Premium Financing
A sophisticated planning strategy that involves borrowing premium from a commercial lender
Why Premium Financing
Premium financing is often used when a client has a relatively illiquid balance sheet, where the borrowing of premium from a commercial lender funds premiums for life insurance planning objectives. In some cases, the client may also perceive more lucrative uses for their capital than just funding their life insurance planning objectives – such as an owner of a capital-intensive business with a high-growth rate.
Premium financing is also used when a client has limited gifting capacity, but has a demonstrable life insurance need. The reason this is favorable for the client is the gift to their trust is equal to the loan interest – not the entire policy premium. The fulfillment of their life insurance objectives can then be accomplished with little to no gift tax impact.
Who uses premium financing?
Often used by clients who have a high-net worth, which may be relatively illiquid. Typical ages are between 40 to 60, though they can be above or below that range. Ideal prospects will expect to post collateral for the loan, pay annual interest, and may have more than one option on how to exit the arrangement (by paying back the loan).
Exit arrangements may include:
A liquidity event, such as the expected sale of a business or property.
The successful termination of a Charitable Lead Annuity Trust (CLAT) or Grantor Retained Annity Trust (GRAT).
A future withdrawal of policy value to repay the commercial lender.
Financing involves significant risk, and should be approached with caution and thoughtful design and close partnership with the client’s legal and tax advisors.
Planning Considerations
The considerations
Premium financing is a complex transaction with many risks, including market uncertainty risk, borrowing-rate risk, and collateral risk. Irrevocable Life Insurance Trust (ILIT) assets may be insufficient to repay the lender.
The opportunity
High-net-worth clients with insurance needs are an impactful opportunity for producers, and premium financing is generally a fit for those objectives. Clients of your practice may also know about premium financing and familiarity with the concept. Highland’s team of specialists can help an advisor position the strategy.
The uses
Premium financing isn’t an objective by itself. Some uses include estate planning (estate equalization, liquidity needs, or tax efficiency). Also, it can be used within business planning to facilitate transferring it to the next generation.
New Business considerations
Underwriting requirements apply, but carriers may ask for more information about the arrangement, including executed loan documents. Lenders require a collateral assignment against the policy, securing interest in the policy value and death benefit.
Case Design
Carriers typically have guidelines limiting availability to high-net-worth clients (often within the $5 M to $10 M range). Typically, the focus is on an increasing death benefit (either option two or a return-of-premium). Generally, cash accumulation policies are favored, because they keep the need for outside collateral within an acceptable range.