By Dr. Robert P. Murphy
June 1, 2021
- The Infinite Banking Concept (or IBC) is the legacy of the late Nelson Nash, financing pioneer and creative visionary. It is experiencing massive gains in popularity since its inception many decades ago.
- Whole life policy loans are infinitely less risky and costly than conventional loans for any individual, because the equity in the policy itself serves as the only collateral. Policy loans are also free of traditional penalties, i.e. late payment fees and seizures.
- IBC reveals a world of financial independence that might seem foreign to those who have previously relied on commercial credit unions. This post stands to verify the amazing descriptions of IBC painted by its diverse group of enthusiastic fans and to answer our most commonly received questions.
- You might also find this page helpful, or this post if you’re here because of Dave Ramsey.
As this is a financial product, we hope you can appreciate that it cannot be fully summarized into a TLDR section. But for those who are seriously considering an IBC policy, the below is for you. By the end of this, you will see through the financial jargon and understand how simple and revolutionary Nash’s concept is, in practice, and what it can offer you.
“What is Infinite Banking?”
When people first hear about the advantages of the IBC, some typical reactions are to say, “How could an insurance policy meet any of my banking needs?” Or, simply, “This sounds too good to be true.”
For example, an IBC agent might tell his or her client that in order to take out a loan against the cash values in a whole life insurance policy, the policyholder simply needs to call the insurance company up and tell them the amount and the address. The person on the phone won’t ask what the loan will be used for, what the income of the borrower (i.e. policyholder) is, what other assets the person might have to serve as collateral, or what timeframe the person intends to take in paying back the loan. Nope, the insurance company employee will simply take down the information and the check may literally go out in the next day’s mail.
In contrast, try pulling the same stunt with a commercial bank or credit union. Even when applying for a secured loan, with, say, a house with lots of equity serving as collateral, a borrower will need to jump through all sorts of hoops and fill out a few forms before getting approval. The process could be quite time consuming, even for someone with impeccable credit and sizable assets.
So, are the IBC agents simply lying? And if not, what gives? Are the insurance companies staffed by magic elves while the banks, by grumpy trolls?
No, the IBC agents aren’t lying, nor is there any need for superstition. I personally have taken out several policy loans since I enrolled in 2009, and have witnessed the simplicity of the process time and time again. I have also, like most people, been an applicant for lines of credit from different commercial banks, and the process is a serious hassle (and not to mention, costly).
The difference in the treatment given to clients by insurers versus conventional lending institutions is the nature of the underlying collateral on the loans.
As an economist, this process is no mystery to me. But I empathize with those who struggle to wrap their heads around it. So, here, I’ll break it down as plainly as possible. Once we understand how a whole life policy works, and what a policy loan really is, then it becomes obvious why the insurer doesn’t require the policyholder to jump through dozens of hoops in order to take out a loan against the cash value of the policy.
Term vs. Whole Life Insurance
What is Term Life Insurance?
Term life insurance is “pure” insurance. The policyholder pays a certain amount of money as a premium, so that if they happen to die during the period in question (say, six months or a year), then and only then will the insurer cut a check to the policyholder’s estate. If the term of the policy runs out and the policyholder is still alive, then they get nothing from the insurer. It’s analogous to buying fire insurance on one’s house. If there’s no fire, then the insurer pays out nothing, and the policyholder’s money spent on premiums is totally gone.
What is Whole Life Insurance?
In contrast, a whole life policy (as the name suggests) is designed to last for a person’s entire life. As long as the person keeps paying premiums, the policy stays in force; there is no predetermined expiration, as is the case with a term policy, which might be designed for, say, a 20- year term. This is straightforward enough, but there’s much more in store with a whole life policy: Cash value (or equity or capital).
Equity in Whole Life Insurance
A useful analogy here is to real estate: The policyholder of a term policy is like someone renting an apartment. The renter pays the rent month after month, and receives shelter in exchange. But after the term of the lease expires, and the landlord raises the rent, the renter moves out of the apartment. This individual has nothing to show for the money they spent over the years, except the memories.
In contrast, someone might buy an apartment unit with a mortgage from a bank. This person’s monthly mortgage payments will be higher than what the renter had to pay each month, assuming they live in comparable apartments. However, with each month’s payment, the buyer acquires more and more equity in the property. After keeping up with their payments for, say, 30 years, the mortgage is paid off and then this individual owns the apartment outright.
The analogy with life insurance should be clear. The term policy in effect is just rented insurance. In contrast, the whole life policyholder gains equity in the policy with each successive payment. Specifically, the cash surrender value grows over time. This is analogous to a homeowner calculating how much equity they have in their property, i.e. asking how much it’s worth minus how much they still owe on it.
For whole life, the cash surrender value is defined as the present discounted value (or net present value) of the expected death benefit payout minus the flow of future premium payments. As time passes, the looming death benefit becomes more and more certain, because the person will either die or attain age 121. On the other hand, with each successive premium payment, the remaining number of such payments dwindles, meaning that the policyholder has a freer and freer claim on the death benefit. This is why the cash value of a policy grows over time.
Is Whole Life Insurance More Expensive Than Term?
As the critics of whole life insurance are quick to point out, the premiums needed in order to keep this type of policy in force are much higher than those for a term policy with a comparable death benefit. Part of this difference is due to the continuation option described above. In other words, since the insurer is agreeing to a level premium for the policyholder’s entire life, the insurer must naturally set the premium high enough to cover the additional expectation that the policyholder’s life will certainly end while the policy is in force. With term life, on the other hand, the vast majority of policies expire without the person dying.
