Direct Recognition vs. Non-Direct Recognition [Which Is Best for Whole Life Dividends]

February 23, 2023
Written by: Steven Gibbs | Last Updated on: January 15, 2024
Fact Checked by Jason Herring and Barry Brooksby (licensed insurance experts)

Insurance and Estates, a strategic life insurance provider composed of life insurance professionals, is committed to integrity in our editorial standards and transparency in how we receive compensation from our insurance partners.

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Difference Between Non Direct Recognition and Direct Recognition

Whole Life Insurance Dividend Crediting Rates 

One of the keys to obtaining financial leverage to pursuing other investments is to create financial arbitrage with your money. If you can borrow a policy loan at say 5% and your dividend rate is 6.5%, you would have a 1.5% arbitrage on your money and this would allow your policy to keep making money (1.5%) regardless of your policy loans.

For this reason, Nelson Nash recommended that folks use a life insurance company that is NON-DIRECT RECOGNITION vs. DIRECT RECOGNITION to make sure your policy performance is not affected by taking policy loans.

Unfortunately, the direct vs non direct recognition conversation is not simple and thus is the subject of much hand wringing in the infinite banking community.

Today’s task is to provide a better answer than has been currently offered to one of the key questions posed by those seeking the best infinite banking solution.

Direct Recognition vs. Non-Direct Recognition

As discussed above, whole life insurance, as well as other types of permanent life insurance with cash value, allows access to the cash value in your policy through policy loans. Policy loans charge a loan rate that may be fixed or adjustable each year depending upon the policy. When a policy loan is taken in a participating whole life insurance policy, the loan amount continues to earn policy dividends.

Crediting Adjustments on Life Insurance Policy Loans

Economics requires that policy loans, along with other factors in the economic environment, can have a negative impact on the dividend rates offered by a life insurance company.

This impact, when applied to an insurance policy is called a “crediting adjustment” and there are two ways this adjustment is applied.

These two ways are either Direct Recognition, which passes the adjustment only to the policy holders who have outstanding loans and Non-Direct Recognition, which passes the adjustment to ALL of the policy holders, regardless of outstanding loans.

This crediting adjustment for direct recognition companies can result in a decrease in the dividend rate for those who hold policy loans.

Non-direct recognition insurance companies will not show an adjustment to the dividend rates; however, the dividend rates in total may be lower and it is important to consider this factor.

Direct recognition companies like Penn Mutual contend that their approach is more fair, whereas non-direct recognition companies like Lafayette Life contend that their approach is more suitable for an infinite banking strategy.

However, as we shall see, it isn’t quite this cut and dry.

Margin Loan Rates vs. Dividend Rates

Another important factor to consider is the margin loan rates vs. dividend rates. A margin loan rate can be defined as the difference in the crediting rate between loaned and non-loaned policy values.

For example, the non-loaned dividend interest credit rate may be 6.5% and the loaned rate may be 4.35% resulting in a net loss. Penn Mutual, as an example, responds to this issue by locking in the margin rate to -.65 % in years 1-10 of the policy AND year 11+ at 0% thus allowing for a break even crediting rate on loaned amounts.

The above math is of course based upon the guaranteed vs. non-guaranteed dividend crediting rates and therefore the return on a direct recognition company could in fact be much more favorable than break even.

The Impact of Lower vs. Higher Long Term Interest Rates

With all of the above in mind, something that people often forget is the impact of the interest rate environment on your infinite banking strategy and choice of company for infinite banking.

Non-direct recognition companies tend to be more favorable, and illustrate better, in a lower interest rate environment with a higher margin between the loan rates AND dividend crediting rates. The idea behind this fact is that interest rates will tend to rise much more quickly than dividend crediting rates.

Direct recognition companies, which allow the margin rate to be locked, tend to be favorable and illustrate better in a higher interest rate environment due to the fact that rising loan rates could exceed dividend crediting rates fairly quickly.

The Impact of Costs

Perhaps the most allusive factor when analyzing the policy performance, when considering direct vs. non-direct recognition, is the cost factor.

For example, a company may post a higher dividend rate and yet the illustrated guaranteed cash value accumulation may appear less favorable than another company. Although this is hard to put a finger on, the natural answer is that the company has the internal discretion to allocate its costs. For this reason, insurance companies with huge advertising budgets may carry higher internal costs than those with a more conservative approach.

For all of the above reasons, the decision whether to go with a direct vs. non-direct recognition company for your infinite banking strategy is not an easy one.

There are factors to consider such as our current interest rate environment, company costs, as well as the overall life insurance company rating of the company you’re considering.

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