.

So, we’re “three for three” so far.

Sadly, from this point forward the train goes completely off the tracks as all manner of overblown assertions are made about the benefits of using a WL policy to warehouse ones savings.  Most of which revolve around imaginary advantages tied to borrowing from a WL policy to finance subsequent purchases or make additional investments.

Which brings us to the likely reason Mr. Nash headed off into the infinitely uncharted shallow waters of WL fantasy in his book.

COLLATERALIZED CONFUSION

Mr. Nash’s book says borrowing from WL policy allows the policyholder to eliminate borrowing from third party.  Which allows the policy owner to “pay themselves” the interest due on the policy loan. 

What this fails to recognize is the policy holder is actually borrowing from the WL company itself.  The reason being, It’s not technically possible to borrow from the policy itself.  At least not the way life companies account for the transaction.

This is an absolute fact. 

As previously explained the WL company uses the cash value in the policy as collateral assuring the loan it makes to the policy holder from its assets will be repaid.  What this means is a portion of the policy cash value equal to the loan balance is restricted.  

NOTE:  That portion of the cash value is no longer available to be withdrawn.  Nor is it accessible by surrendering the policy.  And, if the insured party dies while the loan is outstanding the loan balance will be deducted from the death benefit payable to the beneficiary.  This effectively repays the loan.  Only the remaining death benefit above the loan balance will be paid to the beneficiary. 

Since the loan is actually made by the insurance company the interest paid on the loan is actually being paid to the insurance company as well.  It is not being paid directly into the borrowers WL policy. 

What this means is for all intents and purposes the insurance company is actually a third party lender.  This situation is no different than a normal bank making a loan and requiring the cash value of the borrowers life insurance policy be “collaterally assigned” to the bank until such time as the loan has been repaid.  A very normal and typical transaction when banks are involved in making loans to individuals.

Which is where “collateralized confusion” raises its ugly head relative to borrowing from a life company instead of a bank.  This confusion is the basis for a great deal of misunderstanding about borrowing from a WL policy as expressed in Mr. Nash’s book.  

The confusion arises because technically the cash value collateralizing the loan is still in the policy. Which means dividends are being paid on it adding to the policies future cash value growth.  What isn’t being added is the interest amount paid on the loan.  At least not as a separate additional amount.

Mr. Nash chooses to view this as meaning said borrowed cash value is not gone and spent.  It’s still in the policy. 

Meaning to Mr. Nash that it’s still earning dividends.  Which is true, in one form, or another.  Which depends on how the life company “recognizes” the loans impact on the payment of dividends.  A subject previously discussed. 

The problem with this stream of consciousness based logic is that’s not really what ends up happening.  That said, the obscure nature of WL requires a bit of explaining is needed to clarify just what really does happen.

The book goes on and on about how the interest being paid is “paying oneself”.  Clearly, the assumption is its adding to WL cash values.  Which we already know it isn’t.

The reality is the life company made the loan from its general account.  To do so the company had to sell an asset of equal value in order to advance the loan amount in cash to the policy owner.  Or the company took another policy owners current premium payment and instead of investing it in the general account (purchasing an asset) the company instead used the cash to make the loan. 

Either way, the loan now becomes an asset owned by the general account.  The interest paid on the loan becomes an earnings amount in the general account generated by that loan asset.

This means we can say goodbye to the idea that we are avoiding an interest expense and that the interest we are paying is being paid to our self.  It’s not.  It’s paid to the WL company and added to the general account earnings. 

Any executive or actuary with a WL company will attest to this.  It is a fact.

The fact is what the interest really represents in the general account is earnings on a loan asset (the funds loaned out from the general account to make the policy loan).  Those earnings are taking the place of the earnings that would have been received from whatever other asset those dollars would have been invested in. 

The interest earnings on the loan are no different than the interest earnings on any other general account asset (under the non-direct recognition regime). 

The collective earnings on all general account assets become the source of the annual subsequent board approved credited dividends.

What Mr. Nash sees instead is that we can have our cake (buy what we need) and eat it too (keep our existing savings intact and growing) if we use WL.  And also benefit by “paying oneself” interest on the loan.  Which is the source of his confusion. 

Mr. Nash totally missed the fact the policy owner is paying the loan interest, which in turn is treated as earnings in the general account.  Those earnings are “in lieu of” not “in addition to” the earnings that would otherwise have been received. 

The question here is who actually pays to create the credited dividend.  After all, if the borrower is actually paying the interest into the general account and that in turn becomes the source of the dividend, then it isn’t being earned for them by their cash value.  They are paying it. 

