Episode 57: Cash Value Life Insurance with Matt Golliher

Ben Lakoff, CFA
September 6, 2021
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Today, I’m talking to Matt about Index Universal Life Insurance which is a type of Cash Value Life Insurance.

Life insurance as an asset class and as part of your investment strategy. I have a bit of a mental block when it comes to Life insurance as an asset class, so it’s always good to get to the other side of the story and broaden my perspectives a bit.

Matt Golliher of Vista Investments on Life Insurance as part of your investment strategy.

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Show Notes

0:00:00 Welcome and context

0:01:57 What is your background?

0:03:06 Life Insurance as an investment asset

0:10:05 Tax benefits of using life insurance as an investment strategy

0:16:50 Life insurance as collateral for loans

0:24:01 Life Insurance tax deductions

0:26:34 Are there some structural risks coming from the current financial systems?

0:36:10 In what sort of economic situations does life insurance won’t work?

0:41:30 Custodial risks for life insurance

0:47:30 Regulatory risks for life insurance

0:50:10 How does a loan against your life insurance compare with other forms of loans?

0:57:31 What amount of money is required to make this strategy work?

1:00:00 Where can people find out more about you?

Show Links

Vista Investments

Section 7702 of the U.S. Internal Revenue Service

Episode Transcript

[00:00:00] Ben: Welcome to the alt asset allocation podcast, exploring alternative investment opportunities available to the everyday investor. Here’s your host Ben Lakoff.

Hello and welcome to the all to asset allocation podcast. Today’s interview is with Matt Golyer. I’ve had quite a few crypto podcasts lately, and this one is different.

So different assets classes have different parts of part of a total asset allocation. And today I’m talking to Matt about index universal life insurance, which is a type of cash value, life insurance, life insurance, as an asset class, and part of your investment portfolio. Hey, it’s another tool for your investment portfolio.

And personally, I’ve had a lot of, a bit of a mental block when it comes to life insurance as an asset class. Part of your investment portfolio. So it’s always good to get the other side of the story and broaden my perspectives a bit, and I hope you enjoy it before you listen. Please don’t forget to like, or subscribe to the podcast or even better leave a review.

If you’re watching this on YouTube, please subscribe, subscribe to the channel and, or give it a little thumbs up. These things really, really help. And I really appreciate it. Okay. Matt of Vista investments on life insurance as part of your investment strategy. Enjoy, Hey Matt morning. Welcome to the all to asset allocation podcast.

Excited to have you on.

[00:01:29] Matt: Yeah, thank you. I’m excited to be on.

[00:01:31] Ben: Yeah, absolutely. We actually got to meet in person, not that long ago which is a rarity with my podcast co hosts. I need to start setting up a recording studio I can actually have people in person now that you know, we’re actually okay.

To talk to people in real life.

[00:01:47] Matt: Yeah. That’s an option.

[00:01:49] Ben: Exactly. But yeah, I mean, we were catching up a bit beforehand and I’ve, I’ve had quite a few crypto related podcasts lately. It’d be nice to jump back into the traditional world and talk about something a little bit outside of the traditional world of investing.

That’s not just crypto. I definitely want to get into all of that, but before we get started, can you give a little intro on who you are, where you are, what you do?

[00:02:14] Matt: Yeah, sure. So my name is Matt Collier. I’m a financial advisor with Desta investment partners here in Indiana. And yeah. In short, we help clients with comprehensive financial planning and wealth management.

So everything that goes along with that from portfolio management to financial planning, to insurance planning. Awesome.

[00:02:36] Ben: Yeah. And today you know, stocks and bonds, traditional investments, all of this stuff definitely deserves a place in a overall financial strategy or investment strategy. But what I want to specifically dive into with you today is using life insurance as part of your investment strategy and specifically, you know, as an asset class.

You gave a seminar probably about a month, six weeks ago now talking about this in a little bit more detail, but can you kind of just give me an overview of what this is and how it can be used?

[00:03:11] Matt: Yeah, sure. So, you know, I’m focusing on this right now for a few different reasons. But one of those reasons is that cash value life insurance is not a topic that I would say as well, understood by most people and like any type of financial instrument, nothing makes sense for everybody.

But it’s one of those types of financial vehicles that for the people that it does make sense for, it can be a potentially very attractive option. And so my focus is making sure in our current environment with everything that’s going on and, you know, we could go on with what all that includes from the federal deficits to the fear of rising taxes here at market risk, different things like that.

Specifically what kind of life insurance called index university life insurance is in my opinion, studying to become more of an attractive option for some people. And so that’s what the seminar was mostly about. How clients can use it, not for the death benefit, but for its properties, as far as a tax advantage income and growth vehicle.

[00:04:26] Ben: Okay. Okay. Yeah. Let’s dive into it. How, give me an overview of what it is. I bet people, people, especially my age, myself included here life insurance and I’m like, well, I don’t have kids. I’m in my thirties. I’m healthy, not interested, but thinking about it changing the mentality, I’m thinking of it as a investment vehicle when utilized in the proper way to actually be able to give you a lot of more options.

Let’s let’s dive into it. Teach me about,

[00:04:53] Matt: yeah. So there’s, there’s a few mental framework shifts that I think have to occur before. Know, we can truly understand what it is, how it works and how it might be useful. The first one is to contrast it with the traditional view or use of life insurance.

