Alright today we are going to talk about
policy loans.
When it comes to a whole life insurance policy
we often discuss
how to maximize the cash value.
What's my break-even point?
What's my internal rate of return look like?
What's the long-term
cash value performance look like?
What's my long-term death benefit look like?
It's a lot of fun maximizing the overall value
of a whole life insurance policy
so if you're paying a dollar in
how do you get the most out of that dollar?
That's step 1
step 2 is how do I use the money?
Policy loans
is often the best way to use a policy
one of the best ways
really there are 2 ways
that I can access money
in a cash value life insurance policy
(1) is policy loans
and then (2) is through
what's called a policy withdrawal
which is typically used
as more of a retirement strategy
when I'm looking to disperse income
from the policy
but today we're going to focus on
policy loans
and we're going to go into a deep dive
on the different types of loan interest rates
that are available.
2 main types
we've got fixed loan interest rates
and then also variable loan interest rates
we'll begin with the fixed loan interest rate
because it's pretty straightforward
fixed means it's fixed
and I'll tend to see
a direct recognition contract
anytime I select a fixed loan interest rate
almost every case
not all companies practice this
but usually regardless of the company
if I see a fixed loan interest rate
in the majority of cases
I will have a direct recognition policy.
What that means
a direct recognition policy
is when I borrow against the cash value
the company is going to directly recognize
the fact that I have borrowed against it
and credit me a different dividend interest rate
on borrowed funds
than what I am still receiving in cash value.
As a quick example
if you've got $100,000 in cash value
and the company's paying
a 6% dividend interest rate
if I don't touch that cash value
that 6% dividend
is applied to the entire $100,000
keep in mind that a 6% dividend
does not mean that you're earning 6%
that's a gross rate
we want to look at the internal rate of return
but to get back on track
6% dividend
on the full $100,000 in cash value
I elect to borrow $50,000
half of my cash value
the $50,000 that I have not borrowed
that still receives the same 6% dividend
the $50,000 that I have borrowed
I'm still going to receive a dividend
however the company
will directly recognize
the fact that I have borrowed that $50,000
and apply a different dividend interest rate
on that $50,000
so I still earn dividends
on the full $100,000
but it's going to be split
and I'll see a different dividend
applied to the money still in cash value
the remaining equity I haven't touched
and then the outstanding $50,000
that I have loaned.
Very easy to follow, isn't it?
We're going to look at some examples
in later videos
but fixed loan interest rate
usually results in direct recognition
next we see 6% then 5% to 3%
with most companies
I will see a fixed loan interest rate
between 5% and 6%
and I'm locked into that rate forever.
MassMutual as an example
does offer a fixed loan interest rate at 6%
if I go with that option
I'm locked in at 6% forever
now specific to MassMutual
depending on whether I go with a variable rate
or a fixed rate
that does have an influence
on the design of the policy.
This 5% to 3% as an example
Guardian is a company
that offers a fixed loan interest rate of 5%
when I start a policy with them
I'm locked in at a 5% fixed loan interest rate
now what Guardian offers at year 10
I can elect to change that fixed rate
to a variable loan rate
which has a floor and current rate of 4%
however if I keep it at the 5%
fixed loan interest rate
if I say I don't want to go variable
I want to keep it fixed
what happens is that year 20 or age 65
whichever comes last
the company actually reduces that 5% rate
to a 3% loan interest rate
and that is also a fixed loan interest rate
which can have a nice advantage
especially when I'm looking to disperse
income from my life insurance policy
so 2 different company examples
just to provide more information
as far as what is available
what's not available.
Let's progress on
to the variable loan interest rate
usually a variable loan interest rate
results in the policy
being a non-direct recognition policy
not every single time though
a good example is Penn Mutual
so Penn Mutual
is a direct recognition company
however the loan interest rate
on their whole life insurance products
is a variable loan interest rate
so they do things a little bit differently there
but for the most part
when I see a variable loan interest rate
it usually means that it's non-direct recognition
now the big question that comes up
with variable loan interest rates
is how variable is it?
How much is that rate
going to bounce up and down?
Or the big concern right now
is if interest rates shoot up
like we see an indication that they might
do I have to worry about
the variable loan interest rate
on my policy shooting up?
The answer is maybe
depending on the company, product
and also when you bought that policy
if it's an older policy purchased before 2022
you're locked into the old contract language
if it's a newer policy
it does depend very heavily
on the contract language
we're going to go through an example
shortly in this video
but the gauge that determines
how much that variable loan interest rate
can shoot up and down over time
what the insurance company uses
is Moody's corporate bond average
this is usually
what insurance companies will use
to set their variable loan interest rate.
Now the variable loan interest rate
will have a floor being as low as it can go
what the floor is
is how low the life insurance company
can actually set that variable loan interest rate
as an example if I have a floor of 3%
I can't go any lower than 3%
the actual variable loan rate
on that whole life insurance policy.
