What’s the Rate of Return on an “IBC Policy?”
Why the Question Comes Up
Folks who have just heard about the Infinite Banking Concept (IBC) are quick to ask: “what’s the rate of return?” After all, aren’t we dealing with a financial asset? Surely, it must have some rate of return. Don’t we want our money working hard for us? If the rate of return is low, what’s the use? Plus, isn’t the IBC implemented through dividend-paying whole life insurance? Everyone knows that the “rate of return” in whole life is pretty low — certainly lower than the annual average return in, for example, the S&P 500. I don’t know about you, but I’m pretty skeptical.
Just like that, the IBC-neophyte has painted himself into the semi-certain conclusion that this IBC business is probably a waste of money. This initial skepticism makes it pretty difficult to convey the power of the IBC.
In addressing this question, we need to begin by pointing out where this type of question originates. Why is it that we are conditioned to wonder about rate of return when it comes to analyzing financial assets? Why don’t we immediately wonder about, for example, the contractual guarantees associated with the value of the asset?
The answer is that we have been programmed to evaluate financial assets in the paradigm of investment. Americans are taught that the only sensible thing to do with savings is to invest. Everyone knows that investment comes with risk — the chance of total loss. Risk bears cost, so in order to tolerate the cost of a certain level of risk for a given investment, the individual (and the market) requires some rate of return. The higher the return, the better compensated the individual — or so the thinking goes.
If we follow this line of thought, we cross a number of familiar bridges. We can discuss how higher risk doesn’t necessarily mean a higher return. We can point out the difference between average annualized rate of return and actual compounded rate of return. We can talk about how, in general, the stock market goes up, and that to avoid making psychologically motivated, uneconomic decisions, we might use dollar-cost averaging and systematically put a fixed amount of money into a low-cost, indexed mutual fund.
What advocates of the IBC often fail to realize is that this is a losing argument. The individual who has consumed the conventional financial literature is armed to the teeth with all sorts of mechanisms and strategies to confront the fact that every so often investments lose value. And for all intents and purposes, they’re right. Even if they aren’t right, let’s assume they are. The following point still stands true.
If the focus is on the rate of return, then you’ve missed the point of the IBC.
Exit the Investment-Only Paradigm
Investing is not the only use of savings. Another use for savings is capitalizing.
Capital is the money value of property that we use to acquire other property. It’s property value that we use to acquire other stuff. It’s equity in a house; it’s the value of deposits in a checking account; it’s the cash value of dividend-paying whole life insurance. Regardless of the form in which it might manifest, almost no one in the financial advisory community suggests that individuals strategically accumulate it.
Since we are not taught to strategically accumulate capital, we rely on the capital of those individuals and institutions who do. We borrow from investors, banks, mortgage lenders, credit card and consumer credit companies in order to pay for the things we need. Or, we strategically plan to liquidate capital, also known as “paying cash.” Thus, the two most popular methods for using capital consist of either dependency on third parties or capital liquidation.
The costs of both of these are huge. In terms of dependency on third-party lenders, all sorts of costs accrue to the individual borrower-consumer. In housing, we are hood-winked by single-digit APR, yet effectively pay ~40–55% in interest by volume (total interest and fees divided by the total payments on a mortgage). With automobiles, retailers boost the list price of the vehicle in order to advertise alleged no-interest or zero-interest loans, thereby smuggling the finance charge out of the interest charge and into the retail price. Because credit card interest charges aren’t amortized, the APR is huge, and the consumer is lured with initial teaser rates.
And that’s just the monetary charges! The individual concerned about the rate of return in an “IBC policy” probably has not accounted for the dollar-cost of the hours of their (non-reproducible) time spent securing financing, arguing with lenders, or restructuring repayments. Yet, all of this bears costs. Equally unlikely is it that the individual has priced the risk of a loan — especially a business loan — getting called due (either because the bank needs to raise capital, is bought out during an economic downturn, etc.). Yet, this too bears costs. In sum, the lengthy applications, use-restrictions, physical collateral assignments, mandatory repayment schedules, hostile bill collections departments, and the various risks associated with the above constitute a massive cost that usually goes unaccounted for in typical rate-of-return analysis.
Capital liquidation (paying cash) bears costs too. Every dollar that flows out of one’s control has a present value opportunity cost. That means all the interest and dividends that the dollar could have earned had the individual first contributed to his own capital is gone. In other words, the capital liquidator actively inhibits the growth of his own capital over the course of his lifetime.
The individual pays the monetary and non-monetary costs associated with reliance on third-party lenders and/or the opportunity costs associated with capital liquidation because he lacks optimal capital of his own. He lacks capital of his own because no one has told him that capital is distinct from investment. Whereas capital is property value used to accumulate wealth, investment is an allocation of resources to generate a return. This key distinction has a major implication. That implication has to do with control.
