Read This Before You Purchase a Life Insurance Policy as a “Bank”

Note: we are not in favor of and do not promote or use these types of marketing programs (which should be pretty obvious once you read the article).

There are a variety of marketing programs, “wealth building systems,” etc. that purport to help you become your own “banker,” but are essentially methods for agents to sell whole life insurance. They generally have a lot of obfuscations, questionable “math” and a lot of marketing hype and gimmicks. I won’t cover specific programs since most of them are just variations on a theme, but I’ll cover a couple common claims that many of them seem to make and things to watch out for.

Pay Yourself Interest

One of the things that proponents of these strategies claim is that you pay interest to yourself and that you “recapture” interest that would have been paid to a bank or financing company. First, you do not pay interest to yourself. If you take a loan from an insurance company, you are not borrowing your own money. The insurance company lends money to you from its general account and uses your cash value as collateral. When you pay back the loan and interest, you are paying interest to the insurance company. (Since these are policies from mutual companies, they claim that the interest paid to the company is paying yourself since you’re a policyowner).

Your cash value will continue to grow with an outstanding policy loan (even if you don’t make loan payments; that alone should tell you that you’re not paying interest to yourself). Remember, the company did not directly give you “your” money. The assets backing your cash value were invested long before you requested a policy loan, mostly in bonds and other fixed-income securities.

Insurance companies have cash flow from premiums, bond coupons/maturities, etc. that they need to reinvest, and for the most part it’s reinvested in similar things. But when you request a policy loan, the company can simply “invest” it there. So it’s just another investment the insurance company holds to support its policy obligations. If you go look at an insurance company’s balance sheet, you’ll see “policy loans” listed as an asset category.

If this seems confusing, an easier way to think about it might be to think about a bank loan. You could go to a bank for a loan and assign your cash value as collateral. Of course this loan is different than a policy loan since a bank will want to be repaid at regular intervals, etc. But just as with a policy loan, your cash value is going to continue to grow. But when you make payments to the bank for your loan, would you say that you are paying yourself interest? No, because obviously you are not.

One thing that proponents of these strategies are good at is taking relatively simple concepts and adding a bunch of moving parts and jargon so that most people have trouble following what’s going on. (And I’m not convinced the majority of them fully understand it either beyond the talking points they’ve learned to sell it).

Questionable Math

Suppose that you want to buy a car for $30,000. You can pay cash or finance it. Also assume that you have adequate cash value such that you can borrow $30,000 from your policy at 6%. Also assume you have $30,000 in the bank. If you finance this purchase from your cash value at 6% for five years, the monthly payment would be $577.77.

Proponents of the various banking strategies would tell you that this is ok, because you are still earning compound interest on your cash value (and you are). Assume you earn 5% on your cash value (of course there will be insurance and other costs, but that’s another topic of discussion). The $30,000 that was used as collateral would be worth $38,288.45 at the end of five years. So you’ve earned $8,288.45 in interest, while you only paid $4,666.17 in interest on the car loan (60*577.77 – 30,000), so you’re ahead. This is a “secret” you’ve apparently been missing out on.

But what if you instead paid cash for the car (which proponents advise against since you lose the ability to earn interest on that money after you buy the car) and invested the hypothetical payment at 5%? An investment of $577.77 per month invested at 5% would be worth $39,180.71 at the end of five years, more than the $30,000 investment at 5% would be worth. The problem with their math is that they emphasize the loss of interest on the $30,000 and ignore the fact that you can invest the monthly payment (which you need to reflect if you want an apples to apples comparison).

And your common sense should tell you that there might be a better alternative than borrowing at a higher rate than you are earning. Of course, if you can earn more than your borrowing rate, it makes sense to borrow and not to pay cash. And if the two rates are equal, then paying cash and investing or financing would have the same outcome.

One of the most egregious examples I’ve seen from someone promoting this sort of strategy was the following: buy a car that you finance yourself via a policy loan, or get bank financing. In the bank financing example, the person borrows $40,000 and pays it back over the term of the loan. At the end of the term, all he’s got to show for it is an old vehicle and $0 otherwise.

If he finances it himself, at the end of the loan term he has an old vehicle plus all of his cash value (the collateralized part that was growing the whole time, now unencumbered since he’s paid back the policy loan), seemingly creating money out of nowhere. But the crucial thing that was left out is that he had already accumulated cash value to borrow against. With the bank financing option, the example assumed he began with $0; not exactly a fair comparison. Often these examples have good production value (such as a nicely animated video) that creates an air of legitimacy, so it is easy to be misled.

Conclusion

Life insurance has many useful features, but it should be purchased/sold based on needs and facts, not marketing hype. For example, policy loans could be used to refinance high interest rate debt (assuming better financing is not available elsewhere). But this is something that might come up after you’ve purchased a policy or if you already own one. But why would you buy one just to do some weird trickery with policy loans? It’s generally a good idea to be wary of marketing programs (in any industry) and always a good idea to get a second opinion from someone you know to be trustworthy and knowledgeable.

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