Welcome to Finance and Fury, The Say What Wednesday Edition. Where we answer your questions.

I’m Louis Strange and today’s question comes from Mark.

Hi Louis, I just heard about IBC (INFINITE BANKING CONCEPT) and I would like to know your input on it. They are saying you can be your own bank by setting up a cash flow whole life insurance policy. Then you are able to borrow against your liquidity, I would like to hear your thoughts on it.

 

Spoiler

– this probably can’t work in Australia – run through what this is first and then go through reasons why

 

The concept isn’t that new

– History

  1. The first large-scale attempt to market this concept came about in 1980 – the concept of LEAP – The Lifetime Economic Acceleration Process – since then had IBC with Be Your Own Banker and then also Bank On Yourself more recently 
  2. But the concept dates back further than 1980 – roots of this strategy go back generations — at least prior to the American Civil War – how did it work in practice?
    1. Started with Farmers – struggled with extreme seasonality of cash flows
      1. So farmers would generally have to borrow money to buy farmland, to plant, and to have money to live on while they paid their mortgage, paid their laborers – all while waiting for the harvest if harvest went well – used the money to pay off the debt
      2. But back then the risk was that someone died before the mortgage was paid off – as back in those days, people frequently did not live beyond their mortgages – rather than risk losing the family farm, the family would buy life insurance – If the farmer died before the mortgage was paid off, the life insurance company would pay the death benefit, and the farmer finally ‘bought the farm’ from the bank — which is where the term comes from.
      3. Keep in mind that this was in the days before we had index funds, and before we even had mutual funds as we know them. Or even Super accounts
  1. The system worked well for farmers – If they saved aggressively within a life insurance policy, they got a death benefit, and a ready source of liquidity from loans from the life insurance policy.
    1. And since the policy was ultimately secured by the death benefit, it was a safe loan from the point of view of the insurance company and a bank
    2. Once the farm was paid off, the next generation didn’t have a mortgage anymore – so they could use this policy to buy more land, or to buy a new tractor or combine, build a new house, or anything else they wanted to do.
  2. IBC evolved from this concept – Here’s the pitch, in a nutshell:
    1. Over the course of your life – a lot of people pay interest to creditors on all manner of loans – most mortgages, but also cars to credit cards to even HECS repayments – these interest repayments compounding over time represents a tremendous drain on individual wealth.
    2. Instead – if you aggressively saved money within a certain type of life insurance policy, you could fund these purchases from that policy — and pay the policy back, rather than the bank
      1. Technical issues with this phrasing – it is the functional equivalent of paying yourself for the loan, with interest – essentially – you are retaining the interest within the cash value of your own life insurance policy, rather than paying off the bank

So how does this work and what is Infinite Banking?

