Index Universal Life (IUL)
Premium financing structures mainly incorporate a Whole Life or IUL policy because of the cash value component, which is the equity that will eventually pay back the lender. Although most clients are familiar with Whole Life policies, they tend to be very expensive to finance and can cause an increase in their collateral by 30-40% compared to most IUL policies.
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The cash value performance of an IUL is linked to a monetary trading index, one of the most popular of which is the S&P 500. These products have a performance cap of 10-13.5% and a “floor” of 0-2% (depending on the insurance carrier). It works on a “point-to-point” system. For example, if an IUL was issued and funded on January 1st, if the S&P 500 performed at 15% growth the following January, the client’s cash value would be credited with the full 10-13.5% cap growth. However, if the market experienced a steep decline with no growth, the cash value would not be affected by being credited 0% or even 2% (again, depending on the insurance carrier). See below for a full description on the mechanics of the IUL product.
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Based on historical returns of the S&P 500 going back to the 1930s, every ten, fifteen, and twenty years have shown an average return of 7.50% or greater. Clients who are best fit for premium financing believe, based on the historical returns of the market and given the potential for higher returns from the IUL cap and the protection of the 0- 2% “floor,” that we will see on average a 6-7% return every seven to ten years in growth. See below chart of the seventy-five-year historical returns of the S&P 500.
Index Universal Life products are mostly used due to their flexibility in allowing lenders to overfund the policy, putting excess cash into it so that from day one it starts to grow and build significant cash value. This gives a nice cushion to the policy which makes the lenders and life insurance carriers comfortable. We can use Whole Life products, which increases collateral requirements, hence as to why lenders prefer to use the IUL.
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The idea of max funding is simple. The cost to carry is at the interest on the loan and the average returns in the IUL products have been more than 7.50%. The delta, the spread increases the cash value growth in the policy. That increase in cash value overall is what services the debt on the loan. Eventually, when the cash value exceeds the loan by a significant amount, the loan gets paid off or if there is an early death, it comes out of the cash value and partial face amount. The client can always elect to pay down the loan, but why not have the death benefit do it? We use increasing death benefit riders. That mean:
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Cash Value + Death Benefit - Outstanding Loan Balance = Payout to the ILIT (Tax-Free)