Are IULs the Best Chassis for Infinite Banking?

We frequently get asked about IULs (Indexed Universal Life policies) for Infinite Banking. Most hear about "market-like" returns with floors, which leads them to believe this is a far better "chassis" to use for Infinite Banking as opposed to whole life insurance. We'll explain more about how IULs work later in the post, but before determining the appropriate chassis to use, we first need to start by defining the purpose of Infinite Banking. For instance, when Ford designs a new car, they don't start with the chassis. The vehicle is built for a specific purpose, which gives them insight on how the vehicle should perform.

Purpose of Infinite Banking

As opposed to financing expenditures and investments through third-party lenders, requiring you to save in the future (while paying high volumes of interest in order to do so), Infinite Banking is about saving up-front. As opposed to paying cash for expenses or investments, thereby surrendering all future growth on your capital, Infinite Banking is about temporarily borrowing AGAINST your capital, in which your loan repayments (that you fully control) refuel your capital reserves, while your capital compounds uninterrupted.

Infinite Banking is capitalization strategy built on safely leveraging OPM ("other people's money"). Capital has an acquisitive purpose, and while long-term investments may provide sufficient capital to acquire things in the future, they come with risk. Infinite Banking is a saving strategy, providing guaranteed access to capital whenever you need it.

Collateralized Loans

So, now we can look for the right chassis. Can HELOCs be used to finance expenditures and investments? Yes, and they frequently are. Can margin loans be used to borrow against your investment portfolio to finance expenditures and investments? Yes, and they frequently are. Can Coinbase's Bitcoin loans be used to used to finance expenditures and investments? Yes, and they frequently are.

However, the true power of Infinite Banking comes from the safety and guarantees. Your bank doesn't guarantee your home will retain its value. Your broker doesn't guarantee your equity portfolio won't decline. Coinbase doesn't guarantee that Bitcoin won't crash again at some point. And because of the lender's uncertainty of your collateral, they must either charge higher interest rates or limit your LTV ("loan-to-value"), capping the amount you are able to borrow against. And since the lender can't guarantee your asset, your failure to repay will require the lender to liquidate your asset to cover your debt. It's why unsecured loans like credit cards (which really have no specific asset listed as collateral) require the highest interest rates.

When there's uncertainty in your collateral's value, the lender transfers risk back to the borrower.

Again, Infinite Banking is a saving strategy that allows us to pay for expenditures when we need them or invest opportunistically. When does it seem like your largest expenditures come up? When do the best investment opportunities arise? Is it typically when the economy is thriving, your income is abundant, and asset prices are high? Not for most people. It seems that larger expenses always happen at the worst times, and the best investment opportunities come up during economic stress.

Risk assets are generally correlated (which means they rise and fall together), so when you go to leverage your collateral that has price risk, how much is going to be left when you need it the most? Playing on our car theme, the iconic Porsche 911 chassis will perform incredibly well when it's sunny and 75, but it's practically useless in the snow.

Porsche 911 GT3

All-Terrain

Therefore, we need a durable, time-tested asset that provides the lender with enough certainty in its value to guarantee access to loans while avoiding the need to transfer risk back to the borrower. Doesn't this sound a little bit like insurance? The purpose of insurance is to transfer the risk of loss from an individual or group to an entity that, through the law of large numbers and actuarial expertise, pools and manages risk to provide guaranteed benefits.

This is why Nelson Nash defined whole life insurance as the only suitable product for Infinite Banking. The companies we work with have all paid out a dividend (which is an excess return beyond guaranteed growth of cash value) each year since inception. The newest company we work with was established over 100 years ago. The oldest company we work with precedes the Civil War. Durable. Time-tested. And the contract comes with guarantees that will pay out WHEN you die, not IF you die.

We're borrowing against the cash surrender value ("cash value"). This isn't some made up number. It's not a separate portfolio that's being day-traded and risked by the insurance company. It's a contractually stated amount that the insurance company will pay you to relieve them of the future death benefit. Think of it as the current "equity" of your life insurance policy.

I'm biased having owned two Jeeps, but I think of Infinite Banking as the "Jeep" of financial strategies. "Go Anywhere. Do Anything." Sounds pretty "infinite" to me. After all, there's a reason these were used in WWII.

Jeep Wrangler Rubicon

The Mid-Sized SUV

We aren't anti-investment at all. We just think you should be opportunistic, buying at the right valuations. A properly structured whole life insurance policy is a perfect complement to an investment strategy, allowing you to wait for the right opportunities, knowing your capital will be available when you need it. Equities, bonds, real estate, precious metals, and crypto all serve their own purpose. However, what we don't want to do is get cute by trying to combine the risk of investments with a strategy built on providing safety and guarantees.

