When you look at an insurance illustration, the Year One cash surrender value (CSV) of an index universal life (IUL) illustration assumes the end result of Year One. That’s after interest has been credited to the policy. But in the premium finance world, you make your first-year premium payment before interest is credited to the policy. To accurately calculate the collateral requirement in Year One, a premium finance proposal should assume that the IUL policy gets a zero return and then subtract the Year One cash surrender value from the loan balance. This leaves you with the additional collateral the client must post to the lender before the lender will loan any money. Keep in mind, many lenders only give you 90 to 95% credit on IUL cash surrender values.

In month 11 of the first year of the policy, the lender is getting ready to loan the Year Two premium. The IUL policy has not received any interest credit for Year One or Year Two. So, the client’s collateral requirement for his Year Two premium should assume the IUL policy received 0% interest credit for Years One and Two.

Now, it’s month 23 of a premium financed IUL policy. The lender is getting ready to loan the Year Three premium to the client. The policy was credited interest for Year One, but it has not received any interest credit for Years Two or Three. This is where many premium finance proposals really start to show bogus collateral numbers.

It’s actually pretty easy to figure out if you’re looking at imprecise collateral numbers on a premium finance proposal. If the client’s Year Three collateral requirement is equal to the Year Three loan balance minus the Year Three cash surrender value of the IUL illustration with a projected return, then it’s very likely you have a flawed premium finance proposal. Unfortunately, this inaccurate collateral projection is far too common in the industry.

The two collateral columns below compare the differences between inaccurate and accurate collateral projections. Clearly, there is a dramatic difference in projected collateral over a ten-year period if the life insurance cash surrender values are not discounted correctly.

M47, Pref NS, IUL $840,000 annual premium (7 pay). Client pays loan interest years 1-10.