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How The Loan Ranger Can Save Policies In Peril

There are many sales ideas that revolve around the idea that the cash value of a whole life policy is akin to the policyholder having their own private bank from which loans can be taken. And there is absolutely no reason a policy owner would not do exactly that. Makes sense.

What does not make sense is that many agents who sell these plans forget to monitor those loans to make sure clients do, in fact, either repay them or plan for the potentially negative tax implications, if they don’t.

Our non-scientific data, obtained from decades of trying to untangle the knots clients tie themselves into after years of borrowing and non-repayment, indicate that the mutual carriers’ whole life products are the most borrowed against and also the most difficult to remediate.

To be fair, this is not a criticism about the product itself, but rather the reality of the complexity of how loans affect the structure of a product that clients, and some agents, clearly do not pay close enough attention to.

By the time we see them, most loaned policies are so deeply underwater that they are almost impossible to rescue.

To understand the problem and turn it into an opportunity you need to know a few things about the cause and effects.

Generally, clients take loans from their policies when they are in financial stress. It isn’t hard to imagine a policy owner using their whole life policy or policies as a convenient back-stop for cash flow during economic downturns or market declines, or for college funding, etc. Many planned loans also are taken out for retirement income, deferred compensation and other purposes. And the reality is most mutual company salespeople encourage their clients to purchase multiple policies and repeat this process, compounding the problem over time.

Unfortunately, most of these loans are not being carefully monitored. By the time we see them, most loaned policies are so deeply underwater that they are almost impossible to rescue. And the results are not pleasant. Either the client loses the coverage and creates a large taxable gain, or they accept a steeply discounted death benefit that is insufficient for their needs. By the time these issues surface, the clients are typically distressed by having tried to work out the problem directly with the carrier, whose policy service representatives are woefully under-trained to deal with these issues.

If there is a clear message to agents it is this: If you see clients starting to take loans to pay premiums, do not assume they are suddenly going to repay the loan or start making premium payments. You opened the door to owning insurance without paying for it. Policy owners do not understand the long-term consequences. The trend will continue, and the policy will deteriorate.

In-force illustrations showing projections of the policy not lapsing exacerbate the issue. Now is the time to replace these policies. Do not push the problem down the road until it’s unsolvable and you’re left explaining to your client that their only option is to pay a very large premium or recognize a very large taxable gain. Do the right thing today!

To that point, here are the details of a loan rescue that we recently completed.

The client is an 81-year-old man in good physical health. He had eight Northwestern Mutual whole life policies with:

  • Gross death benefit of $540,716.
  • Net death benefit of $379,554.
  • Total loan value of $161,162.
  • Tax basis of $19,469.
  • Taxable gain of $407,061.
  • Interest rates on loans a mix of 5% and 8%.

The client in this case had first spoken to his semi-retired agent and had been told to ignore the loan notices and not to worry because, “the policies will take care of themselves” and “there are no tax consequences to concern yourself with,” even though he was receiving notices from the carrier warning about the danger.

The client, on the advice of another agent, then contacted the carrier directly and spent considerable time on the phone with policy service, only to become even more concerned when he learned that there is not only a high probability that the death benefits would continue to precipitously decrease, but that some of policies could lapse and create a large tax problem. The client was unprepared for this outcome and wanted to preserve his death benefits and avoid the tax on any gains.

By coincidence, we sent this agent an educational e-mail discussing rescuing old whole life policies that have large loans. The agent contacted us.
We took the data to a large carrier that has one of the best loan rescue teams in the business. Here is what happened next.

First, I spoke with the agent for about 30 minutes, discussing the minefield the client was facing and various ways it can be repaired.

The agent e-mailed me policy statements, and my first suggestion was to arrange a conference call between us and the client. We also invited the client’s son so that another family member could be part of the process to ensure that everyone was on the same page. Throughout the discussion, the consistent message was that the primary obligation in this process was to protect the client.

At the meeting, we advised the client what was about to happen to those policies and suggested how to rescue them. We participated in several more conference calls — sometimes including the relinquishing company — so that there was total transparency. As a result, the client successfully had his eight policies rescued using mirrored loans, preserving the death benefit and no longer having a tax catastrophe on the horizon.

Unlike the agent who handled the client’s old policies, the client’s current agent has marked on his calendar to have subsequent policy reviews to communicate that everything is progressing as expected. The client no longer worries about his policies lapsing.

This agent not only helped his client, but made a well-earned new commission for his efforts.

The final result was that this 81-year-old client received a preferred rating, the new policy provides more net death benefit for less premium outlay and will last well past age 100 at  very conservative interest rate assumptions.

The problems associated with heavily-loaned policies do not go away, and these policies don’t magically lapse without tax consequences. Now is the time to review your client’s policies, before their health issues limit their options.

Anthony Giannone is a partner at CPI Companies. He has more than 15 years of experience in sales and providing support to financial advisors. He may be contacted at [email protected] .


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