Life Insurance Premium Financing – Be Careful Of The Risks.

2 years ago Ted Bernstein 0

Is life insurance premium financing right for you?

Life insurance premium financing is not free life insurance. Alone, this statement will eliminate 90% of the people inquiring about it. The real annual cost is more than the premium for cheap term insurance. There goes another 90%, leaving a legitimate population of 2-3% who qualify with the right profile to consider financing a life insurance policy.

A properly structured premium finance loan is for wealthy people and/or companies who need and want permanent life insurance. It is a low-cost loan because the collateral that supports these loans is strong, typically cash or cash equivalents. The borrowing rate should be considerably less than the owner’s ROI and the insurance policy’s crediting rate. For a  corporation with a 12% bottom line ROI, the long term interest rate should be less than half that 12%, or less than 6%. At loan maturity or before, there must be a clearly defined exit strategy to pay off the loan. Ideally, the debt is retired with cash value from the policy or a combination of cash value and other liquid assets. The life insurance policy, now free of debt, is either sufficiently funded to provide coverage for life or will need annual premiums to keep it inforce until the target date. 

Can Real estate be used as collateral for premium finance loans? In theory, yes. In practicality, NOT LIKELY. As of November 1st, 2018, lenders don’t like using real estate for this type of lending. There are some banks and bankers that work with good clients to effectively use real estate to support these loans. If you are the kind of person that enjoys threading a needle, outdoors on a windy day, you will get more enjoyment from doing that than bringing real estate into the mix. I hear every day about a bank somewhere doing “tons” of premium finance loans using real estate. Unfortunately, these banks remain nameless. If you are a great customer of a bank and that bank will do exceptional things for you for fear of losing your business, it is worth a discussion.

Life insurance premium financing is exclusively for those prospects with legitimate needs for long-term death benefit. If you currently own large amounts of life insurance or may be looking for additional coverage, premium financing may prove to be very beneficial in your overall estate plan. The life insurance policy is often owned in a trust without gift tax or estate tax consequence. It is not uncommon for life insurance policies in excess of $20,000,000 to be owned in properly structured trusts designed to avoid income, gift or estate taxation.

Life Insurance Premium Financing Is Typically Best Suited For:

  1. Clients who NEED significant amounts of death benefit, can afford the premiums, but…
    2. Wish to use that cash flow for other purposes, or
    3. Wish to leave assets free from gift and estate taxes with minimal out-of-pocket cost.

Business owners who want large amounts of death benefit for succession planning, key-person protection and…

  1.  Wish to use corporate assets for superior ROI opportunities.
  2.  Fund executive benefit arrangements (capital split dollar) with meaningful amounts of insurance…
  3.  Wish to use their business balance sheet for other purposes, or
  4.  Wish to purchase life insurance with minimal impact on their balance sheet.

High net worth couples or individuals:

• Need for substantial life insurance and insurable at reasonable rates
• Sophisticated clients who appreciate complex financial transactions involving debt
– Recognizes the need for an exit strategy other than death

The low-interest rate environment created interest in Premium Financing. However, as rates are increasing, the interest expense increases too. Each loan is unique and circumstances should be evaluated during a rising rate period. For some, higher rates means no change to their ROI. For others, it can negatively impact their ROI. You are well advised to engage only with experienced insurance professionals and experienced lenders. 

Top 10 Premium Finance Considerations: Arbitrage, Collateral, and Proper Origination:

1. The borrowing rate is only one consideration in the structure. Client ROI and the policy projections are some others.
2. The lenders and the insurance companies require that 100% of what you borrow (loan value) is provided as collateral for the loan.
3. The relationship between loan rates and carrier’s crediting rate has been correlated for decades. Insurance company crediting rates and dividend scales are typically higher than interest rates.      4. Over the past 30 years, there’s been a strong correlation between interest rates and carrier crediting rates. As borrowing costs increase or decrease, insurance company crediting rates follow. 
5. If you fear this correlation could permanently cease – you may not be a good candidate. 

6. If you believe the strong correlation will persist, as we do, life insurance premium financing may be right for you.
7. This correlation will produce a positive arbitrage, or a cushion. This cushion will create a hedge against interest rate volatility.
8. When interest rates rise quickly, there may be rate compression or even rate inversion. Either scenario could increase the interest expense until rates stabilize.
9. The cash value of the life insurance policy should provide the majority of the required collateral. 
10. A properly structured premium finance loan should not require personal guarantees.

What are some of the risks?

– Policy performance risk.
– Increasing borrowing cost risk or inability to refinance risk.
– Policy lapse risk.
– Collateral call risk.
– Income tax risk.

Never get involved in a premium finance structure unless the life insurance company is aware of the financing, the exit strategies and the overall planning strategy. I have provided expert services to law firms and other state agencies about this very issue. Proper origination is the foundation of recourse premium financing.

Too many premium finance structures are schemes to take advantage of consumers and insurance companies by purchasing policies for the sole purpose of re-selling them for a profit. The policy owner will verify that the life insurance is affordable without financing. We urge you and/or your clients to avoid using life insurance for anything other than its approved uses. Stranger Owned Life Insurance (STOLI) is not legitimate premium financing and should be avoided. 

Please contact Ted Bernstein for guidance and consultation about life insurance financing.  You can Email Ted or contact him directly at 561-869-4500.