So in the traditional death benefit driven type of life insurance strategy, what the objective is, is to secure the largest amount of death benefit protection for the smallest premium payment that we can find. And for clients where death benefit protection is the goal. That’s what we look to do. We work with them to evaluate how much protection they need, and then we shop that out and trying to find them the most competitive option.

So that’s, you know, pretty typical of any type of insurance with the kind that we’re going to be talking about here today. You really kind of turned that on its head. So. We’re doing the exact opposite for these types of policy designs in that we are minimizing the death benefit as much as we possibly can while still having it qualify legally as a life insurance policy.

And we are funding it as aggressively as possible again, without having it considered to be not a life insurance policy anymore. So that’s the first thing to look at. And when I say qualify illegally as a life insurance policy, they’re specifically, I’m talking about IRS code 77 0 2. And to get into a little bit of history, it used to be the case that there weren’t a whole lot of restrictions on how you could design a universal life policy.

So. And back in the seventies, eighties, you could have a policy with a very minimal death benefit and you could fund it with an enormous amount of cash. And the reason that people would do that is in order for that cash value to receive the tax favorable treatment of life insurance. And there’s a few advantages that it has, but essentially what the IRS eventually looked at, those policies, those massively overfunded policies, and really the message was those are life insurance policies that that’s not why you implemented this.

And so in the eighties, they implemented a restriction that basically said, okay, Life insurance cash value. Life insurance can provide some potentially attractive tax advantaged, you know, growth, income, accumulation type of properties, but that shouldn’t be what its primary purposes. And so in order for a policy to qualify as a life insurance policy, it needs to have a certain amount of death benefit relative to the amount of premium dollars that are going into it.

And if it doesn’t meet that requirement, then it turns into what’s called a modified endowment contract. And at that point it loses a lot of the tax advantages that you would look for in a policy like this.

[00:08:07] Ben: So totally makes sense. And that’s like, that is a completely turning it on its head. Right. Instead of having a massive death benefit when you die, if you want as little as possible, because you’re basically spending it down at some point in your life, presumably.

Right. That’s right.

[00:08:21] Matt: Yeah. So it, the wrapper of life insurance is what allows it to receive the tax treatment that it does. What allows you to do some of the things you can do, like policy loans, which we’ll get into, but so it is a life insurance policy. And in order to get those benefits, it needs to legally qualify as one.

But as long as that’s the case, we want as little death benefit insurance inside the policy as possible. Because even though the purpose of it is in death benefit protection, it is still a life insurance policy and it does still cost money to compensate the insurance company for the mortality rate. Of underwriting that policy.

So in the example where if one of these is implemented in the first one or two years, the client gets hit by a bus. Well, but life insurance company is on the hook for a lot of money as a death benefit to their family, and that needs to be underwritten and they need to be compensated for that. So with that in mind though, yeah.

It kind of is the opposite of what you traditionally think of when you think of life insurance

[00:09:33] Ben: makes sense. Okay. Obviously one of the biggest benefits of something like this is tax, we can preface this with, you know, neither of us are tax accountants or lawyers. You’re a financial advisor.

I’m not, but this is certainly not financial advice to anybody listening and what you can say, whatever proper disclaimer you need to before that. But yeah, let’s talk about the tax benefits of using something like this within your investment strategy.

[00:10:00] Matt: Yeah, sure. So life insurance receives like a couple of different advantages.

One is that generally withdraws or partial surrenders as it’s called, when it’s a life insurance policy. As long as the policy is held for 15 years, you know, long enough then withdrawals can be made on a FIFO basis. So instead of for those who aren’t familiar, Five-O means first in, first out versus last in last out.

And what that essentially means is that if you choose to start pulling money out of a policy, you can do it by first pulling out your taxable cost basis. The premiums that you put into it until you get to what would be considered your taxable interest. But the, the biggest advantage in my mind is the ability to take policy loans against the cash value inside the policy.

And. That’s something that you, I mean, you can’t with something like, for example, an IRA or really most investment vehicles, even ones that you could collateralize to, to get a loan, the types of loans that we’re going to talk about are not the same type of thing. So to give you an example in, let’s say that you have an accumulated bucket of money inside of a policy, and you want to pull it out in a tax exempt way.

You can do that through policy loans and broadly speaking, there’s two different kinds. One would just be a fixed rate loan. And the way that those usually look as long as the policy has been in place for a period of time, is that the money that’s taken out is taken out of the interest crediting strategies.

And it’s put into a collateral account where it earns a fixed rate of interest, a loan against that balance has been issued to the policy holder. The loan also has an interest rate, usually the exact same rate as the collateral account. So the way you can think of that one is that it’s a net zero cost loan that allows you to pull money out tax-free so but it’s a, it’s

[00:12:15] Ben: a loophole, instead of pulling out the actual money, you’re pulling out an amount that’s collateralized by that money without technically touching that money.

Right. Right.

[00:12:23] Matt: Exactly. Yeah. And so it, so in that sense, it’s a, it’s a tax bite. It’s a way to pull the money out without realizing the tax consequences, because fascinating, because you’re taking a loan, you’re not actually pulling money out. So there, I think it’s important to pause because this is another, you know, I mentioned that there’s several mental shifts that I think have to occur before.

Before people can really appreciate and understand this idea. And one of those is on the idea of debt and loans and you know what that means. So the biggest distinction to draw between a policy loan against a life insurance policy and most, any other loan that your listeners will be familiar with is that a policy loan is what’s called an unstructured loan.

