John Moriarty (2015)
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Page 6: The main intent of traditional life insurance contracts is for death benefit protection. Any outstanding loans on a policy will directly reduce the death benefit and decrease the amount of coverage received by the policy's beneficiaries. Interest must be paid back or the death benefit will be further reduced and could actually result in negative cash value. This event could cause the policy to lapse and all policy benefits to be eliminated. Should a policy lapse or be surrendered, any policy gains created internally would cause income taxes for the policy holder.
Page 9: We wrote this book to counter the message from mainstream media and large financial institutions who believe there is very little value in owning cash value life insurance for the majority of Americans. If you spend any time listening to people like Dave Ramsey or Suzie Orman, you know their opinion of cash value life insurance. Some of the talking heads will tell you that cash value life insurance is too expensive, a horrible investment, or a product insurance agents sell only because they are paid a large commission to do so!
Page 9: If designed properly and monitored frequently by a financial professional who is well trained in cash flow strategies and alternative asset classes, your opinion of cash value life insurance may change significantly.
Page 9: We believe everyone who has positive cash flow and good habits with money deserves to hear about how a specially designed life insurance contract (SDLIC) can be utilized as both an alternative asset class and a cash flow tool. If you believe in minimizing your risk in your portfolio and want to pay cash for big ticket items in your personal and/or business economy, then we urge you to keep reading.
Page 10: While accumulation strategies are definitely important in a saver's personal or business economy, proper utilization strategies allow people to control the flow of their money while it works for them. We call this phenomenon uninterrupted compound growth. To understand this concept, you also need to realize that there are three different types of return you can create with your money
Page 11: It doesn't matter how much money you make, save, inherit, or receive if you don't have the simple habits of saving first and spending less money than you have available. Otherwise, your financial picture could be in jeopardy
Page 11: Internal return is what your asset generates through its performance (both income and appreciation over time). In most cases, this is calculated as the return on investment (ROI). Most retail, market-driven vehicles (stocks, mutual funds, and exchange-traded funds [ETFs]) use this return to measure their performance
Page 11: But internal return is normally out of your control because you have no way to know how much appreciation you'll earn from the market.
Page 11: External return is rarely considered, but entrepreneurs and institutions take advantage of this economic benefit all of the time. Think of it as your return on cash flow. When you properly utilize your money and leverage your internal return by getting more of your money to flow into your control, the results are magnified. You can do this by minimizing the opportunity costs that impact your daily life, such as: Interest costs from banks, credit cards, and mortgage companies Lack of control of your principal as you pay down debt Restricting the use of your money to one goal only Being held hostage by income taxes when you want to access your money
Page 12: External return is subjective because everyone's financial picture is different.
Page 12: You first need to realize that cash flow is everything. Managing your budget to keep spending on a realistic path while simultaneously building savings is extremely difficult. Next, you should implement financial strategies that get money flowing into your control without completely depleting your savings or access to capital. Paying off credit card debt, student loans, and your home is a very beneficial financial strategy, but if you leave yourself with zero savings to accomplish these goals, you could wind up vulnerable should an unexpected event occur with your job, health, or family that affects you financially
Page 14: This is one big reason I am a proponent of certain types of alternative assets for these types of big-ticket items. If structured properly, certain assets can produce both internal and external returns while you use the money. Instead, you need to look at your financial picture and see how each return impacts your personal economy. The lower your asset values, the greater impact external returns will have on your financial picture.
Page 14: You must find an investment strategy that minimizes risk while achieving an expected internal return. Your financial professional needs to align with it.
Page 16: Most people who are successful at building first-generation wealth intend to leave legacies for multiple generations to use and carry forward. This is what I call one's Eternal return. It is the culmination of your time, talent, and capital passed on to the next generation. It can be comprised of assets, the knowledge you impart to your family during your life, and the goodwill you have created for your family legacy, etc. This type of return includes a lot of intangibles and is sometimes difficult to grasp but make no mistake—it could be the most valuable return of all.
Page 16: As borrowers were benefitting from a 30+ year decline in interest rates, savers were being punished as interest paid on balances in their bank accounts shrank.
Page 17: And, while interest rates were going down, the outstanding debt for our country and the Federal Reserve's balance sheet increased significantly! Over this period of time, Americans were encourage to keep consuming and take risk with their money to keep the economy alive and promote equity investments as opposed to keeping money "on the sidelines" in cash and continue saving.
Page 18: Since the 1960's, people's habits of saving money deteriorated but the stock market has continued to climb over the past 10 years. Ask yourself "Who is benefitting from this stock market surge?"
