Web Exclusive: Unshrinkable Asset (September 1989)
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By Benjamin N. Woodson, CLU
A long-time friend writes to ask "In a recent Back Page in which you were praising GBP (Guaranteed Borrowing Power) you said in effect that if an insured should sell some common stocks to pay off a policy loan, those dollars would immediately double in value as collateral. How so, pray tell."
Well, good friend, I shall attempt a response to your inquiry, but first let us note that I did not say that it would double the amount. I said only that the transaction will double the collateral value of the dollars so transferred. The explanation of this happy fact is very simple, and already well known to you. But possibly you haven't put those facts together in these words. So here it is.
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Cash surrender values are worth exactly 100 percent as collateral-not only from the insurance company itself but also from any banker or other lender interested in making good loans. By contrast, a cross section of conventional collateral is often--probably I can say "usually"--worth no more than 50 percent! And even when it is good for more than 50 percent, as it will be in some circumstances some of the time, this would be more or less exceptional, and usually would be based more on the character, net worth, earning power and good record of the borrower than on the collateral per se.
Thus if I sell 1,000 shares of Imaginary Wickets, Inc., worth on today's market approximately $44,000 and then repay policy loans to that extent, I will have increased my borrowing power from something in the neighborhood of $22,000 up to a full $44,000. And for stocks less esteemed than shares of good old Imaginary, a value as collateral of less than 50 percent might not be extraordinary.
My basic premise is that for most persons in most circumstances, the borrowing power of an asset is 100 percent for cash values and 50 percent, plus or minus, for almost everything else.
But the 50 percent figure becomes more than a generalization when we speak of common stocks. As you know, the Federal Reserve Board has for many years effectively enforced its ruling that no broker, bank or banker may lend more than 50 percent for the purchase, or the continued carrying, of stocks. This "margin requirement" does not directly restrict the use of stocks as collateral for other purposes, but the mere existence of the rule gives stature and dignity to the general concept of 50 percent as the borrowing power of common stocks.
And the concept is true for other assets as well, based on the proposition that the average borrower, dealing with the average banker, and offering an average cross section of stocks, bonds, real estate and other assorted assets will probably have little success in borrowing more than 50 percent of his market value, real or claimed.
Now, over and above the simple but eloquent fact that the equity in a permanent life insurance policy is worth 100 percent as collateral, it is clear that this cash surrender value has still other qualities that add still further to its usefulness as collateral.
Foremost among these qualities is the element of safety. Another such quality is convenience of transfer, and the simplicity and effectiveness of an assignment. Moreover, the life policy equity is unique in respect to its guaranteed borrowing power. The policy contract guarantees to lend as much as 100 percent--whether money is scarce or plentiful, whether bankers are making loans or calling them, whether the general economy is roaring or dragging.
Also, the life insurance equity is collateral supreme because it always offers the better of two interest rates. One of the two is the policy loan rate, whether the particular policy provides for a fixed rate or a formula for determining what rate will be applicable at the time. The second interest offered is simply the going rate for borrowed money at the time of borrowing. If that rate is higher than the policy loan rate, one borrows from the policy itself, of course. But when outside rates are lower than the policy loan rate, we borrow from the bank, using this collateral.
But now comes the best reason of all: The life policy equity is collateral that can't shrink.
It is the simple fact that makes your equity in your policy the best collateral your banker will ever see. It is the simple fact that many a life underwriter knows, or assumes, without having considered the matter in depth. But it is true: The life insurance equity, assigned to a lender "as his interest may appear" is truly unshrinkable. Virtually any other collateral--bonds, stocks, real estate, inventory, receivables, practically anything that might serve as collateral--will rise or fall with market action and economic conditions. And the fact that the life insurance equity won't fall--thus, is unshrinkable--is why the lender can count it at 100 percent, rather than any lesser figure.
Consider the lender's protection. The basic fact is that as long as premiums are duly paid, the lender enjoys an annual increase in the collateral he holds. Wonderful! But suppose the premium isn't paid. Then the lender, who is the temporary owner of the policy by reason of the assignment that has been given, will find that the standard non- forfeiture options will continue to give him total protection.
The first option of course would be to surrender the policy. But short of that extreme and irrevocable solution, he could think of automatic premium loan or extended term. But these, long continued, would gradually extinguish the cash value. So he should, and would, elect reduced paid-up insurance, the cash value of which will be intact at the outset, and then will grow and grow and grow.
That is the lender's final option-his course of last resort-which makes the collateral generally and totally unshrinkable. That, above all else, is why the borrowing power of the life insurance cash value can be as much as double the borrowing power of lesser assets.
Good collateral? No, that understates the case. It is merely Collateral Supreme, that's all.
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