And what that means is that unlike a traditional loan that you would get from a bank or other similar institution, you have to qualify for it. You know, the bank has to be willing to lend you money. You have to show credit worthiness, you have to justify what you’re going to spend the money on. And there’s usually a process you have to go through and loan, underwriting, everything like that.

That’s not the case with a policy, right? So the process of taking that usually as a one page form, and most of that form is instructions for the life insurance company on where you want your money to be sent. And in some cases you don’t even need a form. You can do it online. There’s even some that have checkbooks or, you know, cards attached to it that you can access.

So that’s the first difference is that the life insurance company does not evaluate your credit worthiness in order to pull a policy loan, because they know that the loan is fully collateralized by the amount that has been set aside, inside the policy to collateralize the loan. So in that sense from the life insurance company’s perspective, there really is no chance of default by definition because the collateral is already there.

Right? And so the second big thing to understand is that in most other types of loan structures, The deal is that you get the loan amount from the issuing lender. And in exchange for that, you agree to some sort of prearranged payment schedule of principal and interest. And typically you know, they have different flexibility, but with most loans that most of us are familiar with.

If the loan is not paid back, then that creates a problem. So whether it’s additional accumulated interest penalties dings to your credit and in the severest cases, things like, you know, lawsuits and foreclosure and everything like that. But the biggest thing to understand about an unstructured loan is that it’s not an obligation in the sense that it’s, you know, something that you have to service.

In fact, it’s a loan that you never have to pay back for your entire life. The only times where the loan has to be paid back are if you choose to get rid of the policy, in which case, if the loan balance comes out of your surrender value, your surrender cash value or upon your death, where the balance of the loan is deducted from your gross death benefit.

And the reason why life insurance companies are able to do that is because while the loan is outstanding, it is accumulating interest. That’s interest that the policy holder never has to pay back into if they choose not to. But the life insurance company knows that at some point, even if it’s 40 years from now upon the death of a policy holder, they’re going to get the full value of the loan back plus interest because it’s collateralized by the death benefit of the policy.

[00:16:28] Ben: Oh, that totally makes sense. Okay. Backing up a bit. The idea is you pay money into this account and then you’re that money that’s invested. It has this death benefit benefit and everything else, but the assets are invested earning a little bit of return, but the real power is that you’re able to use that as collateral take out a loan.

And then with that loan invest in another asset. You get like this levered your fingers in both pies at this point, right?

[00:16:58] Matt: Yeah. That’s a really nice segue into the second type of loan, which is primarily the one that I focus on. So I talked about the fixed rate loan, which is essentially a net zero cost loan mechanism that allows policy holders to pull money out, technically as a loan, not a disbursement.

So creating a tax exempt. Way to access cash, but the second type of loan, it depends on in whole life policies. It’s often called a participating loan in universal life policies or index universal life policies. It can be called a few different things, but usually it’s called an alternative loan. And what happens when you do that?

You know, let’s take the same example. You have a bucket of money inside of a policy, and for whatever reason, you want to pull some cash out of it, but you want to do that without realizing tax consequences on the game. And so you decide to take that loan or take that disbursement as a policy loan tax exempt policy loan.

But here, when it’s an alternative loan, the funds are not taken out of the interest crediting strategy, which we’ll get into here in a bit. They, so the funds stay inside the strategy and continue to credit interest. The exact same way as if the loan had never been taken. And so you have a loan balance that is accumulating interest.

You have the interest crediting strategy that is ideally accumulating interest. And the idea there is to achieve interest rate arbitrage, where the amount of interest that the policy is able to generate on the loan amount is higher, at least on average, over time than the amount of interest that the loan balance is.


[00:18:50] Ben: And, and what sort of interest rates are you paying there? I mean, interest rate arbitrage sounds great, but right now in a pretty low yielding environment that we’re living in, this is in July of 2021. You presumably have to go out the risk curve a little bit too, or, or a lot of that to actually get a positive yield on those invested cap cat.


[00:19:18] Matt: Yeah. So I think that brings us to the actual way that these types of policies credit interest. So the first thing to look at and, you know, the, the biggest risk and using leverage strategies like this and attempting the interest rate arbitrage is when you do so on a vehicle that has market risk, you know, in a lot of cases, I once heard the phrase picking up nickels in front of a steam roller.

And a lot of the times it looks like that, you know, it works great until it. And so the, the first big key to understanding how these policies can be effective is that they’re able to credit interest in a way that has no more at risk. So they are index universal life policies because they credit interest based on the performance of an index and different policies can look at different indexes and credit interest in a lot of different ways.

But I’m just going to use as an example, the, the most plain vanilla, most common one, which is a strategy that looks at the S and P 500 on an annual point to point basis and credits interest for the cap. So, as an example, let’s say that. The, so it looks at it on the annual point to point basis where it looks at the S and P 500 at the start of the period.

And then it looks at where the index value finishes one year later on the anniversary date of that index credit in strategy. And historically about three out of every four years, the S and P 500 finishes higher than it was 12 months ago. So in a year where that happens, this strategy would credit interest equal to the increase in value of the index up to a certain cap.

So right now you’re, you’ll see cap rates around 10% or so. So let’s say that in a year where the index rises 7%, the account would be credited 7% in a year where the index rises 10, the account would get 10 in a year where the index goes up 20%. The account would get the cap rate of. So does that make sense?

