Saturday, March 13, 2021

IBC Mailbag: How Does A Policy Loan Create Positive Arbitrage?

Question from a client:  I believe I saw that the current interest rate to borrow on our policies is 5%.  I also believe I saw or heard somewhere that the current rate of growth within our policies is 2-3%.  Are these numbers correct?

First, a correction.  The cash value growth on Infinite Banking whole policies funded with the Paid-Up Additions (PUA) rider are in the 4-5% growth range.  Maybe a just a tad higher depending on age and health rating.


Where you might hear 2-3% talked about on the internet is specifically on the guaranteed interest portion of the policy which does not include dividends.  That portion of the policy grows at 2-3% over the life of the policy, then add dividends and that’s where you get to the 4-5% range.


Interest rates are relative.  When borrowing rates are higher, so is the savings rate, vice versa.  Right now with interest rates being historically low, dividends are also historically low.  The reason why all life insurance companies tie the borrowing loan rate to the Corporate Moody Bond Index is the because they are attempting to match the yield they are receiving on the majority of their investments.  So if interest rates rise, so the will the dividend performance to maintain parity within the policies when borrowing.


Going just a bit further, if the growth is 5% and the borrowing rate is 5%, we would say it’s a wash.  In actuality it’s not because 5% is compounding on the full growth whereas 5% simple interest is being applied to only the portion of cash value borrowed.  There is a positive arbitrage there.  If fact, there’s even a positive arbitrage 4% compounded against 5% simple interest.  Plus as loans are repaid the positive arbitrage spread grows further still. 

Here's why:  100% of each loan repayment you make is applied to principal first, the loan interest is only calculated on your policy anniversary date.  Remember this is way more consumer friendly than any bank loan where the bank will always make sure they get paid their interest first!  


Appreciate all the questions.  Please let me know if you have any other!

Thank you,

John Montoya

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