Direct Recognition Loans: Better or Worse Than Non-Direct Recognition Loans?

Depending on where you are in your life insurance journey, you may or may not have heard the terms direct recognition and non-direct recognition. These terms refer to an internal process within the life insurance company as it relates to paying dividends when you have an outstanding loan. As we’ll get into, there’s ultimately very little difference between the two, however, direct recognition loans seem to get a bad rap in certain circles. Are direct recognition loans actually bad, and how do they stack up against non-direct recognition loans?

What Do Direct Recognition and Non-Direct Recognition Mean?

As mentioned, direct recognition and non-direct recognition are a part of your life insurance contract that dictates how the company applies dividends to your account when you have a policy loan. Life insurance companies do this in order to ensure fairness across policies.

With either type of policy, you earn interest and dividends on all of your cash value when applicable. Where they diverge is HOW the growth rate is applied when there is an outstanding loan. With non-direct recognition, the growth rate is applied evenly to the cash value regardless of whether there is collateral. Direct recognition life insurance policies apply the growth rate differently to cash value that has been collateralized vs. cash value that has not. This can be a positive or negative increase.

What’s the Contention with Direct Recognition?

The reason people seem to have a dim view of direct recognition loans is because of a misconception. The myth is that whatever cash value is collateralized automatically earns a lower rate. Because of this, people think that they’re getting the short end of the stick when they have a direct recognition policy. 

In reality, the loaned cash value has a dividend rate that is a certain number of basis points below the loan rate. If the loan rate is high, this can actually cause the loaned cash value to earn a higher rate than the non-loaned cash value. If the loan rate is low, then yes, the loaned cash value might earn less. 

For example, say the current declared dividend is 6.5 percent. If the loan rate is 8 percent, and the loaned cash value earns 1 point below that, then loaned cash value earns 7 percent. This means that your policy can actually do better if you have an outstanding loan. On the other hand, if the loan rate was 7 percent, then any cash value acting as collateral would only earn 6 percent. 

Is Non-Direct Recognition Better Than Non-Direct Recognition?

Despite the differences, if you analyze two policies over a 30-year time frame, the difference ends up being pennies. Over the years, dividend rates fluctuate, loan rates fluctuate, and so much more. In the race of life, one type of policy is not going to leave another in the dust. You can rest assured that starting a policy is better than getting hung up on the details. And if you’re still struggling to make a choice, maybe have both kinds of policies in your portfolio!

If we can help you start a policy and navigate your loans, we’d be more than happy to get you started down the road. Please book with us here, or email your questions to we*****@pr****************.com.

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