Yeah. Yeah. Okay. So, well the big question is, all right, well, what happens the one out of four years when the index finishes lower year over year and in a second ratio

[00:21:47] Ben: changes going forward, right? Because 75% of the time is quite high, but all the time running evaluation.

[00:21:54] Matt: Yeah. Yep. So in a scenario where the index finishes lower than it was at the starting point, no matter how much lower it finishes the account, earn 0% for the specific strategy we’re talking about.

So in that sense, the strategy can go up or sideways, but it can not go back down due to negative market performance. Now you have cost of insurance fees that will drag on that. And so it would not be technically correct to say that the cash value on these types of policies can never go down. They could, in the event that you were in a zero for the entire year, you would have the cost of insurance come out of that.

But one strategy or a common one that I look at when using this is to dollar cost, average the strategy. So rather than having all the funds look at one point to a point 12 months into the future, this strategy would have one 12th of the money invested month by month. So rather than looking at, for example, July 20, 21 to July, 2022, this would look July to July, August, August, et cetera, et cetera.

And so that’s not the same. The policy still couldn’t earn zero. It certainly could if every one of those months is lower than the previous one, but the likelihood of that occurring that allows us to in theory lower that.

[00:23:25] Ben: Interesting. Okay. What are the tax advantages to contributing to this sort of investment vehicle?

Like you’re able to lower your taxable income because it’s pre-tax as well?

[00:23:40] Matt: No. And in fact, in most cases, life insurance premiums, you, you won’t find those to be tax deductible B the big tax advantage comes in the later years of a policy. When, for example, the the type of concept that I look at at the seminar was the ability to use this to supplement retirement age.

And when we looked at a specific it’s called a life insurance illustration, and that one just showed the account crediting a fixed rate of 5.7% every year, which uses a conservative average for what these types of policies have historically done. So it takes that conservative average, and it just says, this is what would occur if the policy earned the bat every single year, which won’t occur, you know, it, it won’t add the exact same rate every single year.

But when we look at the later years of the policy, the, in here I’m going off memory, but it shows the policy holder taking out, you know, 20% of the value as a distribution and the cash value would go up, not down well, it, in order for an investment account to do that, for that to occur in investment account, it would have to generate.

2020 5% return. But remember this assumes that the policy only earns 5.7% every single year. So the question is, how is it that if it’s the case that it did, in fact only are in 5.7%, how am I able to pull out 20% of the cash value and not only have it not decrease, but have it go up that implies a much higher rate of term?

The reason why is because the policy is not only earning 5.7% on the money on the cash value, the surrender value, it’s also earning 5.7% on every dollar that’s already been pulled out as income.

[00:25:44] Ben: All of these things sound, sound really good. But they’re based on the premise that financial markets continue to look the way that they have for the last.

Yeah, 40 years at least. How do you think about structural risks to the financial system and how they impact the way that these things are used as part of your financial strategy? Or is that perhaps a bit outside the scope of this conversation? Because you have to make some assumptions and the assumption that things work the same way for the last as they have for the last, you know, couple of generations is an okay assumption to make at times.

[00:26:22] Matt: Okay. Yeah. But no, I think that’s a perfect question. And that’s something that I think everyone should understand before they look at potentially implementing something like this is that even though, you know, I mentioned there’s no, there’s no market risk, but that also, that doesn’t mean necessarily that there’s no risk at all.

So I view that as performance risk, where in concept, this looks great. If it does what we think it’s going to do, but that is not guaranteed. So it could vastly underperform what we expect it to do. And so the, the first thing to look at, and the first thing I always try to impress upon anyone looking at these is to have conservative assumptions about the future.

And so one way to look at how these might perform what the concerns are, what the potential sources of optimism are. As I mentioned, the, the cap rates that really have a huge impact on what the average return of a policy will get over time. And those cap rates are based on interest rates in general, because without getting into the mechanics of how life insurance companies are able to credit these strategies, it is essentially they go out and buy bonds on the secondary market.

And then stack options on the underlying index on top of that. And so the interest rate relevant to the bond of the app to purchase leaves more or less room for the option exposure. And so if there’s any actuaries listening I know I just vastly oversimplified that, but that’s good enough to conceptually understand what’s going on there.

And so cap rates historically for these types of policies have been quite higher in the past when interest rates were higher and we saw the rates fall as interest rates fell. So one risk to be aware of is for most of these policies, it is not guaranteed that the life insurance company will keep the same cap rate.

It could raise or lower it, depending on the prevailing interest rate. Now we look at companies that have a good history of not lowering cap rates on enforced policies. But even good ones that do with the zero interest rate environment, we have seen some of them lower the cap rates, the flip side of that, or the optimistic side of that coin is that again, it is not guaranteed that they will do this, but in periods where interest rates have gone back up, we’ve seen those carriers go ahead and raise those caps as well.

And the reason why is because the life insurance company has an enormous financial interest in keeping that policy in force and keeping those dollars inside that policy, because if they don’t, then the policy holder has the ability to move the funds in. What’s called a 10 35 exchange in a tax deferred move from one life insurance policy to a potentially superior one.