After all, the point of Infinite Banking is to "become your own banker." When I think of combining saving and investing, it sounds a lot more like "bank like a bank." Banks take consumer savings, lever those up, and invest in risky assets. This is exactly what happened during the Financial Crisis and with Silicon Valley Bank. When they got in trouble, they didn't take responsibility. But hey, at least they had the taxpayer to bail them out...

Speaking of combining saving with investing... let me introduce you to Infinite Banking built on IULs, which is the Kia Sportage of wealth building strategies. Does it look good on a sunny day sitting on top of light gravel? Sure. Can you cruise down to the store at 30mph to pick up groceries? No problem. Is it a decent "middle-of-the-road" vehicle under perfect conditions? No doubt. But, make no mistake. This vehicle, known for "reliable performance," should not be considered as a "flexible" option that can deliver in the most extreme conditions.

Kia Sportage

Indexed Universal Life (IUL) policies combine complex investment strategies with insurance, which cater to individuals due to their "flexible" premiums and "equity-like" market returns. However, I'd argue that it's not really a fundamental insurance product because the company shifts risk back to the policyholder when conditions are worse than expected.

IUL Issues

Let's start with the investment component. With whole life, the insurance company invests premiums largely in a highly diversified portfolio of high grade corporate bonds. They receive interest, which is used to help pay for administrative expenses, mortality expenses, death benefit claims, and hold sufficient reserves. Anything left over is paid out to the policyholders in the form of dividends.

Meanwhile, IULs don't even "invest" in the market. They use premiums to buy call and put options on the market so these products can have caps and floors. For instance, the equity fund might credit you with a cap of 8-10%, for example, while promising a "floor" of 0%. Since the market averages 10%, it's effectively a risk-free strategy to get equity-like returns... right? No. First, since these aren't investments (they are derivatives), policyholders aren't entitled to dividends. Additionally, just because there's a floor of 0% doesn't mean your cash value can't decline in many cases. Companies use an "averaging" period to try to smooth returns, so they may only make sure that your cash value doesn't dip over a five year period, for example.

Additionally, this is missing a huge point, which is that the market is highly volatile. How many years does the market return exactly 10%? Very few. We typically see 20 point swings, which means you're leaving a lot on the table in the best periods since your returns are capped. For instance, I saw an IUL product with a 7.75% cap rate the other day. While the total return for the S&P 500 was an annualized 13% over the past 20 years, the average crediting amount for the policy was just over 5%.

Many people also neglect the fact that caps can be reduced at the company's discretion. This is exactly what happened for several companies in 2011 when the market was rebounding from the Financial Crisis. Options are MUCH cheaper when there's no volatility, but after a market crash (when there's potential for the biggest upside), the price of options can skyrocket. This means the insurance company had to pay higher expenses to deliver upside returns for policyholders. Did they eat the cost, keeping the risk with the insurance company? Nope, they just lowered the caps. With whole life insurance, all expenses are already baked into the guarantees.

Also, these IUL policy illustrations generally cherry pick their assumptions. When they factor in expenses, they are using current expenses, which assumes they won't increase with inflation. However, when they consider "investment" performance, they use a lookback period, or, in many cases, the agent may insert his/her own figure into the illustration (up to a certain limit), which may portray more optimistic crediting amounts than what policyholders are likely to receive. Whole life insurance dividends are based on CURRENT dividend scales, which are based on the current interest rate environment.

Most importantly, whole life insurance has the cost of insurance embedded within the contract. These are level premiums that cannot increase. However, IULs are built on annual renewable term insurance in order to maintain a level death benefit. As you can imagine, it costs a LOT more to insure someone who is 87 than someone who is 23. Therefore, as the policy ages, the cost of insurance increases and can cannibalize the policy. If there is insufficient cash value, the insurance company puts the risk back onto the insured. He/she can let the policy lapse, pay out of pocket to maintain the death benefit, or reduce the death benefit for this so called "permanent life insurance." Unlike banks, the taxpayer won't be there to bail you out. You're on your own.

Conclusion

With whole life insurance, the lender is the guarantor of your collateral. With IULs, the insurance company doesn't provide those guarantees, which means you - policyholder - may have to open your checkbook at potentially the worst of times. If you want to save, then make sure your capital is actually "safe." If you want to invest, then make sure you can capture maximum upside during the right opportunities. But this adorable attempt at combining life insurance with investing sets people up for failure, especially later in life.

If you really want to buy a Kia Sportage, the grocery-getter of wealth building strategies, to each their own. Just don't count on it to quickly get you around an 18-wheeler while trying to merge in heavy traffic or do much more than drive through loose gravel. We think a far better option is Infinite Banking, which is only suitable with a dividend-paying whole life insurance chassis. You can be certain your cash value will be there when you need it most. Plus, Porsches and Jeeps can also pick up groceries.

To rescue your IUL before it's too late, book a call with us.

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