Think About It-Life Insurance Plan Design
The optimum strategy starts with focus on achieving a tax preferenced future income or death benefit need. The largest premium is paid into the smallest life insurance container. The growth rate on cash values is not left to carrier discretion but instead indexed directly to increases in the S&P 500. The entire premium is borrowed with interest tied to 1 Yr Libor plus 175 bp (2.75% floor). The carrier’s general account yield is used to purchase options on the S&P. When interest rates increase, both Libor (short term) and General Account (mid term) yields move in the same direction and order (notwithstanding the normal lag effect).
S&P performance is the sole investment asset. But unlike traditional equities with their radical swings in direction, this wrapped investment can never experience a negative return. Historically, S&P has returned an average of 6.33% (excluding dividend reinvestment). Introduce a floor of 0% and the same average improves to 11.67 (from 1930 – 2014). The cost of the floor approx 20% of the upside reducing the effective average return to 9.30%.
Positive investment results are immune to interest rate movement. In fact, higher rates translate into better option purchases and ability to capture more of S&P growth. Lower interest rates are also appealing since money is cheaper to capture equity yields in excess of interest costs.
By super funding a life insurance container of any size, the term “cost of insurance” is deducted from the inside cash reserve. And since the cash values grow tax deferred, the effective tax savings is subsidizing the true cost of coverage. As cash values grow, despite increased future age, the effective cost of coverage can become negative.
The same tax law that limits the size and aggregate premium deposits into a life insurance box of any size, requires the carrier to actuarially increase the size of the box as cash values approach full funding. This is the point of maximum returns where cash values and death benefits expand faster and larger than the cost of insurance drain.
Larger cash values also approach aggregate premiums paid sooner thereby reducing the amount of external collateral needed to secure the lender’s total loan. Alternative to posting collateral, most borrowers simply use a letter of credit, @ 1% of the amount involved. This may be the borrowers ONLY cash cost. Stress testing analysis concludes 99% of the time over any 15 year period (since 1930 to present), no collateral call or supplement was needed to accomplish the funding design. Loans (plus accrued interest) are typically repaid to the lender in year 20. Collateral requirements tend to dissipate between years 15 and 20. The total death benefit during loan funding is sufficient to repay the lender and accomplish the insured’s planning need. When relating the LOC (fee) to the insured’s portion of the death benefit, the effective cost is less than a 10 year term premium for identical coverage.
But unlike 10 year term . . . this coverage continues in force for a lifetime.