An Analysis of Universal Life Insurance and the Infinite Banking Concept
In this post, I attempt to give a somewhat detailed critique of Universal Life (UL) and Indexed Universal Life (IUL) insurance products, contrasting them with the principles of dividend-paying whole life insurance as the foundation for the Infinite Banking Concept (IBC). The central argument presented is that UL and IUL policies are fundamentally flawed by design, as they transfer critical long-term risks back to the policyholder, directly contradicting the core purpose of insurance.
The primary flaw identified in all UL products is the internal Cost of Insurance (COI), which increases exponentially as the policyholder ages. This escalating cost structure creates a significant risk that the policy's account value will be depleted over time, potentially causing the policy to lapse precisely when it is needed most. This mechanism is presented as being "by design" and makes these products unsuitable for long-range financial planning.
In contrast, dividend-paying whole life insurance from a mutual company is positioned as the ideal vehicle for strategies like IBC due to its contractual guarantees, predictable growth, and the alignment of interests between the policyholder-owners and the company. The document details the historical context that led to the creation of UL products, including the demutualization of insurance companies and the "buy term, invest the difference" movement of the late 1970s.
Ultimately, my analysis concludes that while IUL policies may appear superior on paper through backward-looking illustrations, their inherent structural risks make them an unstable and inappropriate platform for implementing the Infinite Banking Concept, which requires stability, predictability, and control. The Nelson Nash Institute's official position is that only dividend-paying whole life insurance should be used for this purpose.
1. The Fundamental Flaw of Universal Life Insurance
Presented here is a multi-faceted critique of Universal Life (UL) and its derivatives, such as Indexed Universal Life (IUL), arguing that the product's structure is inherently unstable and shifts undue risk to the consumer.
Violation of Core Insurance Principles
My primary philosophical objection to UL is that it violates the very spirit and essence... of insurance. The purpose of insurance is to transfer risk from an individual to an insurance company in exchange for a premium. Universal Life, however, is designed in a way that transfers the most significant long-term risk—the probability that the policy will not remain in force—back to the policyholder. This is a direct violation of Nelson Nash's foundational rule: "think long range."
The Unstable Internal Mechanism
All UL policies are composed of two main elements: a savings or "side fund" component that earns interest (or is credited based on an index in IULs) and a pure insurance component, referred to as the Cost of Insurance (COI). This "unbundled" design is the source of the product's primary weakness.
• Exponentially Increasing Cost of Insurance (COI): The COI is not level; it increases every year as the policyholder ages.
◦ The cost is minuscule in younger years (30s and 40s).
◦ It begins to "creep up" in the 50s.
◦ It accelerates exponentially in the 60s and "goes vertical" in the 70s.
• Policy Cannibalization: This rising COI is deducted from the policy's account value. If the interest or index credits earned by the side fund are not sufficient to cover the escalating COI and other administrative fees, the account value will begin to deplete. This process can lead to a "death spiral" where the policy owner must pay significantly higher premiums to keep the policy from lapsing, or the death benefit will be reduced. I can say that it is an actuarial certainty that if the policyholder lives long enough, the account values are going to be depleted.
The Illusion of "No Market Risk" in IUL
IUL policies are frequently marketed with the promise of upside market potential with no downside risk, featuring a "floor" that is typically 0%. While it is true the policyholder's funds are not directly in the market and thus not subject to market losses, this messaging obscures the real, more significant risk.
• The Real Risk: The primary risk is not market loss but the policy imploding due to its internal costs. A year of 0% credit from the index is not a neutral event; it is a net loss for the policyholder because the increasing COI and other fees are still deducted from the account value, eroding the principal.
• The Risk Transfer: All universal life policies all of them 100% of them shift the risk to the policyholder... it's the risk that the policy will be enforced the day you graduate.
2. A Comparative Analysis: Whole Life vs. Universal Life
The two types of policies are presented as having fundamentally different designs, guarantees, and risk profiles.
Feature
Dividend-Paying Whole Life (DPWL)
Indexed Universal Life (IUL)
Risk Allocation
(DPWL) The insurance company assumes the long-term mortality and performance risk.
(IUL) The policyholder assumes the risk of rising internal costs outstripping account value growth.
Cost of Insurance
(DPWL) Bundled and baked into a level premium. The cash value is contractually guaranteed to equal the face amount at maturity (age 120).
(IUL) Unbundled and increases exponentially each year.
Guarantees
(DPWL) Contractual guarantees for cash value growth, death benefit (as long as premiums are paid), and nonforfeiture options like Reduced Paid-Up (RPU).
(IUL) Lacks the same contractual guarantees. Limited-pay periods are not contractually guaranteed and depend entirely on non-guaranteed projections.
Illustrations
(DPWL) Based on the company's current dividend scale, projecting forward. "This is what dividend we're paying... representative of our financial experience over the last year."
(IUL) Based on backward-looking "back testing" of historical index performance, often during high-earning periods. Described as an "illustration sale" that "lives in reality" far less than a whole life illustration.