Which sounds a lot like Mr. Nash’s “paying yourself” mantra, but without there being any actual benefit to be gained.  Instead, the dividends that would have been funded from an assets earning are instead funded by the policy owner paying loan interest. 

How that finds the policy owner coming out ahead is difficult to figure.  Impossible actually, since they aren’t coming out ahead.

So much for the idea the original premium created assets are earning and the loan interest is also being collected increasing cash values.  Instead, the loan replaces the assets that were originally acquired and the loan interest replaces the earnings the original assets had been earning. 

And, that is what’s actually happening. 

Without this imaginary benefit “double” benefit, viewed as the cash values collateralizing the loan earning dividends and the loan producing interest earnings paid by the borrower added to it, the book itself would only be about two pages long.

The idea of “paying themselves” more or less falls apart once it is understood that payment is not an added cash value growth benefit.

Since this exposes a fundamental flaw in the books logic let’s drill down into this a bit more in where the confusion originated.

DIRECT RECOGNITION LOAN ACCOUNTING

Life insurance companies that use “direct” recognition divide WL policy cash values into two categories.  Borrowed and “un” borrowed. 

The intent is to allow for crediting different dividend levels on one versus the other. 

Essentially, “direct” recognition is no more than an effort to match the earnings on each portion of a policy owner’s cash value with the earnings each portion generates in the general account.    

While it is possible that by sheer coincidence the borrowed portion of cash value will earn the exact same amount as the unborrowed portion, it is unlikely that will occur.  For that to happen the loan interest rate charged on the borrowed funds would need to be exactly equal to the average earnings rate on all the other invested general account assets. 

Historically speaking high market interest rates typical in past decades resulted in the mix of assets making up the general accounts of the nation’s life insurance companies resulted in the earnings on invested assets that exceeded the interest rate charged on policy loans.  So general account invested assets (the funds not loaned to policy holders) would pretty much always earn more than the interest rates being charged on loans to policy holders.

To address this situation, and in an effort to be fair to those who had not borrowed against policy values, some WL companies adopted an approach they called “direct recognition”.  Since yields on invested assets usually exceeded policy loan interest rates the dividends credited on borrowed funds under a direct recognition approach were always lower than the dividend credited on unborrowed funds.

This seemed like a fair approach to the companies that embraced “direct” recognition loan accounting.  They saw no reason the lower rate earned on borrowed funds (represented by the loan interest received) should result in lower dividends being credited than would otherwise be the case to policy owners with no loans.

Today the situation is far different.  It is now quite possible policy loan interest rates might actually exceed the abysmally low yields being earned on invested general account assets.  Which would mean those who borrowed against cash values might actually be credited with higher dividends than those who did not.  Of course, they are actually just receiving the amount they paid in loan interest on the funds they borrowed, minus some portion kept by the life insurance company to compensate them for the work involved in administering policy loans.

Either way, the question that should be asked about “direct” recognition thinking is this.  Is it “fair” to credit the same dividend on all cash values; borrowed or unborrowed to all policy owners.  Or, is it “more fair” to credit one dividend rate on borrowed funds consistent with the loan interest rate being charged and another pertaining to unborrowed cash values consistent with the yield on invested general account assets.

Most people, fully informed on the matter, would likely view the “direct” recognition approach as “fair”.  After all, it is no more than a method for matching earnings rates on each portion of the cash value with the dividends credited into WL policies.

This “fairness” question seems to have been missed by Mr. Nash.  The reason being he came to view companies that did not use direct recognition as paying dividends on all cash values.  The implication being those with “direct” recognition did not.

This seemingly then evolved into the idea “non- direct” recognition companies also credited the interest paid on borrowed funds into the cash values of borrowing policy owners.  As if there were two totally different things going on. 

One being dividends from the general account earnings being paid on all cash values.   The other being interest paid on policy loans being added directly to the borrowers WL policy cash values. 

Hence was born the infinite banking fantasy that borrowing and paying interest on borrowed funds accelerated cash value growth.  The idea being all cash values are earning credited dividends and the interest being paid is “in addition” to those dividends.  But only with “non-direct” recognition companies. 

While this idea was and is utter and total nonsense, how would anyone unfamiliar with the technicalities involved (like Mr. Nash) know this or figure it out.  After all, for all the reasons previously noted in this and other WL write-ups, understanding WL is virtually impossible.  It’s pretty obscure stuff even to most of the life insurance associates that sell it.