With investing, the whole idea is to forfeit control of resources to the recipient of the investment. With capital, the whole idea is to maximize control of resources under the authority of the individual.
Dividend-paying whole life insurance designed for the IBC is a tool for optimal capital accumulation. It is not an investment and it should not be analyzed like an investment.
Do “IBC policies” have values that grow over time? Yes. Do those values grow at some rate? Yes. But the salient features of an IBC policy have little to do with these positive growth rates. In fact, the positive growth rates of the values in “IBC policies” (cash value, dividends, and the death benefit) are bonus features. An “IBC policy” is optimal for capital accumulation because it is implemented through a piece of private property — a financial asset under the direct, contractual control of the individual. That its values grow is an ancillary side-benefit. That its values grow on a guaranteed basis with highly favorable tax-treatment is an awesome, yet ancillary, side-benefit.
In fact, as you may have sensed, there are benefits — plural — that accrue to the individual who practices the IBC. A legitimate quantitative measure — an aggregate rate of return, if you will — would have to price all of those features and permit of present value discounting. To be fully exact, one would have to also apply expected present value analysis, since, if the insured were to pass away in a given year, the payment of the death benefit would cause whatever the aggregate performance metric is to skyrocket. Complicating matters further is the fact that these figures, discount factors, and mortality expectations will differ for every person and it would differ for the same person over time.
Various IBC Practitioners have tried to quantify the benefits of the IBC. I believe that, in terms of technical logic, it cannot be done. The benefits are too many, and the value of them are subjective and diverse.
The Real Key to High Rates of Return
However, an individual investigating the IBC may still be curious about optimal investment performance. This presupposes that the individual has understood the difference between capital and investment and recognizes the value in strategically accumulating and deploying capital.
This isn’t a mutually exclusive question. It is not a matter of choosing to capitalize or to invest. This isn’t a matter of trade-offs. It’s a matter of sequence.
An individual can approach investing in one of two ways. You can be either under-capitalized or well-capitalized. Check out the slide below from the presentation I gave at the 2019 Nelson Nash Institute Think Tank Symposium for Authorized IBC Practitioners.
In short, opportunity abounds for the well-capitalized — that is, opportunity of both the investment and entrepreneurial types. Individuals with control over large pools of financial value (capital) are well-positioned to take advantage of local, perhaps even exclusive, investment opportunities. These are investment opportunities of a categorically different nature than that of the mass-marketed, relatively homogeneous, impersonal, Fractional Reserve Banking-risk-exposed options available to the under-capitalized.
Where the greatest percentage-gains may lie is in entrepreneurship — the monetization of one’s unique skills and abilities. The modern financial advisory paradigm that prioritizes investment to the exclusion of any sort of capital accumulation leaves the individual utterly bereft of the resources necessary to finance an individual’s transition into self-employment or business ownership. Whereas the very concept that, if implemented, would optimally prepare the individual for entrepreneurship and its potential rewards is the target rate-of-return skepticism.
Frankly, the dynamics offered in the conventional investment paradigm pale in comparison to the (investment and entrepreneurial) opportunities the well-capitalized individual can enjoy. Sadly, many who investigate the Infinite Banking Concept neglect their own potential to encounter and seize these opportunities with proper preparation. Not least of the benefits that accrue to the well-capitalized “Infinite Banker” is the autonomy that comes with possessing such contractual control. Two things are certain of this financial power: it is of unknown magnitude and it is consistently unaccounted for in conventional rate of return analysis.
Finally, the well-capitalized will enjoy a phenomenon rarely understood in the financial world. This is the feeling of opportunity attraction. Everyone knows at some level that people with money have the unique problem of overwhelming petitions from other people for the use of their money. The well-capitalized face the opposite problem of the under-capitalized. Instead of seeking after opportunity (and having to pay costs which then must be minimized through various fund allocation strategies), the well-capitalized are sought after and presented with opportunities. This is why people with money often hesitate to tell others how well-capitalized they are. The tsunami of opportunity can be overwhelming.
Therefore, if one is truly concerned with optimal investment performance, the question ought to be: how best should I prepare? Answer: first become well-capitalized. Or, in the language of the IBC, Become Your Own Banker.
We’ve covered a lot of ground. We talked about how investment analysis is inappropriate for investigation of the IBC or the policies used in order to implement it. Dividend-paying whole life is not an investment. In contrast, it is the optimal tool for capital accumulation. In fact, the individual who opts out of the conventional financial thinking and capitalizes first will often experience a paradigm upgrade when it comes to investing. Rather than playing the role of opportunity-seeker, the well-capitalized individual becomes sought after by those with opportunities. In sum, rate of return analysis is categorically insufficient for capturing the power of the IBC due to the multitude and variance in kind of the many benefits it affords the individual.
Thanks for reading!