And so. Again, not guaranteed by any means, but for a highly rated life insurance carrier, that is one thing to keep in mind is they’re incentivized to have the policy perform because otherwise they know that the funds will leave. And where that, where that gets exciting for me right now, where interest rates are near historic lows is there are some carriers that offer solutions where the interest rate on policy loans for the ones that we talked about is guaranteed for the life of the policy.

It will never go up. So for example, I am implementing one of these for myself right now and I not married. I don’t have kids. So, you know, Matt, why are you buying this big life insurance policy? Well, I’m using it as a cashflow management strategy. Where, you know, throughout the next couple of decades, I’m going to make major purchases, you know, cars, vacations, and engagement ring, you know you know, those types of purchases, we make the, you know, I would call low to mid five figures for most people where most of the time that involves either taking out a loan and an obligation that must be serviced and paid back or draining savings instead of funding it through that, by funding it through a life insurance policy and then paying it back in whatever schedule I decide or as convenient for me, I can continue earning interest net interest on the money that I’ve spent for my vacation or my car.

So when you compare the, the idea of, you know, let’s say that, let’s say that we’re going to buy it. Just to keep numbers kind of even a $50,000 car, you know, in option one, let’s say I pull those funds from some sort of asset, whether it’s an investment account, a savings account, whatever the case is. Well, the, the answer’s obvious, but you know, how much interest is that $50,000 earned for me after I pull it out of the account, there’s nothing, you know, zero.

So excuse me, from, from an opportunity cost standpoint, when I pull $50,000 out of an investment account to purchase a car, their car costs me more than $50,000. It also costs me all the interest I could have earned on that $50,000 for the rest of my life. In option B. Let’s say that I take out an auto loan.

Well, number one, I have to go through the process of qualifying and being underwritten forward and everything like that. And then I end up over a period of several years, paying it back with interest. So in that case, the car costs me $50,000. Plus whatever the amortized interest was over the life of the loan in the third strategy where I borrow it from my own policy, the idea is that I’m able to spend money and earn interest while doing it.

So in a scenario where interest rates are at historic lows were by no means guaranteed, but where there’s a reasonable expectation that as interest rates go back up, if they do that, a policy’s cap rates will rise along with it. But the loan interest rate will stay fixed forever for the rest of my life.

That’s where it gets exciting for me, because at current rates at current caps, you can look and, you know, reasonably expect, let’s say if, if a policy earns, you know, five and a half, 6%, but you can lock in the loan rate for the life of the policy of 5%. Okay. That’s not bad. You know, you can earn half a percent or a percent on for spending money on money that you spend.

And you earn that forever, even if you never pay the loan back. But where it gets exciting for me is if the cap rates go back up because interest rates go back up and in that scenario where, you know, for example, you see a spread between the two rates of two, three, 4% in that scenario, let’s say going back to the car example.

So I pull out $50,000. I purchased my car with it. That loan balance accrues at 5% inside the policy until my death, but that money is not taken out of the interest crediting strategy that continues to compound just as it would as if I’d never pulled the loan out. And if interest rates do what in this case, I would hope they do, which is go back up.

And that scenario I would expect to earn, let’s say a 9% on average, if they go back up, there’s a lot of ifs here, you know, when you’re dealing with

[00:34:53] Ben: yeah, absolutely. We don’t have a crystal ball. Right. You have to make some assumptions.

[00:34:57] Matt: Yeah. So I’m, I’m painting the rosy picture of this, of this strategy.

You know, if it goes perfectly, that that would allow me to earn, you know, net 4% on the $50,000 I spent for the car for the rest of my life. Right. Without me, it’s back into the policy. It’s

[00:35:17] Ben: all opportunity cost. Every investment, every spending decision is it’s allocating capital. That could be somewhere else.

And I’m, you know, generally part of like team never sell, use it as collateral, pull it forward. If you can let that money compound

[00:35:34] Matt: don’t interrupt the compounding. Yeah.

[00:35:37] Ben: Just the, just let it do, do its thing. I’m kind of thinking through, it sounds like the ideal scenario is lock in this fixed rate now, which is for the life of this policy and interest rates slowly tick up.

You’re still getting credit for it. What, in what sort of. Economic situations, would this not be a good situation that you would want to unwind this and, oh, I’m paying interest at 5%. This is something’s gone horribly wrong. What sort of situations does, does that look like? Yeah.

[00:36:14] Matt: So the biggest one is if indexes do not do in the future, what they have done in the past. So we talked about the S and P 500 and yeah, that’s great that historically it’s done XYZ, but we really don’t know what it will do in the future. And there is a very real possibility that moving forward, it doesn’t do what it’s done in the past.

So in that scenario, using this as a cashflow management strategy, if the interest crediting strategy is only averaging, let’s say 4%, let’s say it’s vastly underperforming. What we expected it to do. And the loan is compounding at five. Well, in that case, not only are we not able to earn money on interest rate arbitrage, but it’s actually harming the performance of a policy.

[00:37:03] Ben: Can the interest crediting strategy actually be a debiting strategy if it like it’s negative five,

[00:37:10] Matt: can you elaborate on that?

[00:37:11] Ben: Meaning like, okay, it’s crediting this available interest based on the S and P 500, which goes up 75% of the time. But if it goes down by 10% for the next five years, like, what does that what does that number move to?

[00:37:28] Matt: So in a scenario where that happens, essentially the cash value performance would be 0% per year. And what you would see is the gross cash value slowly dwindled down because of the cost of insurance inside the policy. And once policy loans start being taken from this, the biggest key to managing them is ensuring that the loan balance never becomes higher than the cash value in which case the policy would lapse.

