Direct vs Non-Direct Recognition Life Insurance Companies

The difference between direct recognition and non-direct recognition mutual life insurance companies is in how they handle the dividends on a whole life insurance policy when the policyholder takes out a loan against the policy’s cash value.

1. Direct Recognition: In this case, the insurance company adjusts the dividends on the portion of the cash value that has been used as collateral for a policy loan. This means the company recognizes that a loan has been taken out and may reduce the dividend payout on the borrowed portion of the cash value. However, some direct recognition companies may offer a higher crediting rate on the cash value that is not being borrowed against, potentially offsetting the impact.

• Key Point: Dividends are directly impacted by the policy loan, with possible reductions or adjustments based on the outstanding loan amount.

2. Non-Direct Recognition: These companies do not adjust the dividends when a policy loan is taken out. The policyholder continues to receive the same dividend payout on the entire cash value, regardless of whether they’ve borrowed against it. This approach is more predictable for policyholders who want to know that taking a loan won’t affect their dividends.

• Key Point: Dividends remain unaffected by the loan, so the policy continues to grow as if no loan was taken.

Both approaches work in different scenarios, depending on how the policyholder plans to use loans within their whole life banking strategy. However, a non-direct recognition company is recommended for whole life banking.

Loan Recognition Example:

Bob, a logging contractor, utilizes the whole life banking strategy to refinance his semi truck over seven repayment schedules. We'll see how Bob's cash value and death benefit grow over time, reaching into the millions, compared to a standard dividend-paying whole life policy with no financing activity. He chooses to build his bank with a direct recognition company, vs a non-direct recognition company which is better for banking. A direct recognition company recognizes the loan, reducing the cash value accumulation when a loan is issued. With a non-direct recognition company, the loan is not recognized and the cash value remains unchanged when a loan is issued.

Scenario: Bob Refinances His Peterbilt Truck for Seven Repayment Schedules Using Whole Life Banking

Initial Truck Purchase and Financing:

- Purchase Price: $65,790

- Down Payment: $13,190

- Loan Amount: $52,600

- Interest Rate: 5% (insurance company)

- Chosen Interest Rate: 8% (what a conventional bank would have charged)

- Monthly Payment: $1,502 ($18,000/year)

- Loan Term: 48 months

- Total Paid Over 48 Months: $72,096

- Interest Paid: $19,496 (27% of each payment)

Bob finances the truck purchase using his whole life policy for the loan. Rather than borrowing from a conventional lender, Bob borrows the $52,600 from his policy’s cash value. His policy loan interest rate is 5%, but Bob chooses to repay the loan at 8% interest, mimicking a scenario as if he had taken out a loan from a conventional bank. This is how Bob becomes his own banker. This means the monthly payments ($1,502) stay the same as if he had taken the loan from a traditional lender.

Key Differences by Repayment Schedule:

Repayment Schedule 1 (Years 5-8):

Without Loans

• Cash Value: $167,182

• Death Benefit: $1,651,077

With Loans

• Cash Value: $129,387

• Death Benefit: $1,623,887

With a direct recognition company, the cash value is $37,795 lower, and the death benefit is $27,190 lower due to the loan affecting the dividends.

Repayment Schedule 2 (Years 9-12):

Without Loans

• Cash Value: $215,294

• Death Benefit: $1,534,303

With Loans

• Cash Value: $193,570,

• Death Benefit: $1,559,233

In the second repayment period, the cash value with loans is $21,724 lower, while the death benefit is $24,930 higher due to continued repayment, even with dividend adjustments.

Repayment Schedule 3 (Years 13-16):

Without Loans

Cash Value: $281,585

Death Benefit: $1,470,253

With Loans

• Cash Value: $282,226

• Death Benefit: $1,553,357

By the third repayment schedule, Bob’s cash value with financing catches up to the no-loan scenario and exceeds it by $641, and the death benefit is $83,104 higher.

Repayment Schedule 4 (Years 17-20):

Without Loans

Cash Value: $372,555

Death Benefit: $1,461,233

With Loans

Cash Value: $404,228

Death Benefit: $1,611,186

Here, financing allows Bob’s cash value to grow $31,673 more than without loans, and his death benefit is $149,953 higher. He continues this same financing activity every four years, self-financing another semi truck.

After 32 years, with financing from a direct recognition company, Bob’s cash value reaches $1,112,034 and his death benefit reaches $2,262,110, compared to the no-loan scenario’s $897,818 cash value and $1,825,120 death benefit.

How a Non-Direct Recognition Company Would Compare:

If Bob had chosen a non-direct recognition company, the loan would not affect the dividends or cash value, allowing for uninterrupted growth even while the loan is outstanding. This means Bob could potentially achieve higher cash values and death benefits than in the direct recognition scenario, as his dividends would not be reduced by the loan balance.