Oddly enough, the conclusions noted above are never directly or clearly stated in Mr. Nash’s book.  None the less, his devotees even today rail against “direct” recognition companies and urge WL buyers to seek out “non-direct” companies if they wish to implement the infinite banking strategy as preached by Mr. Nash. 

My guess is a specific statement on the subject in his book would involve Mr. Nash having drifted into the realm of technical knowledge.  Which clearly is not his forte.

Again, and in Mr. Nash’s defense, there was absolutely no way he could verify or disprove his assumption with the illustration software available at the time.  Absent that, it could not be proven to anyone’s satisfaction (other than a product design or actuarial expert) simply by discussing the variables involved. 

When it comes to those that buy WL, who clearly in virtually all cases lack access to actual policy design facts and assumptions, there is no way they can possibly figure out with any certainty how borrowing impacts cash value growth.  Or even know there are two different dividend crediting approaches used by life insurance companies relative to borrowed and unborrowed cash values. 

Which is all Mr. Nash had to go on “back in the day”.  But today even “non-actuary” mortals can speak with absolute certainty on the “with and without” loan scenarios. 

The reason being we can now run comparison illustrations.  Allowing us to prove that even with “non-direct” recognition companies the cash values in either illustrated approach (borrowing or not) are identical.   

LOAN RATE VS. GENERAL ACCOUNT RATE

So let’s drill down into an example to see what actually happens relative to “economic benefit” when it comes to interest payments made by a borrower on policy loans. 

To simply matters we can use a generic “pooled” investment fund thousands of people had put money into instead of a life insurance company’s general account.  Which for all intents and purposes are virtually identical in how they operate.

We can then take the case of someone who paid 5% interest on a loan they took out from the pooled fund.  In this example they were then credited 5% as earnings on the borrowed portion of their share of the pooled assets.  The final assumption being the rest invested pooled assets in the fund earned a 7% overall average net return.

One question is, did they come out ahead by paying themselves the 5% on the funds they had borrowed from the pool?  Obviously not.  Who would view the earnings credited on borrowed funds, the amount they paid in loan interest, as that person having earned 5%.  No one would.

So of course the answer is “no”.  They did not come out ahead.  The fact is it’s a “wash” from an overall financial standpoint relative to their personal wealth total.  The same amount “earned” was paid by them into the investment pool. 

Clearly, there was no overall gain in net worth.  Instead, money just moved from one pocket to another.  Again, it was “a wash”.

But what happens if we only look at the pocket that got the payment.  We could then argue that pocket has more in it than it did before.  Only when we look at both pockets do we get a far different answer.  Then we know one pocket gained 5% while the other lost 5%.

This is a critical point which the infinite banking devotees have chosen to ignore.  It’s important to look at both pockets.  They prefer to only look at the one where the money ended up. 

NOTE:  In essence, and in fact, the policyholder has to pay the life insurance company the interest rate on their borrowed funds.  That subsequently becomes part of the earnings that fund credited dividends into their WL policy. 

The only remaining question is what, if anything, should be done about the fact the borrowed funds only brought 5% in earnings into the fund, while the otherwise normally invested assets earned 7%.  Should only the borrower incur the loss of earnings triggered by their borrowing, or should everyone investing in the pool absorb part of the impact of the lower earnings on borrowed funds. 

Fairness would seemingly dictate the person that borrowed should absorb the impact of the lower amount earned on the borrowed funds.  Meaning they should only be credited with a 5% return on the borrowed portion of their investment in the pool of assets. 

That would be “direct” recognition at work. 

The alternative would be to bring down everyone’s credited dividend by averaging in the lower rate earned on the loaned funds with the higher yield earned on the remaining invested funds.  This might mean everyone would only be credited with 6.5%.  The more of the pool that’s “out on loan to pool participants” the lower the resulting average overall return the pool would earn. 

This would be a “non” direct” recognition result. 

Which makes you wonder, would it be fair that those who didn’t borrow end up with a lower earnings rate being credited to them simply because other participants in the pool did borrow?  Clearly not.

Which makes the approach preferred by infinite banking devotees seem pretty silly.  Which it is. 

But knowing that requires a true understanding of how both approaches work.  Which tells you the typical infinite banking devotee doesn’t really understand this at all.  

Sad but true.

The bottom line is borrowing can reduce the overall yield of the general account.  Which occurs when the loan interest rate charged to borrowers is lower than the yield on otherwise invested assets. 

