Don’t Assume Your Clients Understand Life Insurance

Last year I decided to buy my two sons (8 and 11 years old) and myself motocross dirt bikes. My intention was to find us another hobby that we could enjoy together. I grew up around dirt bikes but never did the motocross thing. Anyway, I bought us all the helmets, boots, pads, braces, etc. and we were going to be hardcore motocrossers! I vividly remember the first day where I loaded up the dirt bikes and took my kids an hour north of Des Moines to a Motocross track where we were going to christen the bikes. I have never seen a motocross track up close prior to this. Well, I remember pulling into the track drive, which was still empty early Saturday morning. I remember getting out to get a closer look at the track while my sons stayed in the truck. As I walked up the first dirt “jump” it seemed big…really big! As I was standing at the top of this mountain looking around, my 8-year-old opens his car door and yells from the truck, “Daddy, are we supposed to ramp that?” I said, “Not today Matthew.” Then we rode the little trails behind the track all day and had a blast!

At the end of the day we watched other riders, that looked to be high schoolers, effortlessly jump those “mountains” like it was muscle memory. The thought of getting to that point seemed impossible last year. Well, we are there!

The parallel is that the way we talk in our business is muscle memory to us just like jumping terraces is to pro motocross riders. If you have been in the business for a long time, what you know and the language you use is now ingrained in your DNA. Therefore, it can be very easy to overlook the lack of understanding that the general population has concerning our products. I am sure a year ago those young high school kids could not fathom why I would not even consider jumping a 15-foot terrace.

In that vein, I want to focus on a few questions/objections around cash value life insurance that I have recently heard from consumers. If you have been in the business for a long time, you have likely heard these questions/objections and likely effortlessly know the answers. Like the kid that effortlessly jumps the terraces. However, many times it is not just knowing the answer but knowing how to respond so the consumer actually understands the answer. Don’t overestimate what the general population knows!

Question/Objection #1: “How is the life insurance cash value non-taxable?”
This is a great question from consumers that do not fully understand cash value life insurance. To answer this question, I usually use the following verbiage to explain this:

Let’s say you pay premiums of $1,000 per year into an IUL or whole life policy. In year 20, and after paying $20,000 in premiums, the cash value has grown to $30,000. How can you gain access to that $30,000? One way is to cash it out. You can simply ask the insurance company for your money back and the insurance company will gladly send you the check. However, that is not the only thing that will be sent to you. A 1099 will also come that will lead to income taxation on the $10,000 you took out above and beyond what you put in. Conversely, if you do not want that 1099 to come, what can you do? Take a loan against the policy. There is a reason that financial professionals discuss policy loans rather than “withdrawals” when they discuss accessing policy cash values. This is because loans are not taxable and withdrawals above basis are! When was the last time you went to get an auto loan and received a 1099 on the amount you got from that bank? Never. Somewhere in the 75,000 pages of IRS Tax Code it says that policy loans are not taxed assuming the policy is not what they call a MEC.

(By the way, to be technical, it’s Section 7702A that says loans are not treated as distributions under Section 72.)

Almost every time, my response above will lead to the second question…

Question/Objection #2: “But that’s my money! Why do I have to take a loan from myself?”
This is where I discuss with the client that, first of all, she wants it to be a loan! Why does she want it to be a loan? Because of the tax advantages we just discussed. Second, it is not a loan “from herself” or “from her policy.” The loan is actually from the insurance company, just like a loan from the bank. However, the hoops that a bank would make her jump through in order to get a loan are non-existent with these policy loans. These loans are contractually guaranteed to be available to her without loan applications, credit reports, W2s, etc. This is because the policy loan is a very safe loan for the insurance company to make, even without all the formalities. Why is it a safe loan? Because that insurance company collateralizes the death benefit in case she were to pass away without paying back the loan. Also, the insurance company would collateralize the surrender value in case she doesn’t pay back the loan and wants to cash out her policy. Therefore on the illustration you will see that the cash value is never reduced when loans are taken. The only values that are reduced on the ledger when loans are taken are the surrender value and the death benefit. That is because of the “lien” assessed against those two values.

When you start thinking of a life insurance company (where the loans come from) as a completely separate entity from the insurance policy (where the client’s cash value is), one’s understanding of life insurance loans becomes a lot easier.

Objection #3: “I don’t trust insurance companies.”
Here is an interesting one… Not long ago I was having dinner with a friend of mine (John) where we were discussing everything we should not discuss—religion, politics and money. He is my age—a very youthful 41 years old—and owns a very successful construction business. He is the epitome of the American Dream and a self-made man. He never went to college, but since he was a teenager he understood that if he worked his tail off he would be rewarded. That has come true for him!

He is a good friend but very set in his ways and has some biases against the financial services business. By the way, my dad owned a construction business while I was growing up, so I have witnessed some of this “anti-white-collar bias” that exists with some blue-collar professionals like my dad and like my friend John.

Anyway, somewhere in the conversation I started discussing how he should look at a cash value life insurance policy, not only for the death benefit but also the ability to take loans against the policy tax-free for his kids’ college or his retirement. I expanded on the concept by laying out what the math on my personal policy looks like as I am the exact same age as he. After he asked for clarification on the loans and the tax status on the loans (as mentioned previously in this article) John indicated that he did not trust insurance companies as they are all out for making a big profit. He also made the statement that the insurance carrier will likely “jack up” the rate charged on everybody’s loans so they can make a “huuuuge” profit. At this point I dusted off my participating whole life bat, because he just threw a hanging curve over the middle of the plate for me!

I then asked John, “So let’s say the insurance carrier jacks your loan rate up to the maximum rate in order to get more profit. Who gets that profit?” He said, “The shareholders/owners get the profit which is the main objective with any corporation—not just insurance companies!” I said, “You are right! But what if you were one of the owners of the company? What if that massive profit that these insurance companies supposedly get were partially paid to you as a dividend because you are one of the owners?” He paused at this point because he was confused. I continued, “So by being an owner, not only do you vote on the Board of Directors for the company, you also get to participate in the profits that may be generated by what the insurance company does with your money and that of a million other policyholders.” After a long pause he says, “How do I do this without buying shares in the company?” I said, “What I just explained to you is how a participating whole life policy works where the policyholders are the owners of the company. You are the insured, you are your own lender, you are an owner of the company, and you also vote on the Board of Directors that run the company.”

I will be meeting with John next week to show him his own illustration that he requested.

As an IUL fanatic, I will say that I also love participating whole life insurance. To me, one is not better than the other; it is a function of where on the risk/return spectrum the client is. Riding the trails is not any better or any worse than riding the motocross track. It is all about what the client is comfortable with.

Charlie Gipple, CLU, ChFC, is the founder and CEO of CG Financial Group, an independent marketing organization serving life, annuity and long term care agents. He is known throughout the industry for his thought leadership on annuities and life insurance. He has conducted hundreds of agent and client educational seminars over the last two decades, ranging from small one-on-one sessions to large national meetings such as the Million Dollar Round Table, Top of Table.

Gipple is a sought-after keynote speaker for many types of events and topics. He has appeared on thestreet.com and AMBest TV. He also personally produces and conducts client seminars on a local level. He is a former executive of various insurance companies.

Gipple can be reached by phone at 515-986-3065. Email: cgipple@cgfinancialgroupllc.com.