Loans ***
A note: These loan provisions are part of the entire contract.
MR. WATSON: I want to borrow money against my life insurance policy, and like a bank, the insurance company will charge me interest to borrow money, using my cash value as collateral. So we will talk about loan provisions. Life insurance policies can have
- a fixed interest rate or
- an adjustable rate.
MR. WATSON: If it's a fixed rate, the insurance company can charge you no more than a 10 percent rate, (make sure you check the law chapters for loan rates). So when they issue a policy, if you want to borrow money, if they issue it with a fixed rate, the maximum they can charge you would be what?
ALL: 10 percent.
MR. WATSON: Or the company may have an adjustable rate. And if they issue a life insurance policy with an adjustable loan rate, they are going to tie it to something called Moody's Bond Index. Moody's is a company who rates bonds (AAA, A minus, etc). Bonds are instruments of debt, indexed means an average.
MR. WATSON: Moody's Bond Index. So if Moody's Bond Index is 16 percent this year, how much can they charge you? 16 percent. It would change every year.
Assignment ***
MR. WATSON: Policy-owners may give or sell their policy. Keep in mind the difference between the policy-owner and the insured. all rights belong to the policy-owner, not the insured.
MR. WATSON: This is called an assignment . An assignment is a transfer of ownership. Who must approve the assignment? The policy owner, the insured, the insurer (company), or a combination of that?
ALL: Policy owner.
MR. WATSON: Only the policy owner must approve the assignment. The company will accept the assignment, the validity of the assignment, without question. It must be done in writing. Okay? Everybody all right? The new owner is known as the assignee .
ALL: Yes.
MR. WATSON: There are two types of assignments.
MR. WATSON: Let's go over the first one, absolute assignment . Absolute is absolute, no strings attached. You're not getting it back. Period.
MR. WATSON: Lebanon, he's got that dreaded flesh-eating disease. Awful, awful thing. He's dying. He's got a $100,000 policy.
MR. WATSON: Lebanon, I will give you $75,000 cash for that policy right now. I will buy the policy from you. You can take that cash and do whatever your wife and you want to do. What do you think?
MAN: Sure.
MR. WATSON: All right. Now, Lebanon assigns his policy over to me - absolute assignment, no strings attached.
MR. WATSON: What am I going do?
WOMAN: Pay the premiums and wait until he dies.
MR. WATSON: First, I'm going to change the beneficiary to me. He gets the $75,000, he and his wife, they adios. When he dies, what do I get? $100,000, for a taxable profit of $25,000. That's called a Viatical settlement.
MR. WATSON: This is called a viatical settlement contract . (Accelerated benefits are similar and you will need to make the distinction. With accelerated benefits, the company pays a % upon diagnosis of terminally ill. More on this below.)
MR. WATSON: Lebanon, how much did your family get from that transaction?
MAN: $75,000
MR. WATSON: $75,000.
MR. WATSON: So, insurance companies came up with a different idea. Insurance companies said, "We'll give you $75,000; and then when you die, we will give your wife the other $25,000." Which is better for him?
WOMAN: The second option.
MR. WATSON: That's called an accelerated benefits rider . Most policies being sold today have that. "Accelerated benefit" means the company will pay you when you are diagnosed as terminally ill or even chronically ill, and when you die your wife will get the rest of it. But not all policies have it.
MAN: What's the benefit to the company in this case?
MR. WATSON: They will sell more policies. Back to this later.
MR. WATSON: The other type of assignment is called a collateral assignment . Let's say I can borrow money, fixed rate at 10 percent. If I can borrow money cheaper at a bank, at 5%, I use my life insurance policy as collateral. I have a $100,000 policy with $25,000 of cash value and let's say it is cheaper to borrow money from a bank. Let's just say that. I would assign my life insurance policy over to the bank as collateral. How much are they going to lend me? $25,000, the same as my cash value. If I die, the bank gets paid off exactly what I owe them. Does that make sense?
ALL: Yes.
MR. WATSON: If I live and I do not pay the loan back, then I defaulted on the loan, and the bank goes after the cash value.
MR. WATSON: Basically there's two types of assignments.
- Collateral
- Absolute.
Only the policy owner must approve the assignment. Do y'all understand?
ALL: Yes.
MR. WATSON: Question: I have a $100,000 policy with $50,000 of cash value. I assigned my life insurance policy to the bank for a loan for $25,000 under an absolute assignment. My wife is the primary beneficiary. If I die, how much will the bank receive? It's a $100,000 policy.
MAN: The whole thing
MR. WATSON: It would be the most idiotic thing I could have done, because you would not do an absolute assignment. You would do a collateral assignments. Do y'all agree?
ALL: Yes.
MAN: So collateral is just a portion of it, whatever you owe the bank?
MR. WATSON: Exactly. Collateral just means it becomes the bank's money if you default on your loan, the cash value of the policy guarantees the loan. Absolute means the whole thing, you're not getting it back.
MAN: It's the bank's.
MR. WATSON: What I should have done would have been a collateral assignment, and then my wife would have received $75,000. The bank would have been paid the $25,000 first and then she would have been paid what's left of the death benefit, or $50,000. Does that make sense?
ALL: Yes.