When that happens, it’s either bad for everyone receiving credited dividends (if the impact of this lower earnings rate is spread over everyone invested in the fund), or it’s just bad for those who borrowed from the fund.

Which is what led to the development of “direct” recognition approach in the first place.  All it is, is an effort to be fair to those that haven’t borrowed.

LOAN TO BUY A CAR EXAMPLE

The infinite banking strategy also suggests there are major added benefits to be gained when loans are taken from a whole life policy (with cash values collateralizing the loan) to make purchases that might otherwise be financed by a 3^rd party lender (a bank or leasing company); like when someone buys a car.

Let’s take a look at what happens with one’s overall financial situation if a car is purchased using funds from any alternative savings source; such as a bank savings account or a brokerage money market account.

Doing so clearly saves the interest expense that would otherwise have been incurred if a loan were taken from a third party.  So the buyer of the car would clearly have more money to save in the future since they would not have an interest expense to pay.  

Offsetting this benefit would be the fact the money withdrawn from the savings or money market account would no longer be earning an interest rate for the account holder. 

Assuming the earnings rate being lost is equal to the loan interest rate being paid, the net effect on the overall wealth of the saver is zero.

The only way the saver comes out ahead would be if the rate of interest paid on the loan would be lower than the rate that would be earned on an alternate investment with a similar risk profile.  Which, historically speaking, is not the situation that typically exists.  The opposite is generally the case.

Still, the only gain would be the spread between the loan interest rate and the alternative investment rate earned to the extent it was higher than the loan rate.  Which if that happened at all, at best this would be a marginal amount all else being equal. 

What we have here is just another example of a “wash.  A situation where the amount saved by not borrowing is offset by the earnings lost on the funds previously saved amount (premium) that would be withdrawn from a WL policy to buy the car.

The end result is the same, whether a WL policy is used or not.  There is no “magic” in borrowing from a WL policy.  Again, something easily proven today, but impossible to prove when the book was written.

This is where the Infinite Banking story begins.  It is also where it fails.  Mr. Nash consistently suggests this approach creates tremendous advantages, but only if a WL policy is used.  Which is utter nonsense. No more than an example of “collateralized confusion”. 

Mr. Nash and his devotees elect to view it as if the policy account is still “intact” because technically the portion borrowed is pledged as collateral.  The WL policy annual statement will still show the total cash value is the combination of both the borrowed and unborrowed cash values.  Which lends itself to this confusion. 

So that’s what all the infinite banking fuss is about.  Collateralized confusion resulting in imaginary benefits that never materialize in the real world when one understands how WL actually works.  That, and a healthy dose of double counting here and there.

Closing off this line of thinking, I don’t think anyone would view an asset as earning a return if they had to pay the funds out of their own pocket (the loan interest) that created the return.  Which is pretty obvious once one understands what’s really happening.

ABUSIVE DIRECT RECOGNITION LOANS

As noted earlier, direct recognition means the existence of a loan is directly recognized.  Which in turn means the borrower is not credited with the same dividends, determined by using the normal “pool all general account earnings” calculation method, credited on unborrowed cash values. 

Keep in mind, the company will typically take a “hair-cut” from this to cover company overhead which is paid from earnings on invested assets and to a lesser degree from premiums paid.  Since borrowed assets are no longer invested and earning, the only source to help with overhead expenses is the interest being paid on the borrowed amount. 

Which is why with most companies the amount credited on borrowed funds is typically lower than the interest rate being paid by the policy owner on them.

Again, it is important to remember the total earnings in the general account are not credited into the WL policies.  There are a number of deductions that occur (either determined by the WL master formula or voted on by the WL companies Board) after which the net remaining amount (if any) is available to be credited into WL policies.

Some view the “hair-cut” reduction from the interest rate being paid on borrowed funds as a penalty for borrowing.  While not always the case, it is quite possible a excessive “haircut” could be applied to discourage borrowing in certain circumstances. 

When the “haircut” is just the amount needed to cover the normal impact of overhead, it is not excessive.  But when it is dramatically greater it can definitely be excessive.  It generally depends on the company itself, the decisions it’s Board makes and its current financial situation. 

It is a fact some companies have in the past, and likely still do, impose severe penalties on borrowing.  They do so by dramatically lowering the dividend amount credited on borrowed funds.  A reduction that might also be imposed on a sliding scale. 

With a “sliding scale” haircut the higher the percentage of cash value borrowed by a policy owner, the higher the haircut imposed.  If understood by the companies policy holders this tends to discourage people from borrowing excessively from their WL policies.

