Why Stop at 10–90? The Real, Most Anti-Base Premium Whole Life Policy Designs
10–90 is not as anti-base as you can go. So why stop there?
What’s an Anti-Base Premium Policy Design?
There is a vein of whole life insurance marketing on social media — maybe even the dominant vein — that advertises that the way to design and buy a whole policy is to limit the base premium to 10% of the annual premium outflow to the life insurance company. The other 90% is allocated to PUA premium.
This is what I’ll call the Anti-Base Premium method of policy design.
Sometimes the Anti-Base Premium method is advertised as the best way to buy whole life insurance for Nelson Nash’s Infinite Banking Concept or IBC.
It is not.
The Anti-Base Premium policy design — in any of its forms — inevitably results in a relatively limited PUA premium payment duration. That is, PUA premium will cause the policy to become a MEC much sooner than it otherwise would have, had the policy been built and purchased with a more substantial percentage of annual outlay allocated to the base premium.
Consequently, policy owners who wish to retain the preferable, traditional tax status of whole life insurance will reduce and ultimately entirely halt PUA premium payments much earlier than they would have otherwise been required to. Often, though not always, the period when PUA premiums must be reduced to retain the preferable tax treatment aligns with the policy owner’s highest income generating years (early 50s to early 60s). Therefore, when cash flow is most available, when the need to pay premium is at its greatest, these policies essentially stop accepting it (the PUA could be paid, but the policy may become a MEC).
In Nelson’s terminology, the Anti-Base Premium approach violates the admonition to Don’t be Afraid to Capitalize and Think Long Range. It’s often promoted in violation of Nelson’s admonition to stop dwelling on rates of return, and focus instead on the volume (the level) of growth. That is, Anti-Base Premium policies show a relatively high percentage of cash value growth compared to premium outlay, both on an aggregate and annual basis, in the early years. Therefore, cash-on-cash or breakeven year (the year where total cash value first exceeds the cost basis) comes earlier in the life of the policy. The positive cash-flow year (the year where annual cash value growth exceeds the annual total premium) also comes earlier. Because base premium payment doesn’t contribute meaningfully to rising cash value growth until several years into the life of a policy, policies with more base premium as a percentage of the total outlay are relatively illiquid compared to their Anti-Base premium counterparts early on in the life of a policy.
Policies with substantial base premium (and, potentially, the appropriate term rider) will typically accept maximum PUA for 25–35 years, depending on dividend performance in the interim time period. Anti-Base Premium policies will rarely accept maximum PUA for up to 15 years. More commonly, one might expect 7–10 years of maximum, 90% of outlay, PUA premiums. For policies where the insured’s underwriting status is Standard Non-Tobacco, positive cash flow years and cash-on-cash years may occur in years 3–4 and 5–6, respectively, on Anti-Base Premium policies; whereas one might expect these inflection points to happen in years 4–6 and 8–10 on more long-term oriented, IBC-style policies.
The Anti-Base premium indulges the conventional financial paradigm: it’s short-term oriented, emphasizes near-term rates of growth, and implies an advisory framework where observing the difference in the magnitude of numbers is substituted for more methodical strategy. Often, but not always, these sales occur in a relatively low-attention environment. That is, quickly after the initial introduction to the client, or at the time of initial contact; a potential client will be asked how much premium they want to pay; the agent will create or request that the insurance company home office create an illustration with a 10–90 design from their preferred carrier; the illustration will be sent to the client; an application interview will be conducted; underwriting ensues; and the policy, if the application is approved, is delivered electronically.
Rarely is there much discussion of the need to solve for the long-term, in fact lifetime, need to recapture more and more of the banking function, or to otherwise solve for the need for capitalization on an on-going basis. There is often very little in the way of client education regarding the particular features of the contract, like: the degree of flexibility in the PUA rider, the type and nature of the term rider, the dividend allocation, the duration of PUA premium payment allowance, whether PUA must be paid at a set premium mode, the nature of the PUA catch-up provision (if any), timing restrictions on PUA premium payment, recognition treatment, premium funding strategy, outside financial conditions, the client’s overall financial condition, death benefit and maximum insurability analysis, among others.
For those wondering how I might know any of this — it’s because I am told these things directly by current and former clients or potential clients of advisors who market the Anti-Base Premium design method.
As I’ve suggested in this article, the Anti-Base Premium policy design method is type of creative insurance design. It is not an IBC-style approach.
And that’s fine! As you’ll see, and as you can probably guess, I’m not a fan of this approach. And while I can envision circumstances where the Anti-Base Premium approach could theoretically align with an otherwise IBC-style financial approach, these are extremely rare, if not non-existent.
But Why Stop at 10–90?
I’ve been aware of at least two mutual life insurance companies that offer policies with unique actuarial design and the necessary riders that allow for an even further reduction in the base premium as a percentage of the total outlay.
One company I know of will allow 5–95 designs. With another, you can get down to 4–96, so long as the insured is in good health.
These policies show even faster cash value growth as a percentage of annual outlay, and even more cash value sooner than in their 10–90 counterparts.
Of course, the dynamic explained above holds here too. As the base premium is crushed, years of maximum PUA premium payment are shaved off. PUA premiums this substantial may only be payable in the first policy year.
But why would that matter? If the goal is to maximize cash value on an annual or aggregate basis as soon as possible, then why stop at 10–90?
After all, as promoters of Anti-Base Premium policy designs suggest, once PUA premium is no longer payable in a non-MEC fashion, the client could just simply go get another policy.