  1. Infinite banking claims to be the process by which an individual becomes his or her own banker – I do use claims here
    1. Go through definition of a bank later –
  2. But Infinite banking is a concept created by American Nelson Nash – wrote a book called “Becoming Your Own Banker”
    1. Nash talks about the use of whole-life insurance policies that distribute dividends and how owning such policies allows individuals to dictate the cash flow in their lives by borrowing against/from themselves instead of depending on banks or lenders for loans
  3. Practical terms – uses the mechanics of Whole Life policies – which is the platform on which IBC is implemented – First – how does this work compared to a term life?
    1. Term Life Insurance – A term life insurance policy operates like other types of insurance you may be familiar with
      1. You take out Life cover at a set level and pay premiums based around your risk factors – age, occupation, etc.
      2. Most term life insurance policies expire without the insurance company having paid out any death benefit claim – at 99 if owned personally or 75 inside super – but most people don’t hold it to then as the premiums get too much
    2. Whole Life Insurance – a permanent life insurance policy never expires and is set up to pay into
      1. It is a hybrid form of policy – has investments which you contribute into along with an insurance component
      2. Unlike Term insurance on stepped premiums – most WOL policies have fixed premiums – pay more now into the policy – effectively “overpaying” for the pure insurance coverage in the early years, while “underpaying” in the later years – but the life insurance company takes the incoming premium payments and “puts them to work” by buying financial assets, such as conservative corporate bonds. Over time, the life insurance company builds up a stockpile of assets effectively “backing up” a Whole Life insurance policy that it has issued in the past
      3. Cash Surrenders – Now consider that as a customer with a Whole Life policy gets older, he or she is a ticking (financial) time bomb from the insurance company’s point of view, because the moment of death — though uncertain in any particular case — is getting closer and closer. That’s why the life insurance company would be happy to pay such a customer a cash surrender value to “walk away” from the policy, and this amount increases over time – also can come from a residual of what is invested
      4. Policy Loans – the owner effectively builds up equity over time, as the cash surrender value increases. As part of the contractual arrangement, if the owner wants cash but does not want to surrender the policy, he or she has the option of borrowing money directly from the life insurance company, with the cash surrender value serving as the collateral on the loan. This occurs “on the side” as it were; the money doesn’t “come out” of the policy.
  1. What this means in practice is that someone who has built up a well-funded Whole Life policy can obtain financing from the life insurance company at a predictable interest rate with no questions asked.
    1. For these WOL polices – the insurance companies normally won’t asses a borrower’s credit score, annual income, the purpose of the loan, etc. the way a conventional lender would – as the money is coming out of your own policy
      1. It is all about using a WOL policy loan and paying this back – so if you need to buy a new car or you don’t borrow money from conventional lenders but, instead, take out a policy loan from your life insurance policy
    2. Had a look at the old AMP policies – rate of 5% is the current offering – but these are mature products – don’t think they offer them anymore
  2. Digging Deeper into the Infinite Banking Concept – In Nash’s infinite banking concept (IBC), the cash surrender value(s) of whole-life insurance policies act as collateral for a loan. The individual simply needs to call the insurance company and ask to take out a policy loan.
    1. A whole-life insurance policy is meant to cover the entirety of an individual’s life, not simply to assist family/friends in the event of the individual’s death – Also due to the nature of the policy – where you over pay now – there should be returns on this to generate an increase in the cash value of the policy
  3. Advantages of Infinite Banking –
    1. Liquidity of the loan – loan can be taken out quickly and the individual can secure cash in hand faster – allows for emergency funding
  4. Disadvantages of Infinite Banking –
    1. The costs of the policy can be high and you need to aggressively put money into it for the cash surrender values to grow – so if you have a large financial commitment already with a family, then it can be hard to make work  
    2. The money you borrow is essentially your own money – just being lent to you by the insurance product

 

Firstly – this is a USA strategy – don’t think it would work so well in Australia for a number of reasons –

  1. Whole of life isn’t offered here – Why? – In short, superannuation was viewed as a replacement, or alternative for, a permanent/whole of life insurance policy
    1. The government made superannuation compulsory to all workers in Australia in 1992 to ensure all Australians would have enough money to retire on
    2. Both employers and employees contribute to the super fund by depositing money which is kept aside and used later in life when the individual reaches retirement – when you pass away – family gets the benefit as well
    3. Similarly to Whole Life Insurance, Superannuation now can include a death benefit insurances which is paid out in the event that the fund member dies before reaching retirement – Term life insurance policies
    4. Superannuation and term life insurance policies work hand in hand to deliver a very similar function to what whole life insurance can provide alone – minus the lending side of things – Therefore, whole life insurance is no longer available for purchase.
  2. Mostly in America – IRS has different treatments to the ATO of recognition of dividends for insurance companies
    1. Also – access to funds by APRA and the ATO is reliant on preservation ages – Even SMSFs you can do in house asset loans – but only for around 5% of the value of the fund
  3. Problem with borrowing against the existing whole of life in Australia – most people either don’t have these policies or don’t have enough cash balance to be able to borrow against their available funds

Summary –

  1. Technically not being your own bank – Definition of a bank – ADI – You deposit funds in your own account – with a ADI –
    1. The equivalent of setting up a loan agreement with yourself – which you can do from a company
    2. Self-insurance strategy – not be your own banker –
  2. For example – say you need $600k borrowings to buy a home? How are you going to buy a home if you don’t have $600k inside of a WOL policy to borrow from the insurance company?
  3. The concept in the USA could work on smaller borrowings – like a big purchase on a CC or car loan – if enough is inside of the policy
  4. But since Super and Term life now replaced the strategy of the WOL – IBC may not work here
  5. In modern times – just be aware of a lot of these concepts are heavily marketed by those selling these products for a living – and are designed for more affluent investors with lots of free cash flow and who have long term liquidity needs – which don’t meet the needs of most everyday people

Thanks for the question Mark

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

 

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