On the other hand, when the “haircut” reduction is reasonable and tied to specific reasons justifying the reduction, it isn’t a penalty.  It’s a logical consequence of how WL policies operate.  Which, of course, is little understood by those who sell it and totally misunderstood by those who buy it.

As noted earlier, the logic behind “direct” recognition is those who borrow should “eat” the difference, if the loan rate is lower than the general account earnings rate.  Which the size of the haircut can have a major impact on.

A situation where a company used an excessive haircut as a penalty to discourage borrowing immediately comes to mind when this topic is raised.  It pertains to an extreme situation North Western Mutual found itself facing during the 1980’s. 

To address the situation NWM imposed a level of haircut many would view as punitive.  While impossible for anyone but NWM’s management to know for sure, It did appear to be imposed on a sliding scale. The greater the percentage of cash value borrowed, the larger the haircut applied to reduce credited dividends on borrowed funds.  

While NWM had a very good reason for doing so, and the penalty approach did ultimately solve the problem, this was still very hurtful to those who could not repay policy loans taken for legitimate or normal purposes.  Like retirement funding or educational funding, or to meet emergency personal needs. 

The problem NWM faced related to the amount of its general account assets that were “out on loan” to policy holders.  The company was literally being liquidated by its policy holders as loan demand forced the ongoing liquidation of general account assets are extreme levels of loss.  Losses sufficient to put NWM out of business if they continued at the pace they had reached.

The reason their clients borrowed related to the short term interest rates being paid on money market accounts and CD’s at the time. Short term interest rates had soared to unheard of levels.  Rates in the mid to high teens and even approaching 20% in some cases. 

Clients were being advised by their professionals to borrow out WL cash values that were earning dividends in the single digit range (or slightly higher) and invest them in the higher yielding and liquid alternatives that paid much more. 

To the extent the loan rate paid on the policy loan was lower than the rate being earned on the alternative investment, the client came out ahead.  And, in most cases far ahead. 

Making matters worse for NWM is the make-up of the general account assets, which were all interest sensitive in nature.  Meaning, as market rates increased the value of the assets declined.  Using a 30 year bond as an example, for every 1% longer term rates increased the value of the bond could go down by about 10%. 

Since longer term market interest rates had increased by more than a few percentage points the value of the assets in the general account had declined by anywhere form 30% to 50%.  When they were sold to fund the money needed to advance borrowings by policyholders, the loss was realized and the capital of the company was impacted. 

If the pace of borrowing continued at the rate that had been reached NWM’s capital could be totally wiped out driving the company into receivership.  Something had to be done and the Board of the company took dramatic action to discourage borrowing by imposing a massive direct recognition haircut structure. 

NOTE:  If one has access to a Flitcraft Compend from the late 1980’s and early 1990’s time frame they will see at one point in time 24% of NWM’s general account assets consisted of policy loans.  At that same time this resource showed most WL oriented companies had 6% or so of general account assets out on loan.

For NWM, in order to loan out 24% of the general account assets the company had sold a corresponding amount of assets.  Which at the levels of loss involved represented an even greater share of past premiums collected and invested. 

To the extent possible new premiums could be diverted to fund borrowings by other WL policy holders.  However, the low interest amounts being credited as dividends made other shorter term investments far more attractive to those who might otherwise have purchased WL policies.  So the volume of new premiums had declined dramatically as well. 

NOTE:  An additional extraneous factor existed that when combined with the high short term interest rates resulted in the massive loan balance scenario NWM was experiencing.

This problems was of NWM’s (and the insurance industries) own making.  It resulted from a tax code change they had no control over that gutted a prior sales strategy their sales associates had aggressively implemented. 

This refers to a once popular sales strategy referred to as “minimum deposit”.  It involved having WL clients pay large premiums for a few years and then borrow from cash values to make future premium payments starting as soon as possible.  The reason for this related to the fact all interest paid by a tax payer was tax deductible.  Since tax rates at the time were in the 50% to 70% range, the ability to deduct interest paid created a tremendous tax advantage. 

Unfortunately, for those who implemented this strategy the interest deduction was eliminated in the 1986 tax reform bill.  After which a great many WL policy holders with large loans opted to take added loans to pay their interest billings as opposed to paying them out of pocket.  Which compounded the growth of policy loans on those policies. 

The total borrowings on minimum deposit funded policies were extremely large. 

To stem the tide of borrowing NWM had to give the borrowers a good reason to stop taking new loans.  They needed to implement an incentive powerful enough to compel them to repay the loans they had already taken (if they could). 