Different companies
have different floors
what you will see
with most life insurance companies
not all of them but with most of them
the floor with respect
to the variable loan interest rate
will be whatever the guaranteed rate is
plus 1%.
As an example here
if I have a product
say it's an older product
with a guaranteed rate of 4%
then the variable loan interest rate floor
is likely 5%.
2 great examples of that
were MassMutual and New York Life
with their variable loan rate provision
it had a floor of 5%
the guaranteed rate was 4%
and there are a lot of other companies
that did that as well
now since the recent 7702 update
and guaranteed rates being reduced
things have changed
but you'll see the same pattern here
if I take a product with a 2% guaranteed rate
well then I'll see
a variable loan interest rate floor of 3%
a good example of that
would be MassMutual's new 10-Pay product
same is true if I have a 3% guaranteed rate
then my variable loan interest rate floor
would be 4%.
So typically I will see this pattern
whatever the guaranteed rate is
add 1% of it
and that's the minimum floor
when we look at the trigger
what that means
is once interest rates exceed
typically 50 basis points or 0.50%
at that point in time
I can expect to see an adjustment
on my loan interest rate.
So a couple of things here
let's walk through this thoroughly
we've got whole life insurance policy
policies and variable loan interest rates
here starting off we've got the year
this year 2022
let's assume we go with a product
that has a 3% variable loan interest rate
the insurance company
has their variable rate set at 3%
assuming you start a policy today
when the company's
variable loan interest rate is at 3%
as a policyholder you'll also be at 3%
now the insurance company will often adjust
their variable loan interest rate
every month
and it's going to be linked
to this guy right here
Moody's corporate bond average.
So assuming that you started a policy today
the loan interest rate was at 3%
if the company's loan interest rate is at 3%
as a policyholder
your loan interest rate is at 3%
that's when we start the policy
next year let's assume interest rates go up
the insurance company
increases their loan interest rate to 4%
as a policyholder your interest rate
loan interest rate would adjust to 4%
now your loan interest rate
can only adjust 1 time per year
and this occurs
on your policy anniversary date
so if you started a policy on June 1st
then June 1st of each year
that would be your policy anniversary date
the insurance company would say
what is our loan interest rate
for the month of June
and that would be your new
loan interest rate for the next year.
If you have a loan outstanding
then the rate is applied
to your entire loan balance
so if I had $100,000 in a policy loan
outstanding in the 1st year at 3%
what would I see there?
3% of $100,000 is $3,000 in interest.
Let's assume
I didn't pay any of the principal
I did pay the interest
the next year the loan interest rate goes up
4% of a $100,000 that's $4,000 in loan interest
I'll have for that particular year
so the interest rate for the company went up
I followed by a full 1%
that's what the adjustment was
now year 3
this is going to touch on the trigger
we mentioned down here
let's assume interest rates go up
but only by 30 basis points
so what a lot of companies are doing here
is they have this 50 basis point
this 0.5% trigger
what I mean when I say that
is if the loan interest rate
does not increase
by more than 50 basis points 0.5%
they will not increase the policies
the policyholders' loan rate
so in this particular example
if year 2 I was at 4%
year 3 interest rates creeped up
a little bit more
but the insurance company's
loan interest rate is now at 4.3%
well what would happen here
is you would remain steady
at the 4% loan interest rate
no change
that's why I've got the 0% adjustment.
Next year 2025
let's assume interest rates shoot up to 7%
what would happen to you as a policyholder
if this was your money?
Well the prior year you're at 4%
did we pass that trigger of 0.5%?
The answer is yes
so we would go all the way up
and we see a 300 basis point increase
we went from 4% to 7%
so if the change is greater than 0.5%
I will see my loan interest rate increase.
Now the next year
let's assume that it decreased
but only by a 0.25%
because remember year 3
if it increased by less than 0.5%
I don't experience an increase
what happens if it decreases
by less than 0.5%?
Well here I would experience the decrease
so if it decreases by 0.1%, 0.3%, 30%,
I will experience the full decrease
but I'll only experience an increase
if it goes up by more than 0.5%.
Very easy to follow, isn't it?
they got to make it so confusing
no, they do their best.
So year 6
let's assume interest rates plummet
just to make the example extreme
and it goes down to 2.8%
that's what the insurance company's
variable loan rate is now
because Moody's corporate bond
indexed average
had come down that much
what would happen
I would come down with it
down to the variable loan interest rate floor
of 3%
so I would see a reduction
of negative 3.75%.
I don't know why I had a plus sign there
doing too many things at once.
But I hope this one was helpful
regarding just the variable rate feature
In any event
I hope you enjoyed this one
if you did please hit the like button
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and we'll talk to you soon.
Thanks so much.
Hey guys Steve Parisi here
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