Page 19: Savers need guidance and alternative strategies right now that provide solutions for both the short term and long term horizon simultaneously.
Page 23: When a person with good money habits spends their money, that principal is viewed as being gone forever. There is an opportunity cost present when this happens as their principal is no longer able to generate any type of return in the future. We call this an external return because the money is no longer in your control. Our intention is to help someone choose to spend their money while reducing or eliminating certain opportunity costs over their lifetime. It's important to understand the dynamic between these three words – SAVE, INVEST, and SPEND – and why some people confuse their meaning.
Page 24: The process of storing money in a safe place is called accumulation and the process of deciding whether to invest or spend your savings is called utilization.
Page 26: Once the door is opened to your business, the number one priority is to create strong cash flow as soon as possible. Positive cash flow will result from a good awareness between what expenses need to be paid on a month-to-month basis and those big ticket purchases that are the wants in your business plan.
Page 27: The important thing to understand in this situation is that you STORE your cash flow in a place where it's safe, liquid, and achieving some level of growth.
Page 27: A successful company operates in a manner where surplus cash flow quickly provides them OPTIONS as to where cash flow is allocated in the future.
Page 27: We've summarized three of the most common scenarios our business clients implement with their cash flow:
- Accelerate the Repayment of Bank Loans
- Build Up Personal Assets
- Build Up Business Assets
Page 28: When a business is successful, one of the best usages of excess cash flow is to reinvest those funds back INTO THE BUSINESS!
Page 29: While improving the ROI of a business is a top priority for an owner, it's also important to minimize any opportunity costs that materialize from certain decisions.
Page 30: Our firm believes today's conservative saver with good money habits needs to consider utilizing a different financial institution to store their money while they are waiting to use it. In essence, you can adopt your own privatized banking strategies through a Specially Designed Life Insurance Contract (SDLIC).
Page 31: Rather we are attempting to design a financial vehicle that can mimic certain banking functions in one's personal/business economy – like financing big ticket purchases and controlling where your cash flow is stored.
Page 31: Certain components must be present for a SDLIC to be optimized: Become insured by a Mutual Insurance Company with strong financials Use a participating whole life contract with design flexibility The contract must allow for access to the policy cash value through policy loans while the policy is being capitalized (the first 5-7 years of the policy) Use a contract that continues to pay dividends at the same level even after a policy loan has been taken (called a non-direct recognition loan)
Page 31: A mutual insurance company (MIC) is an insurance company owned entirely by its policyholders. Any profits earned by a MIC are returned to the policyholders in the form of dividend distributions. The concept of a MIC in the United States dates back to the mid-1700s as a way to pool risks associated with an unexpected loss. Life insurance companies that resemble a mutual structure number less than 50 in the U.S. today. This is due to the conservative nature of MICs.
Page 32: Our company's research has determined there are a select few of the top rated ("A" or above) insurance companies maintaining a mutual structure. Their financial strength is a core reason we communicate SDLIC policies as a safe money alternative to putting cash in the bank or allocating money to bonds.
Page 32: Building a specially designed life insurance contract is all about optimizing the different components of a whole life insurance policy. Here are the main components that can be customized:
Guaranteed Cash Value: This is the amount of cash value available in the policy that is contractually guaranteed. Dividends are added to the guaranteed cash value to get the total cash value in a policy.
Dividends: A dividend paid to your policy represents your share of the mutual insurance company's divisible surplus. The dividend is paid on the anniversary date of your policy. For tax purposes, a policy dividend is treated as a return of capital by the IRS and is not taxable to the policy owner.
Page 33: You may elect to receive dividends in any of the following options:
- Paid in Cash (note: if your dividends received exceed your premiums paid at some point, you will create a taxable event)
- Apply to your Premium Payment (lowering future premiums)
- Accumulate Dividends at Interest (interest earned will create a taxable event)
- Use Dividends to Purchase Paid Up Additions (this is the option always recommended with SDLIC) Once dividends are paid into a policy they are added to the guaranteed cash value and receive compound interest. At this point the dividend is treated as part of the policy cash value for the insured's entire life.
Paid Up Additions (PUA): Paid Up Additions can be added to a whole life contract as a rider or purchased with policy dividends. PUA's immediately increase the cash value in a policy and also become part of the death benefit. PUA's are treated as a single premium insurance contract added to your base policy and allow more design flexibility with SDLIC. PUA's receive their own dividends and those dividends receive compound interest when they remain in the policy.
Page 33: PUA's can be level or a one-time single premium (LPUA or SPUA). SPUA's are received in the first year of the policy and normally result from another policy's cash value being transferred into a SDLIC. This transfer is called a 1035 Exchange. This type of transfer protects the cash value from the old policy from being taxed and it also protects the new SDLIC from becoming a Modified Endowment Contract (MEC).
