Direct Vs Non Direct Recognition Life Insurance – We will also discuss some effective alternatives to direct vs. indirect loans that can significantly improve long-term performance.
Also, if you make it to the end of this article, you will learn about “Hutch’s Decision Tree Logic” where I share my own decision factors that I make when choosing the best type of loan. happenings.
Direct Vs Non Direct Recognition Life Insurance
Direct recognition is a method in which mutual insurance companies have separate dividend rates for borrowed and unborrowed cash amounts. Indirect billing is a method where the insurance company credits all whole life policies with the same amount of dividend even if there is an outstanding loan.
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First, let’s clear up the confusion between direct and indirect recognition loans. Here’s another way to think about it:
A direct recognition loan will have a “direct effect” on your dividend payment. In contrast, indirect recognition loans have “no effect” on lifetime dividend payments. Replace the word “direct” with the word “effect” to easily remember the difference.
To the untrained eye, indirect recognition appears to be the best option if you plan to take out a lifetime loan, but the devil is in the details.
You’ve probably heard that indirect recognition is a type of magic bullet policy that allows you to collect perpetual positive arbitrage from the value of the money you borrow.
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If #1 is true, do you really want to buy insurance from this type of company?
Remember that owning Whole Life makes you part owner of the same insurance company you plan to duplicate. Don’t worry, these companies among themselves are actually the most solvent in the country (we’ll prove that later in this article).
So, if you thought you were going to use Whole Life insurance as some kind of magical free lunch loan scheme, you probably won’t like what I’m going to tell you below, and you’re completely free to walk away.
However, if you’re already a diligent saver who responsibly manages both cash flow and selective debt, you probably want to know if Whole Life can really help you improve that effort.
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Since the choice of Direct or Indirect Recognition happens when you first run a policy, you probably want to understand all the nuances between the two (besides the hype).
Indirect recognition means that the insurance loan has no effect on your dividends. All Whole Life policyholders receive the same interest rate regardless of their outstanding credit.
However, you will find that over time, any positive arbitrage between the company’s overall growth rate with indirect recognition and its borrowing rate is usually very short-lived.
Dividends are declared and determined for the entire insurance year. So, whenever there is a difference between the total return and whatever they charge you for interest on the loan, the life insurance company’s indirect recognition must be either:
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Even if your cash loan has “no effect” on your dividend rate, indirectly recognizing companies will eventually mitigate the impact of the cash payout.
For example, between 2022 and 2023, we see interest rates on indirect credit jump from 3% to over 5.7% as the Fed aggressively raises interest rates.
When you borrow against your whole life insurance policy, you’re not paying yourself interest, as many agents would have you believe. The insurance company simply gives you a loan from their general investment account, while your ever-growing cash value serves as collateral (since they’re already investing for you).
However, in certain periods (like today), some Whole Life policies actually earn a compounding dividend from the drawdown of the loan.
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Direct recognition is a method used by insurance companies to pay a different dividend amount from the cash value of the loan. This adjusted dividend may be lower or higher depending on the lifetime dividend rate and the direct recognition loan rate.
See, Nelson Nash was a Guardian agent in 2000 when he wrote The Infinite Banking Concept – Becoming Your Own Banker and he ran examples throughout the book’s life using the Guardian’s lifetime value of money calculator.
To this day, his examples still convince IBC enthusiasts that their whole life policies will be better off with debt than not. This is not the case even with the best principles of indirect recognition. For example, the top 2 indirect life insurance companies are Mass Mutual and New York Life.
Nelson showed that the increase in loan dividends only occurred because Guardian was a directly recognized company. When the loan rate is higher than the dividend rate, the directly recognized life insurance company will pay a higher dividend on any amount of money that has a directly recognized loan against it.
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Because the purpose of direct recognition is to be fair to all policyholders. And if you borrow at a higher rate than you pay dividends to non-borrowing policyholders, you should be compensated fairly because you’re paying above-market interest back into the company’s general investment account of insurance.
Because these loan payments generate higher dividends for your particular policy, it may seem like you’re paying interest, but technically, you’re not.
I have my own real life example from my husband’s small whole life policy which was the first Guardian we got 15 years ago. It happens to have the same 8% loan rate as the examples in Nelson’s book, at today’s low dividend rate of 5.75%.
In both the left and right scenarios, you will see exactly the same initial cash value and death benefits. For simplicity, we play out this scenario as if he were no longer paying premiums.
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He pays above market for loans, so the company treats him fairly by subsidizing his policy with a higher dividend. In fact, he got 4% more total cash value than if he hadn’t borrowed, nor had he borrowed against his entire balance ($50,000 of $64,521).
I won’t show you this because it’s the best loan option, so don’t get bogged down in the details. We will discuss better loan options later in this article.
Let’s look at an extreme example from the past that may not be so extreme if rates continue to rise.
In 1983-1985, the indirect recognition credit rate was higher than the dividend rate for one of the strongest mutuals:
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If it is a direct credit loan rate that remains higher than your dividend rate, would you receive a better dividend if you borrowed?
People think that the point of direct recognition is to punish them when they borrow, but in fact it is meant to treat all policyholders fairly.
You just saw an example above of how my husband’s current policy received a larger dividend when his interest rate was higher than the dividend rate. This is what happens when you borrow from Direct Recognition in a high interest rate environment where dividend rates have yet to catch up.
As you would probably expect from direct recognition, a lower borrowing rate than the dividend rate will actually reduce your dividend payment…BUT…
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You may have a better overall net result because you have a lower amount of money with a lower interest rate.
Interestingly, when we ran an extreme credit situation for some customers in 2022, the withheld dividends of the lower rate Direct Recognition loan actually outperformed the equally designed Direct non-recognition policy.
Because indirect recognition has a higher interest rate that adds to its higher dividends. Of course, this may not always be the case, but this is what actually happened in the environment of rapidly increasing interest rates in 2022
Part of why I personally favor multiple direct recognition policies is that, as both a trader and an investor, I value control.
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Direct recognition gives me peace of mind knowing that my capital value will not be lost. Only 1 of 2 things can happen:
Regardless, it often doesn’t matter if you have Direct or Indirect because you are usually better off using what I call a “Synthetic Indirect Endorsement” using a Cash Value Line of Credit (CVLOC) over the past 40 years. ).
Because I’ve been borrowing against my Whole Life policies for the past 1.5 decades, I’ve consistently found significantly lower rates than what my Whole Life Direct or Indirect Endorsement policies could offer.
I shop the rates of various turnkey lines of credit that essentially work as a “Synthetic Indirect Loan”.
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A synthetic indirect recognition loan does not have the same “no effect” on your dividend as a real indirect recognition policy loan. This is because a synthetic indirect recognition loan is not linked to your whole life company. It’s simply a turnkey loan program secured by your whole life policy, but offered by a real bank.
Think about it, if borrowing from a foreign lender doesn’t affect your dividend in any way, then it’s all about finding the lowest rate, right?
In fact, even if you have the best indirect credit policy, you’re probably still using a cash value line of credit program if you can lower your loan interest rate by 1-2% per year.
Most people research directly vs. indirect recognition for endless banking, they often react violently as if they shouldn’t. It is usually one of these two mistakes