To do so they imposed a dramatic penalty (in the form of direct recognition) reducing the dividends credited on borrowed funds.  The decline appeared to be as much as 90% on WL policies with large loan balances.  After which cash values collateralizing policy loans earned little or nothing in dividend credits.  Which put these policies at extreme risk of lapse in a very short period of time.

NOTE:  This lapse risk also created a major tax risk for policy holders with large loans.  If those policies lapsed with the loans outstanding it would in most cases create a major taxable event for the policy owner.  The reason being life insurance policy loan balances become taxable when policies lapse.

A lapse in these circumstances would result in a large tax obligation.  It would do so when there was no longer any cash value left in the policy to provide the funds needed to pay the resulting tax. 

A certain lapse was the end result if policy loans were not repaid and interest was paid from added borrowings until cash values were exhausted.  Policy holders also recognized paying policy loan interest rates of 7% or 8% made no sense when it would produce only 1% in dividends (or less) being credited into the policy.  At that minimal dividend rate cash values would be insufficient to pay future premiums by the surrender of dividend additions.  Meaning large premium amounts would also have to be paid “out of pocket” in addition to the interest amount being billed on policy loans. 

A review of an AM Best Flitcraft a decade later showed NWM’s percentage of general account assets out on loan had returned to the far lower industry average level in the mid-single digits.  This was either the result of policy lapses or loan repayments, and likely lots of both. 

This is a case where a “direct” recognition” penalty was punitive.  The good news for NWM is it worked as intended.  The bad news for its policy holders was lots of policy lapses and unexpected tax bills. 

NOTE: The above scenario is definitely part of why the direct recognition crediting method pertaining to cash values collateralizing loans got a bad name. 

NWM had taken the steps needed to protect the company and keep itself in business.  But it clearly did so at the expense of its policyholders who had borrowed. 

While NWM was a mutual company, owned by its policy holders, this was deemed by its Board to be in the best interest of the overall policy holder base.  Had they not done so the ongoing ability of NWM to stay in business would have been at risk.  Of course, if they had failed, the State would have transferred their policies to other companies.  But it would have disrupted dividend crediting and created liquidity issues for years for NWM’s policy holders.

A case where the Board did what it had to do to stop the losses on asset sales triggered by the need to fund ongoing policy holder borrowings.

DIRECT RECOGNITION WRAP UP COMMENTS

So, the bottom line is with direct recognition normal credited dividends are not paid on borrowed funds.  Instead, a lower amount is credited.  The extent of the reduction can be reasonable, or it can take the form of a penalty. 

What sales associates who make a big deal of this issue don’t grasp is the fact the Board of any given WL company at any time can vote to adopt a direct recognition regime.  This has happened many times in the past and will continue to happen in the future as economic and company specific circumstances dictate. 

The dividend crediting method used by any given company is not contractually guaranteed provision.  It’s just a company policy subject to change at any time.  A fact seemingly lost on those who belabor the importance of avoiding “direct” recognition companies.

PAY MORE INTEREST THAN THE LOAN RATE

Another suggestion constantly advocated by Mr. Nash’s book is paying a higher interest rate “to yourself” on policy loans.  Touted as another way to add to ones WL savings and build even greater wealth.

While the thought is expressed as paying a higher interest rate, that isn’t actually possible.  The policy owner can only pay the rate that is billed to them.  When challenged on this the infinite banking devotees say this actually refers to the thought one should purchase a PUA rider to allow for paying added funds above the billed loan interest rate into the WL policy. 

Of course, since you have to buy a PUA rider at the time you purchase a WL policy this isn’t really workable either.  You can’t just add PUA riders whenever you wish.  Policy design and tax rule dictated parameters make this impractical.

The problem is there may be more death benefit needed to meet 7702 testing limits to allow for the PUA payment.  It puts the products ability to continue to qualify as life insurance under IRS rules and guidelines at risk.

Absent adding a term rider in conjunction with adding a PUA rider (which isn’t something that can typically be done either) just adding a PUA rider to allow for added premium payments would likely create a Modified Endowment Contract (MEC).  Which would mean any future loans from the policy would be taxable. 

Even worse, it is possible the Section 7702 definition of life insurance would be violated.  Which would mean all three tax benefits granted by the IRS to life policies would be lost. 

This leaves only one option for someone that wants to “pay themselves more”.  If the saver can’t add a new PUA rider to and existing policy, they must instead buy an additional small face amount WL policy.  Which has its own negative implications.