Term Rider: Depending on the design of a SDLIC, the age of the insured and the health of the insured, additional term insurance may need to be added to the policy in the early years in order to avoid the SDLIC becoming a MEC. This term rider is normally removed after 10 years to optimize the cash value accumulation of the SDLIC.
Page 33: The three main components to build a SDLIC are the:
- Base Premium,
- Level Paid Up Additions (LPUA), and the
- Term Rider. A properly structured SDLIC needs to have adequate early cash values for the policy owner to access while also building a solid dividend scale that creates long term cash value accumulation in the policy. This feat is accomplished by balancing the amount of your annual premiums that are split between Base and LPUA. The trick is to properly allocate enough premiums to both in order to optimize the long term performance of a SDLIC.
Page 34: Most traditional whole life policies are built with 100% of the premiums going towards the base premium. This helps develop a strong, long-term dividend scale but causes the cash value growth in the policy to grow very slowly. This is why most people think a permanent, whole life policy is a horrible investment because they don't have any cash value build up for five, seven, sometimes 10 years.
Page 34: With SDLIC, a policy will be designed where the base premium is 30%-50% of the total premium and PUA's are 50%-70% of the total premium. This design should optimize long-term dividends, increase early cash value access and increase flexibility in utilizing your policy. It is important to understand that this type of policy design does have some limitations. There are certain tests the insurance company must perform on a SDLIC to make sure it is not a Modified Endowment Contract (MEC). If a policy becomes a MEC, it will lose the tax preferential treatment of loans and operate more like an annuity. To protect against a MEC design, there needs to be a certain amount of policy death benefit in the early years of the contract (7-10 years) to meet the MEC guidelines.
Page 34: Any person setting up a SDLIC needs to understand that they will not have access to 100% of their money for 5 to 7 years, depending on the age and health of the insured and the capitalization by the owner.
Page 35: If you are planning to utilize the policy early in its setup (within the first 24 months), it is imperative that you continue to capitalize the policy through year five or at least begin a payback of the policy loan in some minor capacity.
Page 40: It is true that putting your money in a bank account gives you access to 100% of your money, but you should ask yourself "What is the cost of that decision to prioritize 100% liquidity?" You're trading 100% liquidity for virtually no internal return (less than 1%) and once you take money out of your bank account, the money stops working for you forever.
Page 43: The volume of interest measures the total amount of interest you pay during the term of the loan. That figure is more important than the rate of interest that you are charged
Page 44: Even if you don't desire to restructure your existing loan, it is possible that life events may cause financial stress or opportunity and force you to apply for a new loan!
Page 45: Finally, realize that in today's economy, it is rare for a bank to loan you money based on just your ability to pay them back or your history of being a "good customer". These types of personal or signature loans are a thing of the past. Nowadays the most scrutinized part of the loan qualification is the assessment of your collateral. The bank will require that your collateral be appraised and they are in charge of choosing who appraises the collateral in most situations. Also, the bank will want the collateral to be as liquid as possible and they will make sure your loan balance does not exceed a certain percentage of the collateral.
Page 45: In summary, the qualification process for a loan with a bank has these features: Borrower chooses Dollar Amount to borrow Bank requires Borrower to Qualify for the Loan Bank controls the Terms of the Loan The Terms of the Loan are inflexible and cannot be restructured without restarting the loan qualification process Most bank loans require Collateral these days Banks want collateral that is liquid and the value is determined by appraisers normally chosen by the bank
Page 45: This structured loan process favors the bank's financial position over the borrower. What if a more unstructured platform could be utilized to access capital in today's economy? Could opportunity costs be minimized for the borrower?
Page 46: One of the misunderstood features with a life insurance contract is the ability to access the cash value through a policy loan.
"Policy loans are unique among life insurance investments for two reasons. First, they are not made as the result of an investment management decision. They are options exercised at the discretion of the policy holder. Second, because loans should never exceed their cash values and unpaid principal amounts may be deducted from cash surrender or policy death proceeds, the safety of principal associated with most loans is absolute."
Page 46: When comparing the process of a policy loan versus a traditional loan through a bank, the terms are very favorable to the borrower when a life insurance company is the financial institution. Once a policy is funded and money is available, the policy owner can request a loan. There is no qualification process; only a loan request form must be completed noting the dollar amount and the method of payment (mailing the check or direct deposit into a checking account). The policy owner gets to decide when the loan will be repaid (if at all). The flexibility in the repayment structure is ideal because it allows the policy owner to control their personal or business economy. If cash flow is plentiful, an accelerated repayment can be set up.