Of course, this means going through medical and financial underwriting again, at a higher attained age, and after a period of unknown intervening medical and financial circumstances. It also means that the individual’s policy portfolio over the course of their lifetime will ultimately consist of a relatively higher quantity of relatively newer, smaller (in terms of total cash value growth) policies — if the client is successful with those future applications in the first place. It also likely means the incorporation of annually-renewing term riders, blended term-PUA riders, or short-dated level term riders — the faults (in my view) of which I’ve expressed elsewhere — which typically come with relatively greater amounts of death benefit. These greater amounts of death benefit mean less unused insurability at the time of new applications. This is not to say that there is no time ever to add another policy, to the contrary. But it is to say that ultra-low base premium designs unnecessarily reintroduces new policy purchase cycles.
In short, the Anti-Base Premium approach is likely to result in an overall policy system, over the course of one’s lifetime, that simply accepts less premium. The result is less total cash value generation over one’s working lifetime, and potentially by a wide margin, as I show in Lecture 6 of my Whole Life Insurance Mechanics lecture series (see below).
But — very likely — none of that was part of the advisory conversation to begin with. Solving for the banking function — much less on an on-going, lifetime, basis — wasn’t the point.
So What’s Going on Here?
I suspect that the reason more severely Anti-Base Premium approaches are not as popular online yet is because (a) people don’t know about them and (b) many of the insurance providers with which the advisors who use this approach partner don’t allow policy designs this extreme.
Life insurance companies are aware of their agent’s online marketing. And every few years, whole life policies are revised and updated to conform to new regulations and to take into account updated mortality and financial statistics. I have noticed that companies are starting to offer policies that from an actuarial perspective, will accept ultra-high PUA early in the life of the policy, in a non-MEC fashion, whereas in the past, their policies were more traditional, long-term oriented in their actuarial design. I may be speculating, but I suspect that this short-term oriented, maximum-early liquidity approach is popular enough that companies are starting to modify at least some of their product offerings in order to “compete” in this part of the market.
Of course, that “competition” virtually always comes in the form of illustration shopping where a prospective insurance consumer is implicitly encouraged to compare the non-guaranteed, future policy values on whole life insurance illustrations. The higher the numbers (specifically non-guaranteed cash value), the more preferable the product, or so the thinking goes.
This approach overlooks important, qualitative, contractual distinctions between — in particular — PUA riders. As actuaries design whole life policies that can accept ever fewer base premium dollars, the calculations become more fine-tuned and specific. With respect to the MEC rules, the timing and magnitude of PUA premiums becomes more important. Mistimed, or unscheduled, PUA premium payments and PUA premiums of varying or irregular magnitude may be sufficient to cause the policy to become a MEC. Therefore, as these new policies are brought to market, their PUA riders are often more restrictive in terms of the allowable variation (if any) in the timing and magnitude of PUA premiums.
Both of the companies that allow either the 5–95 or 4–96 policy design do not allow any variation at all in terms of the timing and magnitude of PUA premium payments in the first policy year. One of the companies offers no catch-up provision at all. The other’s only covers a two-year period. In one of the companies, the minimum PUA premium is a very substantial percentage of the illustrated premium. In the other, unscheduled PUA premiums are potentially subject to underwriting approval. The PUA riders from the two companies that are most popular among the 10–90 crowd are relatively restrictive, too.
PUA rider restrictiveness (and not to mention the type of term rider necessary for Anti-Base Premium designs) does not mean the issuing company is a bad company, or even that the policy shouldn’t be purchased!
As in all things, there are trade-offs.
However, in my view, the degree of favorability — defined by the degree of unconditional contractual flexibility and control conferred to the client — absolutely matters in the IBC-style planning context, in my opinion. The fact is that as the years roll by, relatively more complicated, more restrictive riders may cause frustrated expectations. Of course, everything might go perfectly well, and these restrictions may never constitute a meaningful obstacle. What we conclude is that all else equal, simpler and more contractually favorable becomes more important as the individual’s time horizon extends.
Regardless, relatively more complicated riders are an ancillary concern. The primary consequence, in my view, is that these policies will not accept the kind of premium over time that a tersely stated policy design ratio might imply.
Consider it this way. How many conventional bankers start actual banks in order to accumulate capital for a limited number of years? More broadly, how many business people go into business to generate profits in the near term only?
What may be the fundamental flaw in the Anti-Base Premium approach to policy design is the implicit belief that premiums are bad. That they’re a necessary evil to be endured rather than an opportunity to embrace. The relationship between premium and cash value is viewed less as symbiotic, and more as zero-sum. The policy owner is “losing something” by paying a premium in order to gain something else, the cash value. As much as possible, for as little as possible is the underlying logic.
That said, there is some cash value accumulation in these creatively-designed policies, whether they are ultra Anti-Base premium as in 4–96, or just modestly so as in 10–90. And some is better than none. Rarely should these policies be exchanged or otherwise cancelled. Most often, they should be kept and whatever premium is payable to them should be paid.
[This isn’t financial or life insurance advice. Talk to a professional regarding your specific situation before doing anything with your money.]
My encouragement follows along with Nelson’s fifth rule: Rethink Your Thinking. What attracted you to message of IBC in the first place? What problem are we actually trying to solve? What is the relationship between premium and cash value, conceptually speaking? Cast your mind out years into the future — think long range. Would you want the opportunity to pay premium 20 or 30 years from now? Statistically speaking, is the pace of your income generation likely to accelerate or decelerate? If the former, would you want the ability to pay relatively more or relatively less to your personal monetary system? Is there some underlying resistance you’ve yet to address? Does the fact of early illiquidity still worry you? Why does it? Are those proper, legitimate reasons? What matters more: early rates of cash value growth relative to initial premiums (the rate), or the maximum level of cash value accumulation (the volume). Put it this way: over your lifetime, would you rather have less capital that grew faster earlier, or more capital that grew faster later?
And in any case, if as a result of examining questions like these you still decide that you want as little base premium as a percentage of annual outlay as possible, just remember that 10–90 is not as low as you can go.