How to get your Arbitrage On

It is all about getting your “Key to a Safe Money Machine!”

by Louis G. LaBash

Mr. Labash is President
, Financial Scenarios LLC, The ‘How Much? Company!’ He develops & provides Interactive Sales software, Sales Guidance, and Training to Insurance Advisors across the country. He has extensive experience in both sales as well as in the area ofinsurance sales software development, marketing program & materials, lead generation systems, video marketing and case development. He started working with  and supporting Life Insurance Advisors on a one on one basis well before the original IBM PC came out. Connect with him by e-mail: [email protected]                                                                                                                                                                                                 

Financial Arbitrage

In the past, when computer systems weren’t quite what they were today, stock traders would see a stock available for sale in one market for $5.00 a share and at the same time see it available for purchase in another market for $5.10. They would then put in a buy order at $5 and a sell order at $5.10 on the two different markets and instantly make $.10 a share. If you did this with 10,000 shares, you instantly made a profit of $1,000.  This can potentially still go on in some markets but the computer systems of today have reduced the opportunities for this to happen dramatically.

Arbitrage as it pertains to insurance policies

Another form of arbitrage occurred in a big way in the life insurance world in the 1980’s. The whole life contracts that were in force at the time, allowed the owners to borrow against the cash value in their policies at 3%, 4% or 5% and the policy holders could turn around and use the borrowed monies to buy, as an example, a 6 month Certificate of Deposit that was paying as much as 17.5%. If they borrowed out $10,000 and paid 5% interest on it or less but at the same time earned 17.5% that meant they made a guaranteed 12.5% if they paid 5% interest on the policy loan. The difference or the extra earnings between the 17.5% and the 5% came out to be a guaranteed extra $1,250 every year that those rates remained that way.

The insurance companies were not real excited about this; because they too wanted to invest that money in those 17.5% CD’s and allow them to earn the 17.5% for the company. The problem for the insurer was if the policy owners did it first, then the money wasn’t available for them to invest in the CD’s as well.

Watch the Safe Money Machine video here

This was such a good deal for the policy owners, that they did it in droves.  It did not bode well with the cash flow at the insurance companies.  This partly caused the insurance companies to modify the loan rates in their new whole life policy’s going forward by going from low fixed rates to higher variable loan rates. The mutual companies which paid dividends (dividends are a return of a premium overcharge if the insurer makes its numbers) to their policy owners, also established this process called “direct recognition”, whereas policies with loans would receive lower dividends than policy’s without loans.

The justification was the insurance company had to reduce the dividends on loaned policies because the insurance company no longer had as much money to invest as they did in policies without loans and because of that they couldn’t as easily earn the returns required to pay the dividends

Now that you have that bit of history, you can just put that on the shelf because there is a new breed of Insurance policies that are designed so the policy holder can safely take money out of the policy, spend it on whatever they wish to spend it on, like groceries, utilities, or even travel and vacation expenses, and then still be able to participate in this new Arbitrage opportunity within the policy. 

How to get your Arbitrage On, today?

First I must say that this is arbitrage with a twist. The arbitrage that occurred in the 80’s had to do with maximizing your investment opportunities, while this arbitrage has to do with maximizing your income opportunities.

This concept has to do with being able to utilize the cash savings in your Indexed Universal Life policy to maximize your retirement income.

Since the product is a life insurance policy the potential client must be insurable or have a spouse that is insurable to put this program in place.

To make this work, one must first take the steps to put your money into an Indexed Universal Life policy from the right carrier. One would do so, in such a way as to maximize the income potential while minimizing the life insurance costs.  This is done by overfunding the policy while abiding by and using the rules and guidelines in Section 7702 of the U.S. Tax Code, to maintain all of the tax benefits in the policy.

  • The Excess Premium is tied to an index account like the S&P 500.  If the Index goes up, the index account grows as well, with a cap.  The current caps on most competitive policies are in the teens. In 2012 most companies IUL polices tied to the S&P 500 earned the top cap rate of around 13%.
  • If the index goes down, since the index account is not actually invested in the market, no loses are incurred.  This concept is called Annual Reset, whereas the values are reset annually to the initial account value, if the market goes down. Some Policies also have 1%, 2%, or 3% minimum underlying guaranteed returns as well.
  • From 2001 to 2010, while the S&P lost a minus .47% over that time period, one popular policy from a preferred company, due to Annual reset, had its index accounts earn a plus 6.76%. They earned over 7% more the S&P 500 did while they were actually tied to the ups and only the ups and to none of the losses the S&P 500, during that time period.
  • When money is taken out of the policy, it is borrowed out, because it is a loan, no income taxes are due, and the loan is collateralized by the money in the policy, which does not have to be paid back until the insured dies. When the insured dies the loans will be then be paid by the death benefit.
  • Any death benefit proceeds over and above the loan balance goes to beneficiary’s income tax free.

