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  #1  
Old 01-30-2019, 02:40 PM
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Default "Key man" Life Insurance to fund a public pension?

I need some help understanding a proposal someone is making and the potential problems/benefits of it. It is basically being proposed as "free money" which automatically raises my suspicion.

The gist is a public retirement system creates a separate trust to purchase single-premium whole life policies on its members. The proceeds are split 50/50 with the member's estate.

To avoid any out of pocket costs to the system, the new trust will use loans to purchase the insurance (presumably collateralized by the insurance policy) which will be paid back from the trust's portion of the death benefits and/or the use of the cash value once the CV is sufficient to cover the loan. Additionally, once available "excess cash flow" will be used to make future life insurance purchases and loans will no longer be used.

I am in the process of asking for projections prepared by individuals making this proposal but I am struggling to see how this makes financial sense. I am guessing this is being sold as a "guaranteed return" but given the constraints surrounding insurance company investing, is this an improvement over the pension trust simply investing in long duration bonds?

I am not familiar with how the cash value accumulates but wouldn't borrowing from the CV to pay back the loan impact the ultimate payout? Can someone help me out with a basic explanation of how the CV generally accumulates? What kind of "guaranteed rates" are we talking about here?

I have a lot of other questions and thoughts but I thought I would throw this out there to get started.
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Old 01-30-2019, 03:08 PM
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Speaking from Canadian knowledge, so rules could be a bit different.

Borrowing from the CV of the policy doesn't make sense, because loan rates are higher than any return they'd get. 6% vs. 3%, something like that. They probably mean borrowing against the policy, but through a standard bank loan.

Usually what you do here is buy the policy, then borrow against it to get most of your premium back. You then pay the interest on the loan, which is one of the rare cases where insurance policy costs can be made tax deductible. The policy will earn more than the loan interest.

Inside a pension plan, I am not sure what the point would be. You are exposing tax sheltered pension money to insurance taxation. The death benefit payout, which is tax free, goes into the trust tax free, but is then taxable when paid out.
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Old 01-30-2019, 03:10 PM
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The insurer might offer a rate better than market. I know of one here that offers 4% fixed ten year.
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Old 01-30-2019, 03:24 PM
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Quote:
Originally Posted by ElDucky View Post
Speaking from Canadian knowledge, so rules could be a bit different.

Borrowing from the CV of the policy doesn't make sense, because loan rates are higher than any return they'd get. 6% vs. 3%, something like that. They probably mean borrowing against the policy, but through a standard bank loan.

Usually what you do here is buy the policy, then borrow against it to get most of your premium back. You then pay the interest on the loan, which is one of the rare cases where insurance policy costs can be made tax deductible. The policy will earn more than the loan interest.

Inside a pension plan, I am not sure what the point would be. You are exposing tax sheltered pension money to insurance taxation. The death benefit payout, which is tax free, goes into the trust tax free, but is then taxable when paid out.
This is literally being sold as "no out-of-pocket" costs (i.e. "free money"). The intent is that a separate trust will be created to hold these assets, not that the existing pension trust will purchase the life insurance policies so there are no existing assets and no contributions will be made to the new trust. Therefore, the initial set of life insurance policies will be purchased via loans. Those loans will be paid back from either the proceeds of the life insurance policy or "when the cash value of a life insurance policy is sufficient the trustee may borrow against the policy to repay the loan of a third-party lender".

There is some discretion regarding the use of funds, so it is not necessarily required to use the CV to pay back the loan, but loans are definitely the intended funding vehicle to get this off the ground.
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Old 01-30-2019, 03:40 PM
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How is the loan interest paid? Is it just allowed to grow the principal? Who is on the hook for it? If it's just the trust, and something goes sideways, then I guess there is no risk.

So, let's take $100 billion worth of risk free money then. Something doesn't make sense, but based on the info, I don't know what it is.
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Old 01-30-2019, 03:49 PM
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Originally Posted by ElDucky View Post
How is the loan interest paid? Is it just allowed to grow the principal? Who is on the hook for it? If it's just the trust, and something goes sideways, then I guess there is no risk.
I honestly don't know. I had a 5 minute conversation about this with the person suggesting it and I have read the text of the proposal so my initial impression is the only way this works is some sort of arbitrage between the CV accumulation and the loan interest, but again, I haven't seen any projections or numbers on this yet.

Quote:
So, let's take $100 billion worth of risk free money then. Something doesn't make sense, but based on the info, I don't know what it is.
That's why I am looking for others opinions as well as what questions you all might ask so you can make me look smarter when I ask them
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Old 01-30-2019, 04:08 PM
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Again in Canada, you can take a loan for 90% of the cash value. I'm not clear how the trust is paying the interest though. I guess they use the loan proceeds to cover the interest.

The initial loan though would seemingly have to be unsecured. How are they getting a loan against a policy that doesn't exist yet? Who is loaning them money to buy a policy and then using that policy as the collateral?

It's just this starting off point that doesn't make sense. Once it's going, it presumably can work.
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Old 01-30-2019, 05:05 PM
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The specifics of the life insurance policy are important here. I think there's a fair bit of this done in the Indexed Universal Life (IUL) market - e.g. this piece from a brokerage.

As you keyed in on, the key is the arbitrage between the CV growth rate and the loan rate. IUL can be illustrated with relatively high credited rates (6-7%+) so depending on the exact time period, could show quite a bit of difference. The catch, of course, is that the IUL credits aren't guaranteed - dependent on both market performance, as well as non-guaranteed elements set by the carrier.
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Old 01-30-2019, 05:12 PM
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Originally Posted by ElDucky View Post
Usually what you do here is buy the policy, then borrow against it to get most of your premium back.
in the US, the IRS has taken a dim view of that.

https://www.businessinsurance.com/ar...-coli-policies
http://www.cfo.com/risk-compliance/2...the-coli-wars/
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The IRS wants $6 million in back taxes from CM Holdings, Camelotís parent company (now owned by Trans World Entertainment). After a similar ruling last year by the U.S. Tax Court, Winn-Dixie Stores was forced to take $42.5 million in charges against earnings this past August.
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Old 01-30-2019, 05:18 PM
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I used to work for a consulting company that did quite a bit of similar projects. But one of the benefits was *ahem* "tax efficiency". The clients weren't doing it just to reduce their taxes, no no no, there were many reasons and tax efficiency was only one of them.

I'd be surprised to see this used with pension assets which are already tax efficient, that takes away one of the major drivers of this

Quote:
Originally Posted by Kenny View Post
my initial impression is the only way this works is some sort of arbitrage between the CV accumulation and the loan interest
So you borrow at 3% and invest at 6%? Good luck.

I remember being on a call with a prospective client and he said near the beginning of the call, "If you are going to tell me the advantage of this plan is to borrow at 3% and invest at 6%, this is going to be a short call". We of course insisted that the idea was much more sophisticated than that. He did not become a client.

Last edited by Woodrow; 01-30-2019 at 05:33 PM..
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