Page 46: If cash flow is temporarily tight, then a decision to delay repayment until a future date may be appropriate. And if the policy loan is being utilized to create wealth by other means (a strategic investment or paying off debt), the positive leverage created by the SDLIC can lead to the policy owner benefiting from uninterrupted compound growth.
Page 47: In our opinion, the best types of policies that produce uninterrupted compound growth have certain features in their product design
- The contract offers non-direct recognition loans. This means your policy loan is made directly with the life insurance company and you are borrowing from their general assets. This loan method does not impact the dividends paid to your policy or the compound interest earned on your policy. Essentially, your internal return is unaffected. The insurance company will hold your policy's cash surrender value and the death benefit as collateral for your loan. If you decide to surrender your policy while a loan balance exists or if you die with a policy loan, the loan balance plus interest is subtracted and the remainder is paid either to the policy owner (in the example of surrender) or the beneficiary (in the example of death).
- The contract offers a favorable amortization when loan repayments are made. As mentioned earlier, most financial institutions will control the amortization of how much principal and interest compose each payment. However, if you have a SDLIC with an insurance company who amortizes the loan in the borrowers favor, the results can offer substantially more flexibility. Finding an insurance company that will apply a large percentage of loan repayments towards principal first means those funds are available to be accessed by the policy owner for immediate borrowing! Finding an insurance company that applies 100% of the loan repayments to principal is ideal and working with an advisor who is an expert in SDLIC can accomplish this task.
- When a policy loan is made with an insurance company they will require collateral just like any other financial institution. However, the insurance company is willing to accept an illiquid form of collateral – the policy death benefit. As long as you keep your policy inforce and maintain some amount of cash surrender value, your death benefit will be used to pay off the loan balance. The remaining death benefit will pass to your beneficiary(ies) income tax free. At this time, I think it is important to address one of the most common concerns with this strategy that involves borrowing from a life insurance policy:
Page 48: Why is it a good idea to borrow my own money and pay interest on my own money? The answer to this question is rooted in both the tax code and the structure of a life insurance company.
Page 48: First, you want to borrow through your life insurance policy because policy loans have preferential treatment in the Internal Revenue Code (see IRC Section 7702). Technically, you are borrowing from the life insurance company while they are holding your cash surrender value and death benefit as collateral. Through a policy loan you can access internal growth and principal without being taxed as long as the policy remains in force.
Page 48: The second thing to realize is the difference between PAYING interest on a loan and being CHARGED interest on a loan. Paying interest means the interest is already built into the amortization of your loan payment. With a policy loan, the insurance company CHARGES you interest and that interest is paid after your principal is prioritized. So, if an insurance company applies 100% of your loan payment to the principal balance that means your loan principal gets paid off first and the interest is the last thing to be eliminated. If the loan is non-direct recognition, the loan interest will not improve the internal return on the policy if it is paid off. So, the interest may be left to accumulate against the death benefit, so as not to interrupt access to the policy utilization while the insured is still alive.
Page 48: Again, you must understand that the RATE of interest charged is not as important as the VOLUME of interest that accumulates over time. Most Americans have been conditioned to focus on the interest rate itself versus when you are paying interest and how much over time.
Page 48: The benefit of the SDLIC is that the volume of interest decreases over time when loans are paid back because that money is going to the loan balance, not paying the interest to the life insurance company. Very few financial professionals can explain this difference to you! In order to optimize a SDLIC in your financial picture, it is imperative that you customize its design to fit your cash flow, available assets, income tax situation and your utilization needs
Page 49: The concept of using a Specially Designed Life Insurance Contract (SDLIC) as an alternative asset class to bonds and cash is a concept taking shape in the financial services industry. Here are some reasons why we believe that a SDLIC can replace the role that traditional fixed income assets performed in your portfolio over the last 30+ years.