In fact, things are even bleaker for the insurance company. At a certain point, the owner of a whole life policy gets a huge check from the insurer even if they are still living. Nowadays, the cutoff age may be 121 years. For example, an individual might sign up for a $1 million death benefit whole life policy when they’re 25 years old. So long as that person continues to make their premium payments, he or she can go on paying the same premium, even as they age, and become a much higher risk to the insurer with each passing year. Ultimately, if and when the person reaches 121 years, the insurance company sends them a check for at least $1 million (in practice, it may be more, since the person will have purchased more “death benefit” along the way).
Now we see why whole life policies are more expensive—and rewarding in the end—than term policies with the same initial death benefit.
When critics declare that whole life insurance is a subpar financial product, because one can get “the same” insurance from a term policy at a cheaper rate, this is akin to someone saying that buying a house is subpar to renting, on the basis that one can rent the same living space for lower monthly payments. The famous “buy term and invest the difference” strategy ignores other differences too. So, next, we will focus on policy loans.
Whole Life Insurance Policy Loans
In order to fulfill its contractual obligations to a whole life policyholder, the insurer must take a portion of each premium payment and invest it conservatively. As a whole life policy ages, the insurer had better have a growing stockpile of financial assets earmarked for the policyholder, so that if and when the individual reaches age 121, the insurer can hand over the assets now worth, say, $1 million.
From the insurer’s perspective, then, there are numerous streams of income every month flowing from the various policyholders. Some of them actually die, and thus payments must be made in accordance with the contractual death benefits. Beyond that, there are salaries and other overhead expenses to be paid. After these expenses, what’s left can be plowed into investments so that the total assets of the insurer grow over time, just as the policyholders all think that their cash values are growing.
When a whole life policyholder applies for a loan, the insurer does not “take it out” of the policy. Rather, the insurance company takes some of the money that it otherwise would have invested in outside assets, and instead loans it to the policyholder. Strictly speaking, in terms of the cash flow, a policy loan doesn’t “touch” the whole life policy at all. Rather, the insurer makes a loan on the side to the policyholder.
The insurance company is quite happy to make such a loan, because the policyholder pledges the cash value of their own whole life policy as collateral. To repeat, strictly speaking, the policy loan does not “suck out” the cash value of a policy, but rather the outstanding loan (depending on its size) offsets some of the cash value. In the same way, if a homeowner applies for a home equity loan, they don’t literally sell off the guest bedroom to the bank. Rather, they take out a loan from the bank and pledge the equity in their house as collateral.
Now we see why insurers are so free-wheeling when it comes to policy loans, whereas commercial banks and credit unions are more stringent: the collateral on policy loans is much more liquid than on conventional secured loans.
Policy Loans vs. Conventional Loans
Consider what happens if a whole life policyholder has taken out a $10,000 loan at 5% interest. Suppose they never make any payments on it, so that the outstanding loan balance has grown to $10,500 a year later. Then the policyholder is hit by a bus and dies.
Does the insurance company care? Not at all (unless the employees knew the policyholder personally!) Because the individual owned a whole life policy, the insurer would owe their estate for the death benefit sooner or later, either way. Suppose the death benefit originally would have been $500,000. Now, because of the outstanding policy loan, the insurer subtracts the balance and sends the policyholder’s beneficiary a check for $489,500.
In contrast, suppose the policyholder had gone to a commercial bank, asking for a secured loan of $10,000, with their new boat serving as collateral. If the policyholder missed a payment on the loan, the bank would start to worry. As the loan rolled over at interest, it might eventually grow to be more than the underlying collateral was worth. But this isn’t likely to happen with a well-structured whole life policy loan, because the underlying cash value grows predictably over time, too.
Another problem for the commercial bank is that if the individual defaults and the bank seizes their boat, the bank might discover that the person didn’t take good care of the asset, especially when they saw the default coming. Again, in contrast, there’s nothing that the policyholder can do to ruin the cash value in their policy. The insurer doesn’t allow them to borrow more against it than the present cash value at any given time. There is no need for the policyholder to do anything “responsible” to keep the collateral in good shape, since the collateral in this case is just the death benefit (or money).
Finally, even if the boat has been kept in good condition, such that its market value is more than the balance on the loan, the bank still has to go through the hassle of selling it. This can be a major problem, especially in our current situation where banks are the reluctant owners of millions of foreclosed homes. Again, in contrast, the insurer doesn’t have to do anything to “seize” the collateral of the policyholder who defaults on a policy loan. It simply subtracts the relevant amount from the check it otherwise would have sent.
Once we understand the nature of a whole life policy and how policy loans actually work, it becomes clear why insurers offer loans at such attractive interest rates and almost unbelievable terms. The explanation is that the underlying collateral—the cash value of the policy itself—makes such loans the safest investments imaginable for the insurer. No matter what, they are going to be repaid, because they are already contractually obligated to pay a death benefit to the policyholder. The outstanding loan balance, if any, can just be subtracted before the check is sent out.
Now, hopefully, you understand the value in a whole life insurance policy, and how IBC works as a creative means of achieving financial independence and generating wealth. Please leave any thoughts or questions in the comments below for further discussion on this topic.
If you’d like to speak with an IBC agent in your area, click here.
Editor’s note 8 August, 2021: This article was updated to include relevant links and media and reflect the current product experience.