The latter action is usually the direction this sales tactic takes.  It’s actually a terrible idea in that low face amount policies earn dramatically reduced dividends. The cash value build up for small policies is far lower than for larger policies. As such, the likelihood of ending up with an acceptable rate of return on a small face amount WL policy is nil.

It’s also worth noting that decades ago PUA riders were notoriously inflexible.  A fact that still is true with most WL companies today.

Also worth noting is the fact when PUA riders are illustrated for multiple years (at the time of sale).  The number of years illustrated dictates how long they can be paid.  And, they must be paid each year for the right to keep paying them to carry forward.  If not, the right is forfeited. 

There is no flexibility to start and stop paying PUA rider amounts into and existing policy “at will”.  Companies typically have strict limits on both the amount of PUA rider premiums they will allow and/or the number of years they will allow them to be paid. 

While IRS considerations alone dictate this it also has to do with the way life companies prefer to have general account assets invested.  Not to mention the fact cost loads built into PUA riders are minimal versus base WL premiums.  The life company itself derives virtually no benefit from PUA premiums.

The bottom line is WL policies are nowhere near as flexible as the book seems to suggest they are.  Decades ago they were totally inflexible. What Mr. Nash’s book suggests simply could not be done at the time it was written and still is virtually impossible to implement in any fashion even today.

IS THERE A BETTER LIFE PRODUCT

The best question infinite banking devotees could possibly ask is, is there a more flexible “fixed” life general account product that would allow for borrowing at a lower cost and which would operate in a more flexible manner than WL. 

The answer to this question would be “yes”. 

There is another general account based product perfected in the last decade that did not exist when Mr. Nash wrote his well-intentioned book.  Had it existed then, perhaps it is the product Mr. Nash might have written about.  But it didn’t.. 

The better product choice is an Index Universal Life product.  Unfortunately, it is a Universal Life (UL) product derivative which makes it difficult for any true WL devotee to appreciate. 

WL devotees despise and distrust UL products.

The index version of the UL product does not suffer from the shortcomings inherent in the fixed interest traditional UL policy design.  Which is the version of UL that most WL devotees are familiar with.

 Nor does it suffer from the extreme levels of cash value volatility inherent in the Variable UL product design.   A product where client funds are directly invested in equity accounts so they are subject to stock market volatility. 

The Index UL policy design eliminates all the negatives associated with either of the above UL predecessor products.  It offers a far greater upside than WL while working with the same returns being earned in the life company’s general account.  The product is leaner, totally transparent and extremely flexible.  It also offers loan attributes unavailable with WL companies.

This statement is supported by historically predictable levels of return associated with the long established S&P 500 index.  Its cash values are never invested directly in the stocks making up the index.  Which is why the volatility typical of the stock market does not impact those who use this life product to build cash values.

While the inner workings of the Index UL policy are somewhat complex, the design concept itself is the epitome of simplicity.  A design embraced by many actuaries of companies that were built based on the sale of WL products.  It is the logical next evolutionary step for a fixed life insurance product.

Anyone who finds this description to be of interest should now take the time to read the “How it Works” product write up on how an Index UL policy operates (once it’s written and added to the website).  It’s benefits and other supporting information on likely ROR’s that can be anticipated will be discussed in detail. 

While index life it is somewhat like WL in that early year cash values are suppressed (for good reason) the fact is borrowing in early policy years produces no actual economic benefit, so losing that option really is no loss at all.

And, unlike WL, the level of gains that can accumulate and be borrowed out later to fund retirement needs is far greater than a WL product can deliver based on identical levels of general account yields.   

The upside for those who choose to save using life insurance cash value products is borrowing out gains without paying taxes and being able to spend them without any tax being due.  This is a very powerful benefit, the net impact of which more than offsets internal product level costs. 

Tax rates are obscenely high for higher income taxpayers.  Losing 30% or 40% of ones gains to taxes is a norm.  The internal product costs in a properly and competitively structured life product border on absorbing 10% to 20% of gains realized.  The positive difference is able to compound within the IUL policy to the policy owners benefit.

It is difficult to pinpoint any value gained from paying taxes.  A topic best left to academics to identify the broader social benefits derived from programs designed by ineffective politicians with rampant personal agendas. 

As far as using a cash value life insurance product goes, the portion of the returns earned lost to policy costs serves a purpose.  It pays for the death benefit needed to create the massive future tax free death benefit infusion that pays off the loans that allowed gains to be accessed and spent without taxation.  And it produces the balance above that borrowed amount paid to the surviving family members.  Which typically in the years before retirement distributions begin is the entire death benefit amount. 

