An Introduction to the Infinite Banking Concept

An Introduction to the Infinite Banking Concept

Originally published by: Robert P. Murphy

The Infinite Banking Concept (IBC) allows households and businesses to become financially independent by “becoming their own bankers.” R. Nelson Nash discovered IBC in the early 1980s, as he was struggling with high interest rates on loans he had taken out from commercial banks.

As he contemplated the financial mess he’d created for himself, Nash had an epiphany: He realized he could fund Whole Life insurance policies in order to create his own set of “banks,” which would serve as a repository for his savings and allow him access to cash when he needed to make large purchases. By switching his financing needs away from outside lenders and towards his own resources, Nash would take control of his financial world, thus achieving peace of mind and (in a sense) recapturing interest payments.

Nash learned the mechanics of Whole Life policies, which are the platform on which IBC is implemented.

Nash was educated as a forester and credits this mindset with his emphasis on long-term planning. While working as a private-sector forestry consultant in the 1950s, Nash became aware that something was wrong with the collectivist economic philosophy guiding our government officials and the major media, but he lacked a systematic framework. Someone introduced him to the Foundation for Economic Education (FEE), and Nash ended up being personally mentored in his study of Austrian economics by FEE’s founder, Leonard E. Read.

It was in his later career in life insurance that Nash learned the mechanics of Whole Life policies, which are the platform on which IBC is implemented. To appreciate IBC, we first need to understand the different types of insurance.

Term Life Insurance

A term life insurance policy operates like other types of insurance you may be familiar with. For example, with a fire insurance policy, a homeowner pays premiums to the insurance company, and if there’s ever a fire, the homeowner gets a check to cover the damages. Likewise with a car insurance policy: The driver pays a regular premium (every month or year), and if there’s an accident during that time, the insurance company sends a check to repair the damage (or to buy a new vehicle). In either case, the premium is simply covering the “pure” cost of the insurance, plus a margin for overhead and profit.

If the person lives throughout the full term specified in the initial contract, then the contract ends and the person must re-apply for life insurance.

In order to set an appropriate premium, actuaries look at historical statistics, and estimate how many houses out of a sample will burn down during the year, or how many drivers out of a sample will get into a car accident. Fire or car insurance is a “good deal” for the buyer because it transforms the small chance of a huge financial loss into a “guaranteed” fixed premium expense. (Economists describe this by saying most people are “risk-averse.”)

A similar process occurs with term life insurance. Someone who’s (say) 25 years old can take out a life insurance policy which promises to pay (say) $1 million. The policy is constructed to be in force only for a certain term, such as 10 or 20 or 30 years. After reviewing the medical condition of the applicant, the insurance company offers a policy with a fixed monthly (or annual, etc.) premium payment. So long as the person keeps making those premium payments, he or she maintains life insurance coverage and will have a $1 million death benefit go to the named beneficiary if the person dies during the term.

However, if the person lives throughout the full term specified in the initial contract, then the contract ends and the person must re-apply for life insurance, or go without. (For example, if a 25-year-old took out a 30-year term policy, then at age 55 the person would have to get a new policy, which would entail much higher premium payments.) In practice, most term life insurance policies expire without the insurance company having paid out any death benefit claim.

Whole Life Insurance

The life insurance company takes the incoming premium payments and “puts them to work” by buying financial assets.

In contrast, a permanent life insurance policy never expires. The original, classic example of such a policy is a Whole Life policy, which (as the name suggests) stays in force throughout the applicant’s whole life. (Up through the 1960s, Whole Life insurance was a staple of Americans’ household saving.) Contractually, the owner of a Whole Life policy is entitled to perpetual coverage, so long as he or she keeps making the fixed premium payments. The insurance company knows that if the customer keeps the policy in force, eventually it will have to pay out the death benefit. (Also, if the person happens to live a very long time—such as 121 years with newly issued policies—then the Whole Life policy will “complete” or “mature” and the insurance company will pay the face death benefit, even though the insured person is still alive.)

Because the premium (whether it’s monthly, semiannual, annual, etc.) for a Whole Life policy is fixed throughout the life of the owner, the actuaries set the level at an average amount such that the policy owner is effectively “overpaying” for the pure insurance coverage in the early years, while “underpaying” in the later years. In practice, what happens is that the life insurance company takes the incoming premium payments and “puts them to work” by buying financial assets, such as conservative corporate bonds. Over time, the life insurance company builds up a stockpile of assets effectively “backing up” a Whole Life insurance policy that it has issued in the past.

Cash Surrenders

Now consider that as a customer with a Whole Life policy gets older, he or she is a ticking (financial) time bomb from the insurance company’s point of view, because the moment of death—though uncertain in any particular case—is getting closer and closer. That’s why the life insurance company would be happy to pay such a customer a cash surrender value to “walk away” from the policy, and this amount increases over time.

The life insurance company would be happy to pay a customer a cash surrender value to “walk away” from the policy, and this amount increases over time.

For example, if a healthy 25-year-old takes out a Whole Life policy with a death benefit of $1 million and that requires premium payments every year, a few years later at age 28 that particular policy still wouldn’t represent a very large financial liability to the company, and that’s why the cash surrender value might only be a few thousand dollars. But if we fast forward to age 98, then that Whole Life policy is a very serious item to the life insurance company. It knows that very soon, it will have to pay out $1 million to the named beneficiary on the policy, and that it will only get a handful (if that) more premium payments in return.

But on the bright side, by age 98 the life insurance company has been collecting premium payments for 73 years from this hypothetical customer, and thus has a large amount of assets “backing up” the policy. That’s why the insurance company would be willing and able to pay a much larger cash surrender value (approaching $1 million) to the customer if he or she would agree to walk away at that late date.

Policy Loans

There’s one last component we need to explain: policy loans. With a Whole Life policy, the owner effectively builds up equity over time, as the cash surrender value increases. As part of the contractual arrangement, if the owner wants cash but does not want to surrender the policy, he or she has the option of borrowing money directly from the life insurance company, with the cash surrender value serving as the collateral on the loan. This occurs “on the side” as it were; the money doesn’t “come out” of the policy.

IBC is about using policy loans (and paying them back) in order to take control of the money flow in your life.

What this means in practice is that someone who has built up one or more well-funded Whole Life policies can obtain financing from the life insurance company at a predictable interest rate with no questions asked. (Because the insurance companies themselves guarantee the collateral on policy loans, they don’t care about the borrower’s credit score, annual income, purpose of the loan, etc. the way a conventional lender would.) As Nelson Nash explains in his bestselling book, Becoming Your Own Banker, IBC is about using policy loans (and paying them back) in order to take control of the money flow in your life. When you need to buy a new car or invest in an attractive parcel of real estate, you don’t borrow money from conventional lenders but, instead, take out a policy loan from the life insurance company.

IBC isn’t magic. Yet once you understand the capabilities of a properly designed dividend-paying Whole Life insurance policy, you can appreciate Nash’s vision. He has discovered a very conservative, time-tested method to accumulate savings which can be deployed to take advantage of investment opportunities when they come along. IBC allows you to “become your own banker” and effectively secede from the current system which is dominated by Wall Street and commercial banks.

This essay is, of course, a very brief introduction to IBC. For more information go to the Nelson Nash Institute website. The present author co-wrote a short book on the topic along with Nelson Nash and Carlos Lara, available at: www.TheCaseForIBC.com.

Robert P. Murphy is senior economist at the Independent Energy Institute, a research assistant professor with the Free Market Institute at Texas Tech University, and a Research Fellow at the Independent Institute.

This article was originally published on FEE.org. Read the original article.

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