And that often has tax consequences when you’re using it this way. So the, the worst case scenario would be one where the, the cash value just does not perform at all the stock market goes down and it does it for a decade. And you just see your policy value dwindle while your loan value accumulates until eventually you, you have to terminate the policy.

That in my mind is what the worst case scenario is.

[00:38:28] Ben: But the underlying investment immense are always made in credited based on the S and P 500.

[00:38:35] Matt: No. So yeah, that, that brings me to one point, which is that a way to help diversify some of that risk away is that almost all carriers offer policies like this, that look at more than one index.

And especially in the low interest rate environment, they’ve done some, some where I think are pretty cool things where you know, they look out and structure proprietary indexes that are designed with the intention of performing better in a low interest rate environment. And so w one example of something that’s different from a cap rate would be a strategy that looks at a completely different index.

Let’s say it’s a volatility controlled, managed index. You know, issued by JP Morgan fidelity and instead of credit into a cap rate, what these ones often will do, you is grant unlimited upside potential. So, you know, one way that that might look is that the policy, you still credits interest on an annual point to point basis.

So any year where the index finishes up, it credits interest, right? I’d say a hundred percent. Some of them have participation rates higher than a hundred percent, but just to keep it simple, let’s just say a hundred percent and that’s uncapped. So because of the nature of the index, the odds that it’s going to increase, you know, 30% like the SMP can, or I would argue pretty low, but that would be a scenario to, to help mitigate the risk of, you know, a policy or a 0% for a very extended period of time.

But the other way that I look at it is. If that were to happen, it is certainly the case that I’m not going to like how my life insurance policy performed for me, but in order for it to do that, that, that would mean the stock market would have to go down every year, 10 years straight. And so I don’t like what my life insurance policy did, but I really don’t like what my other stuff did.

[00:40:40] Ben: Exactly. Okay. I’m just playing devil’s advocate here, but like your entrusting, the carrier. You have a bit of custodial, like counterpart party risk. Obviously if that company disappears, they’ve they have your money, but the other thing is you’re, you’re essentially trusting them to make good investment decisions for that money, right?

[00:41:05] Matt: Yeah. So yeah, essentially this, the entire performance. You know, besides the market and things, it centers on the issuing carrier that you’ve got the license insurance policy through. So a couple of things to look for to help, you know, again, against having a potentially negative experience are, you know, we look at highly right companies with a strong track record of policy performance and enforce policies.

One thing to look at is what’s called a mutual life insurance company versus a stock life insurance company. And means is that the life insurance company is owned by its policy holders, not by stock shareholders. And so the strategy there is to align incentives to where the management of the company is determined by the leadership that is elected by the policy holders, which.

It intends to have the, have the company managed for the benefit of the policy, not for the stockholders. So that’s one yeah. Common thing to look at. And that’s not to say that there are good stuff, doc insurance companies out there. Cause there are, but that’s one thing to look at. And another thing that I think helps put that into context, because that is a significant risk, but let, let’s compare it to ask the question risk compared to what?

So when, when I look at that, the, you know, of course what’s the worst case scenario would be that the life insurance company completely defaults on its obligation to policy holders and collapses. And so in that scenario, oftentimes clients will ask, you know, are, are these things FBIC insured or what happened?

We are what happened so that if that were to occur yeah, I’m in America now. And so I can only speak for those titles. Structures and things, but the backstop against that is what’s called the state guarantee fund. And the way that it works is that in the event where a life insurance company becomes insolvent and unable to meet the obligations that as to its policy holders, the guarantee fund exception to make those policy holders hole up to applicable limits.

So it kind of looks like FDAC, but it is not FDAC and it’s administered at the state level, not the federal level. So, but the, the other thing to take into account is that scenario historically has not happened. And so a lot of people take heart in the fact that life insurance companies, during things like the great depression and other financial crises performed admirable.

And, you know, there is an example of some companies where, you know, in I’m using the example of a whole life carrier now where they pay policy dividends, and that drives an enormous amount of a policies. Performance is the optional dividend that the carrier pays to its policy. So you think, well, there’s no guarantee that that will be paid out, but yeah, there are life insurance companies that have a track record, 50 in some cases over a hundred years long of never missing a dividend.

So even through world wars and everything that happens there. And so that’s a risk to be aware of for sure. But I would, I would not put that as a category risk, you know, above and beyond. No most of the types of things that we do, you know, when, when you hold money in an investment account, there’s counterparty risk there, that’s insured by civic up to applicable limits it.

You know, in my mind, you can’t really quantify those risks cleanly by view them as roughly roughly equal.

[00:45:07] Ben: Yeah. What about regulatory or like policy risk suddenly saying that, Hey, these things are being used as investment vehicles. Like we’re going to tax the heck out of them because this is not the purpose.

They’re their stated reason for existence. I mean, do you think through that much or it’s just kind of part of it?

[00:45:30] Matt: Yeah. Well I think, yeah, I think it would be irresponsible not to think about that because that did happen in the 1980s where the IRS passed a series of laws, TEFRA DEFRA Tamra, you know, lots of different acronyms.

That created IRS code 77 0 2 and 77 0 2. legally defining what a life insurance policy is and what a modified endowment contract is. And so they did that for that exact reason, where it became a obvious that these policies were not being used as life insurance. They were being used as tax shelters. And the, you saw a strong policy response to that.