Ownership Structure
(DPWL) Typically issued by mutual companies, where policyholders are part-owners and share in profits via dividends.
(IUL) Often issued by stock or demutualized companies, where the primary duty is to shareholders, not policyholders.
Fees & Charges
(DPWL) Costs are bundled into the premium. While there is an initial startup period with low liquidity, there are no explicit "surrender charges."
(IUL) Contains numerous explicit fees (policy fee, mortality fee, excess fees) deducted before funds are credited. Subject to surrender charges for 7 to 18 years.
Upside Potential
(DPWL) Stable, predictable growth through guaranteed cash value and non-guaranteed dividends.
(IUL) Potential for higher returns tied to an index, but this is limited by caps, participation rates, and other factors controlled by the insurance company. Caps "always come down."
3. Historical Context and Industry Evolution
The development and popularity of UL products are rooted in specific historical events that reshaped the insurance industry.
• Ralph Nader and the "Buy Term, Invest the Difference" Movement (1979): Consumer advocate Ralph Nader held congressional hearings accusing the life insurance industry of "fleecing the American public" with high-premium whole life policies. This popularized the "buy term and invest the difference" mantra, opening the door for Wall Street to capture funds through mutual funds and qualified plans (401k, Keogh).
• Demutualization (late 1970s - 1980s): Faced with negative press and falling sales, many mutual insurance companies (owned by policyholders) demutualized, becoming stock companies. This allowed them to raise capital by selling stock but severed the ownership link with policyholders. A bit of research suggests that company executives received "a heavy payout," benefiting more than the policyholders.
• The Industry's Response: To compete with Wall Street and respond to criticism that whole life was too complex, the newly demutualized companies created UL products.
◦ Universal Life (1980s): Launched during a period of high interest rates, making the side fund projections look very attractive.
◦ Variable Universal Life (VUL) (1990s): Replaced the simple side fund with mutual fund-like "sub-accounts," directly exposing policy values to market risk.
◦ Indexed Universal Life (IUL) (late 1990s): Created as an alternative after market downturns hurt VUL sales. It links returns to an external index with a protective floor, marketed as a "can't lose" proposition.
4. The Infinite Banking Concept (IBC) and Product Suitability
The book Becoming Your Own Banker® and The Nelson Nash Institute are equivocal about which product is appropriate for implementing IBC, a strategy developed by Nelson Nash to control the banking function in one's life.
Core Principles of IBC
• Purpose: The goal of IBC is to "get the bankers out of your life" by creating and controlling your own pool of capital. It is about controlling a process (the banking function), not chasing the highest rate of return.
• Foundation: The concept requires a financial vehicle that facilitates the "systematic formation of capital" in a way that is predictable, stable, and contractually accessible.
• Key Characteristics: IBC requires a platform that is guaranteed, stable, and provides contractual rights to capital via policy loans.
Why Whole Life is the Designated Vehicle
Dividend-paying whole life insurance possesses all the necessary characteristics for IBC:
• Predictability: Guaranteed cash value growth provides a stable base for capital accumulation.
• Control: The policyholder has a contractual right to take policy loans against the cash value.
• Stability: As the product of a mutual company, it is designed for the long-term benefit of its policyholder-owners.
Why Universal Life is Unsuitable for IBC
Despite arguments that IUL can be properly structured for banking, I assert here that it is fundamentally incompatible.
• The "Rate of Return" Fallacy: The primary argument for using IUL for IBC is its potential for a higher rate of return. This is dismissed as a sales tactic based on unrealistic illustrations that ignore the catastrophic risk of the rising COI. I believe that their argument is solely based on rate of return.
• Inherent Instability: You cannot correct a product that is flawed by design from the beginning. The unpredictable nature of index credits combined with the predictable and relentless increase in the COI makes IUL an unstable platform for a long-term banking strategy.
• The Long-Term Outcome: Even if one successfully uses an IUL for banking for 20, 30, or 40 years, the eventual outcome is likely to be much less death benefit and almost no account value due to the COI.
5. Nelson Nash Institute's Official Stance and Mission
The Nelson Nash Institute (NNI) maintains a clear and rigid position on the implementation of the Infinite Banking Concept.
• Practitioner Program Mandate: The NNI forbids its authorized IBC practitioners from using any product other than dividend-paying whole life insurance for their clients. This is a core tenet of the signed practitioner agreement required to enroll in their program.
• Educational Mission: The institute's primary goal is to change the public's thought process about finance, grounded in the Austrian school of economic thought. Its program is designed to teach agents the relationship between Austrian economics, capital theory, and privatized banking, rather than simply being a sales training course.
• Response to Public Perception: In light of recent negative press and lawsuits involving IUL (specifically mentioning the Kyle Busch case), the NNI issued a formal position statement to clarify its stance. This was done to differentiate the principles of IBC and whole life insurance from the issues plaguing IUL, preventing the "whole industry" from getting a "black eye." The NNI encourages the public to learn directly from Nelson Nash's original works (books and videos) rather than from misconceptions in the media or financial industry.
Click HERE for the official statement from NNI regarding the use of IUL for IBC.