As an Example, you can safely contribute small or large sums of money, as there are no real limitations on contributions into a properly structured life insurance, into the policy over a minimum of 5 years and then as early as year 6 (the longer you wait, due to power of compound interest, the better) you can then stop contributing to the policy and begin borrowing money out of the policy  income tax free, at low variable interest rates (currently in the 4% to 5% range with a max of 6%) for any purpose.

At the same time, that money that you borrowed from the insurance company, is backed by money that is still in the policy and the collateralized money is still tied to (but not invested in) a stock market index (usually the S&P 500) that will continue grow along with the index.

In 2012, the clients that borrowed money from my IUL of choice, paid about 4% interest but earned about 13% on the money in the policy that backed the loan.   They made about 9% more on the money they took out to spend, invest, or pay living expenses than they paid for the use of it.

If the market goes up as high as the cap again in 2013, which it looks like it will, the policyholders will make approximately another 13% minus the 4% loan fees or  9% on the money they took out last year and also on any of the money they borrow out this year. Once you take your money out of the any other type of savings or retirement plan, then that money is no longer earning money for you.  Since the money in the policy can still earn income even after you used it as collateral for a policy loan, it will then take much longer to use up all of the money, if ever, than it would if the money was depleted from the account immediately and was no longer available to contribute to the continued growth of the plan. The collateralized moneys continue to earn money that will also be available on an income tax free basis through policy loans.

Some may say that this sounds too good to be true. There is a downside risk to all of this.

  • If you purchase a policy that does not have a feature or rider that provides for over-loan protection, then the client could possibly borrow out so much money that they would lapse the policy. If that happened all earnings in the policy as well as the money earned in the policy that was used to pay the interest in the past, would be considered taxable and taxes would be payable that for that tax year.
    • The over-loan protection feature just turns the policy into a smaller paid up policy before that happens.
  • Also the concept works very well when the market index is going up faster than the loan rate, which is currently around 4%. If the market is going down or sideways than that would adversely affect the policy and provide no income to pay the interest and could affect it dramatically in the later years.
    • Fortunately the policy of choice, allows the client to change their loan program at any time to a “0” cost wash loan, if and when the client sees the market going down or sideways. Then on the next anniversary date the client can opt to move back to a variable loan and participate in the arbitrage again, if they feel market is then going in the right direction again.

A properly structured Max-Funded Indexed Universal Life policy can be:

“The Best Retirement Plan of the 21st Century!”

  •     First and foremost it provides life insurance coverage.
  •     It provides Tax deferred cash value growth.
  •     It can earn market like returns. With a Cap in the Teens.
  •     The investment portion cannot suffer any losses with Annual Reset.
  •     You can borrow the money out for any reason at any time income tax free before age 59 ½ without incurring any tax penalties.
  •     You can earn income on the money you took out of the policy and actually spent on something else, because of the arbitrage capabilities.
  •     You do not have to pay the loans back until death occurs. When the loans are paid by the life insurance portion of the policy.
  •     Any proceeds for the life insurance above and beyond the loans are paid to your beneficiaries on an income tax free basis.

In order for this to work best you need to use a policy that provides a safe money and growth scenario that also:

  •     Provides competitive low cost life insurance rates.
  •     Has relatively High Caps to take advantage of market like returns.
  •     Does not invest your money directly in the market.
  •     Has multiple index account options to allow for diversification.
  •     Includes Variable loan rate with guaranteed low rate caps.
  •     Provides an option to change to a “0” cost wash loan as needed, without having to pay off the variable loan.
  •     Has Over-loan Protection.
  •     Is offered by at least an A+ Rated Insurance company (these are long term programs and companies have to be able to stay in business for a long time).

This is the Safe Money Machine!

Watch the Safe Money Machine video here

Legal Disclaimer:

Financial Scenarios LLC and the Advisor that provided this document to you does not represent, warrant or guarantee financial or retirement planning performance or results. Nor does it represent, warrant, or guarantee that analysis of past financial performance can predict or is any indication of future financial performance.

Financial Scenarios LLC and the Advisor that provided this document to you does not recommend any particular asset allocation, security, or investment method nor does Financial Scenarios LLC or the Advisor that provided this document to you provide customized tax, legal, investment advice or strategies.  Rates of return and calculations, if any, are for illustration purposes only and do not represent any specific investment results. Before taking any action, you should seek the advice of qualified legal