The way that I look at, you know, for anyone who chooses to use one of these or look at those is historically when policies like that are implemented, they tend to not be retrofitted. And so there is, you know, I always say, do you want to make an idiot of yourself, try to predict what Congress is going to do.

You know, they could, they could do anything. There there’s no shortage of what kinds of laws they can pass. They could inferior. Completely strip out all the tax benefits of even Inforce policies, but history tells me that that’s fairly unlikely. And I think the reason why the biggest reason is no, as much as we may not like politicians, Congress, you know, I think they do understand that if regulation, financial and tax regulation were to be applied retroactively, that would render, found financial planning possible.

You know, the, the average, this one would have no ability to make sound long-term financial decisions. If the assumption upon which those decisions were made could be changed on a and so I I’m aware of that and something to definitely keep in mind, but. That’s not a, in my mind, a huge risk when I look at the incentives.

And when I look at history where, you know, for example, the the recent one that just popped into my mind is the recent change to how non-spouse beneficiaries can inherit IRAs. Well, with the, I believe it’s the secure act a few years ago, one of the ways that one side was able to fund some of the tax cuts is they eliminated.

What’s called the IRA stretch. Where if you inherit an IRA from someone who’s not your spouse, you used to be able to spread the tax consequences out over the rest of your life. You know, because every dollar you pull out is going to be taxed as ordinary income in the case of a traditional IRA. And they changed to that after January 1st, 2020, is that if you’re a non-spouse beneficiary, inheriting a traditional IRA, All the money has to be out of the account in 10 years.

So they, they no longer allow you to spread that tax consequence out. They, they force you to incur the tax liability on distributions within those 10 years, but that only applies to IRAs that were inherited on or after that date that did not retroactively apply to anyone who had inherited IRA before that.

And that’s typically what you see. And I, I cannot think of any example where the. The United States, federal government has retroactively enacted a law like that, but that’s not to say that they couldn’t make it.

[00:49:15] Ben: Yeah, I wouldn’t know. Or wouldn’t. Yeah, for sure. When thinking about this particular strategy, I’ve it all started with crypto, honestly, as putting eith or WTTC some sort of crypto collateral and taking out a loan with few clicks of a smart contract.

These loans are incredibly low to 3%. It’s over collateralized. I don’t have to deal with anything. It kind of led me down this path of like team never selling opportunity costs, always thinking through this. I have wealth front, which is something I’ve been recommending for years. Sorry, it’s a robo-advisor but I mean, with a few clicks, I took out a loan.

Like literally two clicks. I took out a loan collateralized by my investment stock portfolio and 3.7, 5%. And it’s in my bank account, you know, in one to three days. Cause it’s T plus three, but I’m relatively instant from like a traditional financial worlds standpoint. I’m thinking about the average investor or somebody that has something like wealth front, or even like, you know, fidelity.

I called them and there’s like 7% margin loans, which is not that interesting. But you have these as your options of like, don’t sell your stocks portfolios and take out a loan, then you have perhaps equity in a home. You can take like a hilar or a second mortgage on your house and access that those funds.

And then you’re still invested in the underlying because. If housing prices go up by 20% over the next three years, like you didn’t sell your house and you access that value. You still get the underlying appreciation. How, how do you think of this health insurance strategy fitting into these other options that I have as the average investor?

[00:51:03] Matt: Yeah, I’m really glad you asked it that way, because that, that brings me to what I think is the most common criticism of cash value life insurance that the I personally have heard. And that I think most people have heard, which for anyone who is familiar with like Dave Ramsey, for example, the, the idea of, you know, buy term and invest the difference permanent life insurance makes you worse off over the longterm compared to, you know, throwing it in an S and P 500 fund, for example, you know, that’s the way I think about that is not only is that not right.

That’s not even wrong, that that just misses the point. And so the clearest way to think about that is they’re designed to do different things. And so, yes, it is true that let’s say that our client’s goal is to accumulate a portfolio, contribute to it and grow that portfolio as much as possible life insurance is not where you want to do that.

And in fact, if you’re looking at the accumulation value, you know, any good portfolio will almost certainly out right, perform the growth of that value over any significant period of time, at least historically you would expect it to so where this would make more sense than some of those other strategies that you talked about would be four.

People who are looking for a way to accomplish that interest rate arbitrage in a way that has no downside risk for the collateralized assets. So that’s, that’s the biggest one where if if if someone is, you know, for whatever reason, if they’re able and willing to take on that market risk on a leveraged asset, then yeah.

Do that, that, that makes more sense. But in cases where that’s not the play, for example, where I talked about using it as a cashflow management strategy, for the same reason, I would never advise a client who is, you know, going to put a large down payment on a house. I would never suggest that they throw that into an S and P 500 fund if they plan on spending it in the next, you know, two years or so, because there’s a very significant chance that by the time they go to pull the funds out, they’ll have suffered a negative return.

And so for that same reason, when this is being used as a cashflow management savings strategy, to me, it makes more sense to collateralize the loan and achieve arbitrage with something that has no downside risk so that you don’t expose yourself to the potential that, you know, the value dips. And now you have to account for that.

And the other scenario where I think that’s most relevant is for people who are approaching retirement and are looking to use this type of strategy as a source of supplemental retirement income. So one of the ways that can be valuable is, you know, they, they talk about, you know, what’s called a safe withdrawal rate.

