Life Insurance Premium Financing – Know The Risks.



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Is life insurance premium financing right for you?

Life insurance premium financing is not free life insurance. By itself, this will eliminate 90% of the prospects. The annual out of pocket cost is more than the cost of cheap term insurance. There goes another 90%, leaving a legitimate population of 2-3% of all prospects who qualify for financing a life insurance policy.

A properly structured premium finance loan is for wealthy people 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. For a  corporation with a 12% ROI, the long term interest rate should be less than half, or less than 6% in this example. At loan maturity or before, there must be a clearly defined exit strategy to pay off the loan. The debt can be retired with cash value from the policy or other liquid assets. After loan repayment, the life insurance policy is either sufficiently funded to provide coverage for life or may need additional premiums to keep it inforce until the optimal duration. 

Can Real estate be used as collateral for premium finance loans? In theory, yes. In practicality, NOT LIKELY. Lenders typically don’t like using real estate for this type of lending. There are some lenders that work with good clients to effectively use real estate to support these loans. This complicates something that is already complex. If you are a great customer of a bank and that bank will do exceptional things for you, 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 permanent coverage, premium financing may be 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 Suited For:

  1. Clients who NEED significant amounts of permanent death benefit and CAN afford the premiums.
    2. Clients who understand leverage, or
    3. Wish to use life insurance to offset estate taxes.

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

    •  Wish to use corporate assets for superior ROI opportunities.
    •  Fund executive benefit arrangements (capital split dollar) with meaningful amounts of insurance…
    •  Wish to use their business balance sheet for other purposes, or

The low-interest rate environment created interest in Premium Financing. As rates increase, 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: 

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 insurance company crediting rates. 
5. If you fear this correlation could change – you may not be a good candidate for premium financing. 

6. If you believe the strong correlation will continue, life insurance premium financing may be right for you.
7. This correlation will produce a positive arbitrage, or an excess cash cushion that 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 often provides 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.

Avoid getting involved in a premium finance structure without the life insurance company being aware of the financing arrangement, 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 successful 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. We urge everyone 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.

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