Insurance is a method of risk management. When you purchase insurance from an insurance company, you transfer the cost of a potential loss to the insurance company in exchange for a fee known as a premium. Insurance companies invest the funds safely to grow and pay out when a claim is made.
Fortunately, the concept of premium financing provides you with the desired freedom. It enables you to acquire life insurance while paying the premiums from a different source. It is not only an interesting financial strategy, but it also allows you to secure your and your family’s lives.
We will thoroughly explain the concept of Premium Financing and how to apply it to your life. We’ll go over:
- What are premium payments
- The Risks
- How does Life Insurance Premium Financing work?
Hopefully, this article will assist you in becoming more financially self-sufficient.
What is Life Insurance Premium Financing?
The loan of funds to a business owner, a person (usually high net worth individuals), or a company to cover the cost of life insurance premiums provided by an insurance company is known as premium financing loans. Premium finance loans are typically provided by a third-party finance entity known as a premium financing company; however, a life insurance company and insurance brokerage occasionally provide premium financing through premium finance platforms. Premium financing is primarily used to finance life insurance instead of property and casualty insurance.
To finance a premium, the individual or company seeking insurance coverage must enter into a premium finance agreement with a life insurance premium finance company. The loan period can range from one year to the policy’s life. After that, the premium finance company pays the insurance premium or initial premium, and bills the individual or company, typically in monthly installments, for the policy loan’s cost.
The borrowing policy owner will typically make regular payments (on a monthly or annual basis) on these premium finance loans. Some people, if properly structured, choose to roll up or capitalize interest into their premium financing arrangement in the hope that the policy cash value growth of the underlying life insurance products will outperform the accruing loan rate. It is important to note that whenever the cash surrender value of the insurance loan balance is less than the outstanding loan balance, the borrower is responsible for posting collateral.
Like any other loans or financing arrangement, this type of financial strategy comes with a few risks you need to look out for.
The Interest Rate Risk of Market Volatility
Because the interest rate risk due on money lent to pay premiums is linked to an index, typically the LIBOR (London Interbank Offered Rate) or Prime, The total interest charge will rise if interest rates rise. Suppose the policy owner is unable to make interest payments. In that case, they risk losing their insurance and incurring significant debt if the policy loan ‘s surrender value is less than the balance owed.
If this happens, the client will be unable to pay the premiums on a non-financed policy in any case, so as with anything else, make sure you can afford the policy. When responsible lenders (licensed professional) conduct financial underwriting, they consider this risk.
Loan rates are typically pegged to 1 year LIBOR with a competitive spread of 180 bit/s. Most borrowing rates can be expected to range between 2.5 and 6 percent, depending on the fluctuation of the one-year LIBOR plus the fixed spread.
Renewal Dangers of Premium Finance
Borrowers are typically required to re-qualify each time the loan is renewed. At this point, the loan’s collateral is re-evaluated (collateral might include real estate, stocks, and other assets and investments). If the collateral’s value falls below a certain threshold, the insured may be required to provide additional collateral to secure the loan.
Otherwise, the loan could become due or be renewed at a higher interest rate. Because the loan is renewed at the end of each term until the insured dies, qualification risk is always present, whether it’s related to collateral value or another factor under the lender’s underwriting standards.
Credit Rating Risk for Carriers
Financing terms are affected by the carrier holding the financed policy’s credit rating. Carrier downgrades may cause the lender to refuse to pay additional premiums, requiring the borrower to post additional collateral or call the loan and collapse all collateral to cover any money owed to the lender. The majority of premium finance platforms require carriers to have an S&P rating of A or higher.
Rate of credit risk
Carriers have complete control over the crediting rate of in-force blocks of business. Crediting rates are not guaranteed at the moment. As a result, any illustrated interest rate arbitrage between the policy crediting rate and the loan interest rate may no longer exist in the future.
Credit spread danger
Life insurance companies and premium finance lenders both use the same basic financial instruments. Carriers use corporate debt to fund insurance contracts. Liquidity is provided by lenders at personal debt rates. Corporate bond yields are lower than personal debt yields. As a result, the client financing the premiums may incur a negative spread. Through Indexing, Indexed Universal Life insurance may provide the policy with the interest crediting required to support the arbitrage.
The concept of insurable interest dates back to the English legal system. Wagering on an insured’s life was expected. Many times, a person with no interest, economic or otherwise, would take out a life insurance contract on a sea captain sailing dangerous routes, a boxer facing a lethal opponent, and so on.
As a result, the English courts ruled that anyone taking out an insurance policy on the life of an insured must have an insurable interest in their life. In layman’s terms, this means that you must benefit more from having the insured person alive than dead. Direct blood relatives have an unquestionable interest in a family member. A business partner may have a vested interest in another company.
This is a widely misunderstood idea. When a policy is issued, either insurable interest exists or it does not. Insurable interest is never an issue if an insured is premium financing a policy and his direct blood relatives are named as beneficiaries when the policy is issued. There are no insurable interest issues if an insured changes ownership of the policy as soon as it is issued, but the beneficiaries are related by blood at the time the policy is issued.
Life insurance is considered personal property. It is similar to owning a car, a house, or any other asset. You can pledge it, sell it, or change ownership as long as it was issued with the death benefit going to your beneficiaries.
Recent court cases have heard insurance carrier arguments regarding the sale or transfer of ownership of policies in courts across the country by insureds who sold their policies to investors. The courts have consistently ruled in favor of the insureds, concluding that an insurable interest existed at the time the policy was issued and that the right to sell or transfer the policy after issuance was a choice enjoyed by any asset holder. Many life insurance companies have attempted and generally failed to challenge these sales on the basis of insurable interest or by attempting to prove that the insured intended to sell the policy. When there is insurable interest at policy, the courts have determined that intent is irrelevant.