The fact is a great many people actually waste money paying for term insurance, which is a pure expense that one has to die to benefit from.  It’s important to keep in mind term is priced to not be available at the ages most people are likely to pass away. 

The fact is term insurance policies are no longer in force at death for well over 95 % of those who purchase it.  Meaning for them and their families every dollar spent on term insurance is wasted since no death benefit will ever be paid. 

So the question is, if someone is going to spend money on term insurance anyway, why not instead buy a product where taxes can be avoided and those savings not only offset the cost of the insurance but also leave the saver far ahead of the game. 

WHICH BRINGS US FULL CIRCLE

This brings us back to a point made at the beginning of this write up.

When someone decides to save money instead of spend money they will have more money in the future than they otherwise would have had. 

So, in that respect the infinite banking idea is a way to build wealth. Beyond that, the infinite banking strategy falls apart.

That said, the attempts to explain how early year policy borrowing and repayments create added value are both inaccurate and overblown.  Sadly, no matter how well intentioned those who advocate this approach may be, they benefits touted are based on misunderstandings as to how WL works.

Relative to the finer points on how a whole life product works the book completely out of touch with reality.  Overblown assertions abound along with double counting and illusions about “paying oneself” which can be attributed to “collateralized confusion”.

That said, if saving money is the goal, it certainly can be accomplished by using a WL policy.  But beyond that simple statement there is no added benefit gained by using WL as suggested in Mr. Nash’s book.

IS THERE AN INFINITE BANKING BENEFIT

The answer is a muted “yes”. 

A “yes” that applies to any cash value life policy, and for that matter, to any effort a person makes to save money using any vehicle.

Including stuffing cash in jars buried in the back yard, or hidden under the mattress. 

Those who save money have more than those who don’t.  Beyond that, the infinite strategy itself is bankrupt relative to any added benefits gained.

The only real advantage to borrowing from a life policy relates to borrowing gains, not borrowing the premium amounts paid in the early years.  Adding PUA riders to create early cash values does nothing to create an actual benefit.  All it does is create early year cash value liquidity so those funds can be borrowed.  Which produced no benefit. 

Unfortunately, today’s low interest rates find WL products can only generate a marginal earnings potential.  This further diminishes the importance of any fixed interest dependent life products living benefit advantage; the ability to borrow out and spend gains without the need to pay taxes. 

The gains that can be expected in a WL policy today are now minimal to none existent.

Only when a policy owner accesses gains and spends them without paying tax, do they have a true benefit.  But the rate of return on the fund committed to the product or program must be sufficient to beat inflation and create true real compounded growth at a meaningful rate.  This is a function of the economic environment as pertains the products growth element.

It is also important to keep in mind the returns supporting cash value growth must also be high enough to offset internal product costs.  It is the net final internal rate of return on the premiums paid into a life product that determine if a solid value was achieved.  The fact taxes are avoided gives life insurance an edge over many other alternative savings programs.  And worth noting again is the fact that many people opt to pay for term insurance anyway.  A cost that is better covered and significantly reduced inside a cash value accumulation product. 

The further good news with any cash value life product the death benefit is tax free.  It can be sued to repay the loans used to access gains and the interest paid by added borrowing. 

This combination of borrowing gains, paying interest with added loans, spending the gains borrowed without paying tax and having the loan balance repaid with tax free dollars at death is unbeatable.  No other product delivers that mix of benefits while also providing a large death benefit protection level protecting the savers family during the accumulation years. 

While a person literally must die to get the final tax free end result with life insurance, the fact is, everyone dies!  So why not get a benefit that can be used (spent) during one’s lifetime?

WL is by design and regulation an interest product.  All studies prove interest rates over longer time frames lag the rate of inflation. Interest rates over the last few decades have been abysmally low.  These facts alone mean WL is not a viable retirement savings tool. 

Saving money without out-earning inflation won’t allow someone to fund their retirement needs.  Real growth above inflation is needed for a meaningful amount of retirement funds to accumulate.

This is not the fault of the WL product.  Nor is it the fault of the companies that designed and marketed WL products for decades. 

It’s not a fault.  It’s just a fact.

The hope is this write up dispels the myths that the infinite banking concept seeks to spread.  The use of a failed and false narrative to promote the sale of a product, no matter how well intended, is simply not acceptable.  

Sadly, in life and with life insurance, ignorance is as damaging as ill intent.  What more can one say.

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