Dividend Paying Whole Life Insurance has MORE in common with banking than life insurance.

At first glance, this statement would appear to be utter nonsense. Even those that are somewhat familiar to IBC would be skeptical of the use of the word more in the above claim. I know that I can bank with Dividend-Paying Whole Life Insurance, but how could it have MORE in common with banking than life insurance? It IS life insurance. As Lee Corso would say, “not so fast my friend.”

As R. Nelson Nash would start when making this point, it all comes down to proper classification.

BANKING

What is known today as banking, comes from two different concepts that do not necessarily have anything to do with each other. The first is as a deposit warehouse, just like your local storage company or safety deposit boxes at banks. When gold was the money standard, people would not want to keep all of their wealth in their house or on their person at all times. It made more sense to have it on deposit, and walk around with a note that guaranteed the future exchange of the note back into gold. Money warehousing on its own, is a perfectly legitimate business practice, when done at 100% reserve, in the same way that a grain silo or storage facility is a legitimate business that provides an essential and useful function for society. An essential function that would keep each bank honest was the act of a clearing house. If one institution issued more notes than it had gold in reserve, through clearing houses their gold supply would dwindle, and eventually there would be a run on the insolvent institution. Unfortunately, Central Banks, backed by governments collude to allow for fractional reserve banking, where there are more notes with claims to gold outstanding than actual gold on reserve, and then on top of that, governments then severed any tie to redeemability, and the value of any currency in the world rests on the government’s fiat. To go any deeper into this problem would lose the point of the essay, so we will turn to legitimate baking function number two, credit intermediary.

In society, there are people with capital reserves that they wish to put to use, and those without sufficient capital, in seek of credit in order to finance either a business venture or their own consumption. Just as middle men serve an essential function in so many other markets (grocery stores, real estate agents, etc), they are vital in improving the efficiency of the credit market. Imagine trying to secure a $250k loan without an intermediary, you would need to find someone who had saved and was looking to lend that much to just one person. Instead, let’s introduce the credit intermediary, he can pool resources and capital from many savers and develop expertise in assessing different credit risks of borrowers. He can improve the efficiency of both, while still maintaining a spread on interest charged and capital returned to savers. In this sense, his services do not ‘cost’ anything, people would be poorer without them. This should in no way serve as a defense of how our modern Cerberus monster of a banking system works in the United States today, rather it goes to point out just how far away we are from the ideal, legitimate banking functions.

Andrew Jackson fighting the banking snakes and dragons

INSURANCE

An insurance contract is when someone transfers the risk of a potential loss to a third party who promises to indemnify the policy holder in case of a specific loss event. Property can be insured against loss or damage due to specific events such as theft, fire or flood. Premium payments are pooled among policyholders and are paid out to the ones that suffer the loss. Since nobody knows who specifically will be the losers beforehand, and people are generally risk averse, people gain satisfaction from the certain knowledge of the premium payment and knowing that they will not have to come out of pocket for the full value of replacement of their property in case of damage. Again, the service to society as a whole is obvious. Not only does the insurer benefit each individual by taking on the risk, but due to economies of scale, it allows more capital to be put to use in other ways throughout the economy. If the entire concept of insurance did not exist, people would need to keep enough liquid savings to replace damaged property on hand or else run the risk of having their entire life interrupted in the event of a loss.

When it comes to life insurance, let us first examine term life insurance. It works similarly to property insurance, except that the asset being insured is a person’s life against the loss of death. One year, 10 year, 30 year term policies all work the same basic way, the insurance company puts the individual in a risk pool based on a number of factors, most of which relate to age and health, and then determines actuarially how many people in that pool will die over a given period. This is why term life insurance works so similarly to other types of property insurance. Nobody knows the specific individuals that will die during that term, but it is a catastrophic loss to the families that lose a loved one early, especially in the prime working years. Therefore, people are willing to pay a premium for a given death benefit if they were to die during the term of the contract.

WHOLE LIFE INSURANCE

The key factor that drives the difference in nature of whole life insurance, is that the nature of risk is completely different. Because we are all going to die one day, it is not a matter of IF, but WHEN the insurance company will pay the death benefit to the beneficiary. On the face of it, this might not seem like a fundamental change, but it is. A whole life contract is a promise to pay, but unlike term contracts its payment is guaranteed to happen. In the term insurance risk pool, most people will not die during the term, and their premium payments contribute to the claim payments on the policies that are paid out, but in the world of whole life, everybody (that keeps their policy in force) gets a pay out. Hopefully the wheels are starting to turn now.

This is why whole life policies have a cash surrender value. If someone surrenders their policy, it takes the death benefit liability off the books of the insurance company. The cash surrender value economically speaking, represents the net discounted present value of the death benefit, less the net discounted present value of the flow of future premium payments [D-P=C]. This is why there is a guaranteed column on insurance illustrations, and why the cash value column is always increasing on them. The further in time that we move, the more present that death benefit value is, i.e. it is being discounted less because it is more likely to happen sooner the older we get. With each premium payment that is made, the future flow of premium payments decreases. So, when we reexamine the simple equation, D (present value of death benefit) is increasing every year, and P (present value of future premium flow) is decreasing every year; it becomes obvious why C (Cash Value) must increase each year.

INFINITE BANKING

The next step in the chain is understanding policy loans. Because of the nature of the whole life contract, a collateralized policy loan is the safest place that an insurance company can deploy capital. The collateral of the loan is the insurance company’s own liability to that policy holder’s beneficiary. It WILL earn back the principle with the interest that is stated in the contract, either through policy loan repayment, or by a reduced death benefit check.

Now we can attempt to put all the pieces back together. In a dividend-paying whole life policy, the policyholder pays in premium payments, and as a result, the policyholder has contractually guaranteed access to an ever increasing cash value stockpile. This allows the Infinite Banker to manage cash flows on their terms. Policy loans can be paid back on whatever time-table makes sense to the policyholder, or never at all. The Infinite Bankers only worry is to deal with the human problems: to act as an honest banker to himself and not to ‘steal the peas’ out the backdoor of his own grocery store.

It is a misnomer to conflate premium payments with deposits. Once money is paid in the form of premium, that money belongs to the insurance company. And when money is accessed, that money is coming from the insurance company. The interest charged on policy loans is forever kept by the insurance company (of which the policyholder is a partial owner). There is no magic in loans.

But it is also important to always keep in mind ‘compared to what?’ Checking account balances in the modern system are not true deposits either. Not only does it operate under a fundamentally insolvent fractional reserve system, but as Carlos Lara warns us, there is now the threat of bail-ins to worry us.

Now let us examine how well dividend paying whole life insurance performs in the role of credit intermediary. The insurance company must put its received premium payments to work in order to meet its future obligations. Companies that are used for IBC policies have been around for over 100 years, and have paid a dividend to its policyholders in each and every one of those years (through world wars, the great depression, stagflation, housing booms and busts, etc). The policyholder has the benefit of having contractually guaranteed access to capital on the most favorable of terms, while at the same time, knowing that his cash value is contractually guaranteed to increase, AND knowing that it will likely increase more than it is contractually guaranteed because of the historical performance of the company and the knowledge that with great capital, comes great (and unique) opportunity. A further benefit to the policyholder is that the cost of his capital is always explicit, it is harder to forget that capital always has a cost when you see a policy loan rollover at interest compared to when it is merely an opportunity cost of lost potential gain in the form of saving up cash and spending it.

So when we come down to a final examination and classification, dividend paying whole life insurance has more of the characteristics of banking, than it does term life insurance.