If you’re pulling a retirement income off of a portfolio and you know, what are the odds that if you pull X amount out, you’ll run out of money within your life expectancy. And then. Somewhat counter-intuitive realization for some people, is that even if a portfolio does, in fact average, let’s say 7% over the course of 20 or 30 years, that would not mean that the investor could pull out 7% of income every year.

In fact, by doing that, they would have a significant chance of running the account down to zero because of sequence of returns, risk, where in, when you’re pulling an income off of a volatile portfolio in the years where it goes down, you have to liquidate more shares of the investment to generate the same number of dollars in income.

And so that when the positive volatility comes and the portfolio recovers, those shares, aren’t there to capture that upside gain. And so traditionally where retirees or people approaching retirement, one to mitigate their market risk, they’ve looked at things like box. And things that are, you know, historically less risky than stocks, but right now that’s a pretty big challenge.

I would say, you know, finding a way to help hedge against market risk in a way that offers any sort of attractive return at all is a consistent challenge that we’re seeing people face. And so that’s I alluded to the fact that the interest rate environment for a few different reasons is why I think it, it’s interesting to look at this strategy and, and that’s one reason why, because I know of no other type of instrument that gives the opportunity for five, six, 7% returns in a way that has no market risk.

[00:56:14] Ben: Right. No, that’s awesome. I think the type of investors that should be really interested are it sounds like approaching retirement or perhaps a little bit later in later stage, or, I mean, you’re obviously not there, but well maybe you are, but in turn for the age category, at least, but I’m curious what sort of amounts are needed to make an investment strategy like this work, because presumably if I have $10,000 and I want to do this, it might not make sense.

Is that number a hundred K a million? Like what sort of amount should I want to dedicate to this sort of strategy for it to make financial sense?

[00:56:52] Matt: Yeah. So in terms of, you know, what types of dollar amounts could get a policy like this? You know, it, it ranges and it can go down pretty low, you know? So for usually the minimum is something the minimum is based on the face amount or death benefit of a policy.

And so the premium that you’re allowed to put in depends on your age and ability, things like that. But I would, rather than dollar amounts, I would think of it as this is a strategy to use. Once I would call it the a few of the other boxes are checked. So for example, I would not suggest that someone implement this, if they are not contributing or have not accumulated into enough growth assets, that they’re going to be able to reach their goals.

That way, you know, th this is something that would be implemented on top of that. But to just to give a little bit of context, usually the policies that we look at are funded over a five-year period. That’s the funding window, because that’s about as aggressively as you can fund these. Turning it into a MEC, a modified endowment contract.

For example, if you put all the money in upfront year one, that would be a modified endowment contract. So in a five-year funding window, you know, typically for that type of strategy it depends on, you know, location in the country, but a common one here in Indiana, where it might make sense would be something between 50 and $150,000 annual premium for five years would be in the neighborhood of a common type of one that I would say.

[00:58:42] Ben: Okay, that makes sense. Matt has been tremendously helpful. I think learning, I have this mental block definitely that it’s like health insurance. I don’t want that. It’s always good to take a second. Look, I keep saying, yeah, I don’t even know which insurance it is. Insurance in general. It’s like, yeah, it’s a just in case I something that I hopefully don’t have to figure out if it’s a good policy or not, but yeah, I really appreciate you coming on and taking the time to go through this and I’m going to link up a ton of these things in the show notes, for sure, because you’ve dropped a lot of knowledge.

But if you have any parting thoughts or lastly, you know, where can people find out more about you or Vista or wherever you’d like to send my.

[00:59:24] Matt: Yeah. Sure. So, yeah, you, you mentioned at the top that, you know, you’ve been doing a lot of crypto type of S episodes. And so this is you know, you might call it a boring change of pace going to life insurance from crypto.

But one of the things that interests me when, you know, once, you know, your mind kind of wraps around how the concept works is the implications it can have for defy insurance, if, and when that industry ever, you know, ever matures, because in theory, all the types of things that I talked about, the interest crediting strategies could be accomplished on a decentralized platform looking at instead of the S and P 500 looking at Bitcoin, for example.

So going down that rabbit hole is kind of cool. So. Yeah, that’s interesting to me. So I’m glad to be able to be on this particular show, talking about, you know, a relatively boring asset class in life insurance. But but yeah, so again my name is Matt and I’m with Vista investment partners here in Indiana, and really the best way for people to find me and us learn a little bit more about us would be Vista our website, and learn from there.

[01:00:40] Ben: No worries. And don’t worry about boring. I think boring. It requires no, I mean, seriously, it, it deserves a place in most people’s portfolios and if you’re a hundred percent crypto, you’ve been pulling your hair out over the past six months or whatever. Yeah. It’s nice to have these.

More stable, consistent pieces of overall well-constructed portfolio. Don’t worry about it at all. And I’m sure my listeners will really eat it up. Well, thank you so much, Matt really appreciate you taking the time and coming on today.

[01:01:09] Matt: Thank you for having me.

[01:01:11] Ben: There you have it. Thank you for listening.

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Happy investing


Ben Lakoff is an entrepreneur and finance professional. He has developed strong global finance experience through 10 years of international assignments in the US, Brazil, Afghanistan, Southeast Asia, Czech Republic and through the award of his Chartered Financial Analyst (CFA) certification.