Premium Financing
A sophisticated planning strategy involving borrowing premium from a commercial lender to fund premiums for life insurance planning objectives.
Why premium financing
Premium financing is often used when a client has a relatively illiquid balance sheet. 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 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/policy-performance risk, borrowing-rate risk, and collateral risk. Irrevocable Life Insurance Trust (ILIT) assets, or policy values, may be insufficient to repay lender – so, a well-planned exit strategy is vital for the success of a financing arrangement.
The opportunity
High-net-worth clients with demonstrable insurance planning needs are a major, impactful opportunity for insurance producers. And premium financing is sometimes a fit for those planning objectives. High-net-worth clients of your practice may also frequently run into premium financing, whether proposed by you or other advisors, and familiarity with the concept, and Highland’s team of specialists, can help you best position this for your clients.
The uses
Premium financing helps clients reach their planning objectives – it’s not an objective in and of itself. Uses for premium financing include estate planning, whether it’s for estate equalization, liquidity needs, or tax efficiency. It can also be used within closely held business planning to facilitate transferring the business to the next generation.
New Business considerations
Normal underwriting requirements will apply, but carriers may also ask for more information about the financing arrangement, including copies of executed loan documents prior to issue. Lenders will require a collateral assignment against the issued policy, securing their interest in the policy value and death benefit.
Case Design
Carriers will typically have premium financing guidelines that limit the availability to high-net-worth individuals – often the minimum net worth is in the $5 M to $10 M range. The case design typically focuses on an increasing death benefit (either option two or a return-of-premium death benefit). In general, cash accumulation policies are often favored, because they help keep the need for outside collateral within an acceptable range.