After the transaction is in place the owner of the policy has all rights to the policy except for the cash value and all rights affecting the cash value growth which is owned by the Trust and pledged to the bank.
Once the policy is in force, the cash value will earn interest.` The insurance company will deduct the cost of maintaining the insurance from the earnings credited on the cash value. The net earnings may then be withdrawn from the policy by the Trustee and used to pay the interest due on the bank loan. The insurance company will give a minimum of 30 days notice to S.T.P. Enterprises, Inc. and the client of any change in the crediting rate on the cash value. The borrowing rate currently changes with the Prime Rate or LIBOR and changes are effective immediately.
When there is a positive spread between the net crediting rate of the policy's cash value, for example 10%, and the loan interest borrowing rate, for example 9%, the Arbitrage is positive and the insurance has little or no out-of-pocket cost to the client. However, if at any time the net earnings on the cash value do not provide the trust with sufficient proceeds to pay the interest due on the bank loan, the Arbitrage is negative.
The Trustees will track the interest charged on the bank loan and the interest credited by the insurance company on the cash value. The computer calculations project those Trusts, if any, where the earnings on the cash value will be insufficient to pay the interest due on the bank loan. The Trustee will then notify those clients that the arbitrage will become negative and of the amount necessary to make up the shortfall. The client then has the option of unwinding the Arbitrage Program and continuing the coverage himself/herself after the bank loan and Trust are paid, or making up the Arbitrage shortfall by paying the difference. If the shortfall is not paid, the Trustees may withdraw the cash surrender value from the policy and pay off the bank loan. The Trust will retain that portion of the cash surrender value, if any, which exceeds the amount of the loan, and distribute it to S.T.P. Enterprises, Inc. as beneficiary of the Trust. The assignments of the cash value to the Trust are released when the bank loan is paid off. The client becomes the owner of the entire policy. The client then has the option of whether or not to continue the insurance coverage. Since there has been no termination of the policy, proof of insurability is not required. The client will be responsible for paying future insurance premiums.
The S.T.P. Arbitrage Life Insurance Program bank loan operates on the principle of collateralization. At all times the bank must be collateralized for their entire principal and interest from either one or both of two sources. The first source, obviously, is the cash value of the policy. Thus, if the cash value is sufficient to pay both the principal and the interest due on the policy, no negative Arbitrage bill is sent and the bank will look solely to the cash value of the policy for repayment of its loan. If, however, the cash value is insufficient to pay both the principal and interest of the bank loan, the bank demands that deposits be made inside the bank such that the bank need only look to the cash in its offices and the cash value in the policy to pay off the bank loan plus its interest in its entirety. Negative Arbitrage payments are billed to the client and the projected amounts are found in the illustration under the heading "Supplemental Payments". Supplemental payments are billed quarterly and payments are due promptly such that the bank never falls into a position where they are not 100% collateralized. In the first year, the amount billed will only be due to either an increase in the borrowing rate charged on the loan or a decrease in the crediting rate paid to the cash value. For example, a one-half point increase in the borrowing rate on a loan/premium of $250,000 would cost $1,250 annually. This assumes that the crediting rate on the cash value remains constant. All quarterly bills are based on projections such that the bank will be at least 100% collateralized for its loan plus interest at the end of the billing quarter. After the first year, the client is billed quarterly for the supplemental payment found on the original illustration plus or minus prorations due and/or credited on account of any change from the original crediting or borrowing rate. Then any change that occurs to either the crediting or borrowing rate during the year will be made up during a quarterly bill adjustment. Once again, the quarterly amounts billed will be those amounts necessary to collateralize the bank in full principal plus its interest at the end of each billing quarter.
The cost of maintaining the part of the life insurance still owned by the client is deducted monthly from the cash value owned by the Trust. The client thus receives an economic benefit of the amount deducted from the cash value for the life insurance protection each year. This amount is 1099'd to the client each calendar year. How the client treats this amount is solely the responsibility of the client and his advisors. However, S.T.P. illustrates its belief that any 1099'd economic benefit may be offset by any payment made by the client to receive that economic benefit, analogous to split dollar. Thus in periods of negative Arbitrage billing, the illustration utilized by S.T.P. demonstrates an offset of the amount paid by the client against the economic benefit 1099'd to the client.
The S.T.P. Arbitrage Life Insurance Program uses only increasing death benefit permanent life insurance policies. Upon the death of the insured, the insurance company will pay the net death benefit to the beneficiary of the insurance policy as selected by the client. The cash value is paid to the Bank and used to pay the bank loan. To the extent the cash value at that time exceeds the principal and interest on the loan, the Trust will pay the excess to S.T.P. Enterprises, Inc; as beneficiary of the Trust.
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