Life insurance companies (specifically mutual insurance companies - MIC) are financial institutions with unique characteristics that can offer a different way to allocate your monies versus bonds and cash. What makes a life insurance company unique is that their operation is more of a liability driven business with actuarial certainties already factored into their financial models. The main financial product offered to the public, a life insurance contract, provides protection through the death benefit as well as the accumulation of savings. Because both the death benefit and cash value of the policy are a liability on the insurance company's financials, it is very important that the assets held on their books represent a conservative portfolio. Looking at data provided by SNL Financial, the life insurance industry aggregate assets accomplish this goal:
- Bonds - 74.8% (mainly corporate bonds)
- Equities - 2.3%
- Mortgages - 9.9%
- Real Estate - 0.6%
- Policy Loans - 3.7%
- Cash and Short Term Investments - 3.1%
- Derivatives - 1.2%
- Other Investments - 4.4%
- TOTAL ASSETS - 100%
First thing to understand when investing is size matters. The larger your portfolio or the more money you have to invest, finding better opportunities with more attractive terms is a possibility. Who do you think will get access to better yielding bonds: an individual with $500,000 to invest OR an insurance company with $50 million to invest? FDIC pools its reserves into the Deposit Insurance Fund (DIF). When people deposit or save money in a bank, they are under the impression that their money has FDIC protection. It is important to know what assets are actually backing their bank's assets should the bank fail for some reason. At the end of 2007, the DIF had a balance of $52.4 Billion on insured deposits of $4.29 Trillion. That represents a reserve ratio of 1.22%. The fund is mandated by law to keep a balance in the DIF equivalent to 1.15% of insured deposits. That ratio is extremely low compared to reserve requirements for other types of financial institutions and that is why the FDIC also reminds depositors on their website www.fdic.gov that FDIC deposit insurance is backed by the full faith and credit of the United States government. What that essentially tells you is the US government will use all of its powers to tax and spend to protect depositors. Of course, it is ironic that the people being affected by higher taxes and loss of purchasing power through currency devaluation are the same people depositing more of their savings into banks! Finding another financial institution that values financial strengths as one of its main purposes is paramount for conservative savers today.
The purpose of most fixed income investments inside of a portfolio is to minimize risks associated with equity securities and fulfill the need of generating income off your portfolio.
Page 53: A SDLIC has the characteristics to accomplish your Utilization strategies while minimizing the key risks that threaten your personal economy:
1. Market Volatility: The benefit of SDLIC is that it doesn't rely on stock market performance at all to accomplish its intended results. As mentioned before, life insurance companies on average have less than 3% of their assets in equities.
2. Inflation: While interest rate movements can be a symptom or result of inflation, the real definition should be understood as the loss of purchasing power through the devaluation of our currency. In order to stay ahead of inflation, one needs to utilize strategies that grow your assets at a rate above the inflation rate. That rate of growth can be created through income and appreciation sources. A SDLIC is able to provide conservative savers a way to hedge inflationary concerns and its impact on your personal/business economy. As interest rates rise, dividend rates can rise to offset the negative impact on your financial picture. Since dividends are positively correlated to interest rate movements, there is a way to have your money working for you (through dividends and interest) while you also have the ability to utilize your money (through policy loans). This combination is hard to find in other asset classes.
3. Income Taxes: Most mutual insurance companies who offer policies that fit the SDLIC strategy are more than 100 years old. For example, one company that we utilize, Lafayette Life, has been operating since 1905. That means they are older than our Internal Revenue Code, which was established in 1913 with the creation of the Internal Revenue Service. Since the inception of our tax code, life insurance contracts have always received tax preferential treatment. For example, dividends from whole life policies are treated as a return of capital for tax purposes making those policies very tax efficient. The internal build-up of cash value in a policy grows tax deferred and is accessible by the policy owner on a tax free basis through proper use of policy loans. Finally, beneficiaries receive the death benefit income tax free. If a policy loan exists when the insured passes away, the loan balance is simply subtracted from the death benefit and the remaining balance goes to the beneficiary income tax free.
4. Longevity Risk: Determining a way to take care of both your month-to-month expenses and big ticket items in retirement is essential if a retiree wants to enjoy retirement! SDLIC's are built to manage one's big ticket items throughout retirement and all of its other benefits optimize its utilization so the purpose of one's money is protected.
If a SDLIC is set up with the right contract offered from a highly rated mutual insurance company, then you will own a very unique financial vehicle. SDLIC's achieve uninterrupted compound growth when very few asset classes have the ability to do so. It's tough for people to comprehend this concept because most people are not aware of the opportunity costs that relate to every financial decision. When you choose to do something with your money (save it, spend it, or invest it), the opportunity cost relates to the fact that your money could always be doing something else. Depending on your mindset with money or finance related decisions, opportunity costs can result in more of your money flowing out of your control and into the control of other financial institutions. With the implementation of a SDLIC, your personal/business economy has the ability to optimize the internal, external, and eternal returns of your financial picture. There has got to be a better way to save and utilize those dollars than leaving it in the current system that does not add any value to one's personal or business economy. For most Americans the traditional view of assets allocation has benefitted them greatly as they've accumulated money for several decades. Those same people are now paralyzed due to a lack of confidence in their financial strategies because the economic environment has changed so drastically.
Page 64: Most people are unaware that the SEC's stated mission is to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.