There are two primary uses of this program:
1. To provide income replacement to the spouse of the insured upon the insured’s death.
2. To provide the funds needed by Generation II to pay the estate taxes due upon Generation I’s death.
HOW IT WORKS:
In this program, we use a 10-pay IUL wherein the client pays a fixed outlay in years 1-20 in an amount similar to the annual premium expense on a 20-year term policy.
In years 1-10, approximately 10% of the actual IUL premium is paid by the client (the fixed annual budget that is equal to the 20-year term premiums). The remaining policy premium is financed and the interest is accrued. This is not a “free insurance program,” for the client is paying approximately 10% of the annual premium out-of-pocket via the fixed budget.
In years 11-20 (after the 10-pay policy premium funding has ended), the client continues to pay the same fixed annual outlay, however this outlay is used to pay down the principal loan balance. The interest due on the principal loan balance continues to be accrued.
There will always be an outside collateral requirement in this program (typically for the first 8-10 years of the third party loan), and the client is required to sign a personal guaranty on the loan. Different lenders on our platform will require different forms of collateral. Some will require liquid collateral to be housed with them, whether such collateral be marketable securities or cash, and other lenders will take a collateral assignment against the funds that remain with another institution or surrender values of another in-force policy.
Loan-To-Value (LTV) requirements will vary based on the type and source of collateral. When solely using policy values and cash as collateral, most of our lenders will require a 90%-95% LTV. However, one of our lenders will even allow certain types of real estate to be used as collateral (with a 50%-65% LTV requirement) and a maximum of a $10MM cumulative loan amount.
WHEN IT WORKS:
(because if this is designed incorrectly, this concept may NOT work)
There is certainly an element of risk in any interest accrual program due to the compounding debt. Though we are not a fan of compound debt, there are some unique circumstances in which a PARTIAL interest accrual strategy can make sense.
Typically, the client needs to have a minimum net worth of $25,000,000. Their perspective when using this type of strategy is:
1. They don’t mind the risk of potential negative interest arbitrage.
2. They have the money to pay the full interest, but would rather deploy those funds elsewhere.
3. They have the net worth to be able to pay off the third party lender at any time with outside funds.
In addition, they must have enough "skin-in-the-game" to responsibly use this strategy. Under our definition of "skin-in-the-game," the client must pay some "equity premiums" into the policy, either in the form of actual out-of-pocket premiums, or in the form of immediately paying down the loan principal. If they do this, their net loan balance is less in the early years than if they had borrowed 100% of the premium, and paid interest out-of-pocket. Obviously, there is a crossover point in which the accrued loan balance eclipses the principal paid out-of-pocket, and this is where the value of the proprietary Lionsmark Capital backtesting software capabilities truly shine.
We backtest this program in our proprietary software to show the client when the compounded debt becomes unsustainable by the policy values alone (especially during times of volatility and hyper-borrowing rate increases). As long as they understand this risk, and assuming their net worth and financial situation deems this a suitable strategy, and assuming their financial advisors agree with the suitability of this strategy, we can facilitate this program.
We typically do NOT endorse using any interest accrual strategy for the purpose of accumulating cash value for future retirement income drawdowns, unless however it passes our stress-test using the worst 40-year period out of the 121 different 40-year periods our proprietary software models.
We have backtested and stress-tested TONS of these types of programs (promoted by our competitors) within our proprietary software, and in almost every single case, the strategy falls apart when exposed to volatility.
In any type of interest accrual request we receive from a client or an advisor, we first backtest and stress-test the design. Then, if we are comfortable with that specific case and that specific design, we will transparently ask for pre-approval from the carrier’s Advanced Markets team.
If everyone is onboard and unanimously agrees that the program is suitable for the client, we will facilitate the lending program.
WHAT INTEREST ACCRUAL IS (AND WHAT IT IS NOT)
Interest Accrual is a tool. If used responsibly, it can be a great tool. If used irresponsibly, it can create a catastrophe. To use an analogy, a hammer is an nail gun is an effective tool when used by a skilled carpenter, but when used incorrectly by a 3-year old child, it can be deadly.
The problem with interest accrual (as it pertains to premium financing) is that it is currently being used by many other premium financing intermediaries as a "free insurance" magic trick. It doesn't take a Ph.D. in mathematics to figure out that if you illustrate a policy's cash value receiving a positive static return every year, along with a third-party borrowing rate that is less than the policy credit each year into perpetuity, the likelihood of success is great. But that is not how the real world works. There is always volatility in the policy's crediting rate, and there is typically volatility in third-party lender borrowing rates. Lionsmark Capital's proprietary software has the ability to model such volatility in both areas. In fact, we are the only premium financing intermediary in the industry that has the ability to model this volatility on both sides.
PARTICIPATING/VARIABLE/INDEX POLICY LOAN RATES
In addition to the third-party lender loan rates, another variable that must be considered is participating/variable/index policy loan rates. In this PEIA strategy, the third-party lender loan is paid off using a participating/variable/index policy loan (as opposed to a withdrawal or a fixed policy loan), which introduces another variable into this equation.
Our competitors' premium financing designs often show a participating loan rate that was conveniently less than the index crediting rate, which gave the illustration a perpetual advantage every year. These depictions would show (what we consider to be) an unrealistically positive scenario wherein positive interest arbitrage worked to the illustration's advantage, especially pre-AG-49A.
This issue inspired us to build an additional feature in our proprietary software wherein we can model both fixed policy loans AND participating policy loans to see the true compound effect of each of the variables listed below are mixed, creating several different "cocktails" of combinations:
1. S&P 500 Historical Volatility
2. Participating Loan Rates (for both third-party lender payoffs and income drawdowns)
3. Different Floors & Caps
4. Different Multiplier Charges & Bonuses
5. Different LTV Ratios When Using Interest Accrual
6. The Correlation Between Historical Libor Rates vs. S&P 500 Returns
These multi-variable combinations of real-world features/scenarios are what makes a premium financing platform mathematically prudent and sustainable, versus being irresponsible and overly risky.
Lionsmark Capital is the ONLY premium financing intermediary that has the ability to model all of these different variables in a variety of "cocktails" to see which combinations are mathematically prudent, and which ones are not. This is all done in the spirit of consumer protection and transparency.
Watch the video below where we walk through a case study using this platform...