The majority of premium financing arrangements designed to provide liquidity to the client at death are fully collateralized. To satisfy collateral, the client must usually post a Letter of Credit (LOC), securities accounts, other non-financed life insurance’s other assets, annuities, or any other hard assets approved by the lender. Collateral requirements may change depending on economic conditions, forcing the client to liquidate positions in order to post collateral. Furthermore, if the value of collateralized assets such as real estate or securities falls, the insured or their estate may be required to post additional collateral.
Risk of Settlement
Some premium financing programs are sold with the expectation that the policy will be worth a lot of money at the end of the term. The client can then exit the financing arrangement and realize a profit. The secondary market for life insurance is extremely volatile. Settlement offers will differ depending on the interest rate environment and the extent to which capital will wait for a return. Any premium finance program or broker that induces you to enter into a premium finance transaction solely for the purpose of selling the policy after it is no longer contestable by the issuing carrier (generally two years) may be illegal and violate state insurable interest laws.
Benefits of Premium Finance
Why would people consider insurance premium financing in the first place? Almost half of all Americans have life insurance coverage to ensure that their loved ones are financially secure if the insured dies.
Premiums vary greatly depending on policy type, age, health and policy size.
Taking out a personal loan to pay high insurance premiums may be less risky than insurance premium financing.
A 47-year-old nonsmoking man, for example, could get a 20-year $100,000 term life policy for about $19 per month; a $250,000 policy would cost about $34 per month.
Premiums can easily cost $100,000 or more per year, premium financing may make sense because it allows people to borrow at a rate close to a benchmark short-term rate while investing the money in higher-yielding investments. Premium financing can also keep the insured from paying capital gains taxes if they liquidated assets to pay for the premium in full.
The benefits of Premium Financing are:
The Ability to Obtain Necessary Life Insurance at a Low Current Out-of-Pocket Cost
This eliminates the need for high-net-worth earners to pay wasteful term insurance premiums payments during their working years.
Save Up on Premiums That Would Have Been Paid in Vehicles With Higher Interest Rates of Return
Significantly more money is compounding in your favor, even if encumbered by the initial premium finance loan.
The Ability to Invest the Initial Capital Elsewhere
The ability to keep your other liquid and illiquid assets deployed in another location.
Possibility of positive arbitrage between the cash value growth rate of the policy and the premium-financed loan rate. It is obviously dependent on actual performance.
Potential for additional tax-free retirement distributions that are not subject to your highest and most penal tax brackets.
Tax-Free Death Benefit
The existence of a tax-free death benefit outside the estate allows the insured to tactically spend down less tax-efficient assets in their estate during their lifetime, as well as the ability to use another more complex estate planning exit strategy.
How Does PFIL Work?
Most of the time, high-net-worth individuals apply for a large amount of life insurance for estate or retirement planning. The majority of the life insurance policies will be Indexed Universal Life Insurance or Whole Life insurance policies because lenders recognize that these types of policies are pretty stable and can thus offer a very high loan-to-value ratio of 90% or higher.
Indexed Universal Life and Whole Life insurance provide a high loan to value ratio for premium financing.
Premium-financed life insurance policies are typically funded with the maximum allowable premium during the first 4-7 years to achieve a high early cash value and long-term solid performance.
The borrower may pay the first premium out of pocket to avoid posting collateral. The policyholder will more often than not concurrently petition a third-party lender for a large premium finance loan to pay premiums. The individual, trust, or business is expected to make regular payments to the lender.
Regardless, the policy owner must be prepared to post sufficient liquid assets or marketable securities as collateral if there is a shortfall between the policy cash values and the total amount borrowed for premium-financed life insurance. However, if properly designed, life insurance policies can often make up the lion’s share of the collateral required by the lender. To avoid this additional moving target with premium financing, the policy owner may even have to make early premium payments.
Consider Financing Your Life Yourself
The Infinite Banking Concept
Connect your beneficiaries’ future financial security with the possibility of meeting all of your financial needs right now. Though it may appear impossible, we can assure you that it is entirely within your grasp. That is why you should familiarize yourself with the concept of Infinite Banking.
Infinite banking allows you to operate and borrow money the same way a traditional bank does, but without relying on a third party. You will be a creditor as well as a lender.
Instead of borrowing from a bank, you borrow money from yourself and control your cash flow while still allowing your life insurance policy to earn dividends (money) even though you are using the funds elsewhere. In other words, you accumulate wealth by borrowing and repaying the capital contained in the cash value of your permanent life insurance policy.
One of the most significant benefits of a whole life insurance policy is that you will never have to deal with banking fees or loan interest rates. You can borrow money as a policyholder using your policy’s cash value. You would never have to borrow from a bank again if you used this borrowing setup. Instead, you would borrow for yourself (via your life insurance policy’s death benefit) and pay yourself back over time. As a result, you are your own bank.
Infinite banking’s goal is to replicate the process as much as possible to increase the value of your own bank.
The lending and repayment of money typically held in the cash value of a permanent life insurance policy occurs during the duplication process.
Infinite banking enables you to better work towards your individual and unique financial goals for yourself and your family and control your finances without dealing with banking fees or loan interest rates.
Implementing this banking strategy into your life gives you much better control over your finances and aids in accumulating wealth through the use of a life insurance policy.
We hope we brought the topic of the premium finance agreement closer to you and how to use premium finance strategies to your advantage. Choose Premium Finance and use your money elsewhere than for paying premiums.
Consider incorporating Infinite Banking into your retirement planning if you want to invest in your future while also gaining financial freedom. At Wealth Nation, we will teach you how to manage, create, use, and multiply your money completely independently by utilizing your life insurance.