'Free Multimillion-Dollar Life Insurance' Has Some Insurers Running For The Exits – Forbes

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Gary Marenzi is a very accomplished man. He advises television production companies and is a multimillionaire. But in a Los Angeles court lawsuit he filed in July 2021, he states that he and his family were taken for a ride by two life insurance agents and the companies they represent when he signed on for $40 million of “free” life insurance.

Marenzi agreed to an insurance plan known as “premium-financed indexed universal life insurance.” It’s as complicated as the name sounds. It is designed for millionaires like him who want to help their heirs avoid paying taxes after his death. Because a life insurance death benefit is paid to beneficiaries tax-free, wealth can be passed on through a life insurance payout.

Unlike other life insurance policies, the cash value inside an indexed universal life insurance (IUL) policy is tethered to one or more indices, often ones like the Standard & Poor’s 500, Nasdaq-100 or or Russell 2000. When the index associated with your IUL goes up, you should see gains in the cash value within your life insurance policy.

As the stock market continues to soar, IUL policies have become one of the life insurance industry’s most profitable products. This is particularly due to the ongoing Covid pandemic, which has raised the need for insurance for almost a third of consumers, according to Elaine Tumicki, corporate vice president at LIMRA, which conducts financial research on the life insurance industry. Tumicki says indexed universal life insurance sales rose 20% during the April through June period as compared with last year, and that there are at least 33 companies selling IUL.

Hanging onto Assets

Premium-financed IUL is a conduit to help wealthy people retain their substantial holdings in real estate and other investments that they don’t wish to sell. Instead, they buy multimillion-dollar life policies without expending the big cash payments necessary to finance them.

Here’s how it works: A life insurance agent locates a bank or lender willing to provide a large loan to the person who is buying the policy. Theoretically, the loan will be paid back using the cash value that’s building inside this big insurance policy, and the policyowner won’t have to take a dime out of their own pocket.

When insurance agents sell these policies, they often use a set of life insurance “policy illustrations” to show clients that they’ll make a ton of money in the future through the gains in cash value. Supposedly the gains will be so great that the person can simply take money from the cash value to pay the loan bill that’s due each month. In other words: an essentially “free” multimillion-dollar life insurance policy.

And, as the cash value in the policy grows in this scheme, the policyowner even expects to get back the collateral they used in order to obtain the massive loan they took out to pay for the policy.

But then, if the scheme goes wrong, the bottom falls out: The cash value doesn’t make the expected gains, and the giant policy payments and loan bills are coming due. The “illustrations” that were used for the rosy outlook are often flawed with “opaque and unaccountable features by agents who have no obligation to work in the client’s best interest,” and are sold as “an indirect way to play the options market,” says consumer advocate Birny Birnbaum, director of the Center for Economic Justice.

Although LIMRA doesn’t track the number of premium-financed IULs sold or in force, experts in the insurance business say they’ve grown exponentially over the last decade. “Insurers have seen a flood of premiums funded by these loans,” says Steven Roth, the president of Wealth Management International.

The reason for this growth is likely simple: Larger insurance policies generate larger commissions for the agents. Lawrence Rybka, the chairman of Valmark Financial Group, says he’s seen agents boast of sales “each of which generated hundreds of thousands of dollars in commissions.” All were telling clients to borrow $2 million to $3.5 million from banks in order to finance their large premium payments on IUL policies. These policies often have death benefits of $5 million to $20 million each. Rybka estimates that more than 60% of all IUL premiums are probably financed.

Insurers Take a Step Back

But recently some major insurance companies put a temporary halt to the gold rush. “We have made the decision to immediately suspend all new premium financed business for the remainder of 2021,” says insurer Penn Mutual in a notice to agents. Also:

Allianz says that it “plans to limit its premium finance business as a percentage of its total business” because of “additional risks.”
Securian Financial is putting new cases that involve premium financing “on hold” until 2022.

So what has insurers running for the exits? First, there are nagging fears that this highly-touted and complicated product is being oversold by agents who don’t know what they are doing and are working from flawed data.

AIG, once the world’s largest insurance company, now says it will put additional restrictions on agents selling these policies. The AIG notice says that it won’t allow agents without experience in premium financing to have or use its illustrations.

The AIG notice also points out the “interest rate risk” inherent in premium financing. Many of these loans have a variable interest rate based on the market, and a lot of pundits predict an increase in the federal funds rates next year, which could make the cost to the client who has taken out the million-dollar loan much higher.

Then there’s the time element. Even though the life insurance policy may be in effect until the insured dies—which could be in 20 to 30 years—the banks may change the interest rates on the loans when they come up for renewal, usually every three to five years.

And, finally, there’s the danger of reputation-damaging lawsuits by customers like Marenzi who have the resources to at least embarrass insurers and perhaps win million-dollar settlements.

Stress, Loss Of Sleep and Humiliation

The bottom line for Gary Marenzi was that it wasn’t long before his “free” life insurance policy wasn’t “free.” According to his lawsuit, he was told within a few months that he needed to come up with more money for this policy “that wasn’t supposed to cost him anything.” And then came the surprise demand for additional collateral for the loan.

“In the end he would lose money on the policy that was supposed to give him and his family $40 million of free money,” the suit claims. Not to mention the “stress, loss of sleep and humiliation” he suffered. The lawsuit outcome is yet to be decided.

For certain people sophisticated with life insurance, under certain conditions, these policies can benefit the very wealthy—provided they know their advisers, trust them and, most importantly, monitor the policy’s performance as closely as the daily stock market. Loan payments due to the bank and interest gains on the cash value in the policy don’t always match up with each other, which can also mean surprise payments for either the policy or the loan. And clients also have to watch out for taxable gains whenever they withdraw cash value.

Premium-financed indexed universal life insurance is no “castle in the clouds,” says Rybka.

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IUL for Regular Folks

While you may not be among those being pitched on a premium financing scheme, you might be getting a pitch from an agent on indexed universal life insurance. Be aware that sales pitches are often based on the non-guaranteed parts of the IUL policy illustration. Make sure you’re looking at the guaranteed sections for a view of what reality might be. And don’t buy any life insurance that you don’t understand.