You have heard the term, but you don’t know how it works. You may even be familiar with the strategy, but not aware of the nuances. How might this strategy benefit your clients? And which ones? Why should one use premium financing over other types of loan investment alternatives?
Premium financing is a strategy whereby a qualified borrower accesses third-party financing to pay for large life insurance premiums. The insurance companies have constructed specific products for these financed plans to minimize outside collateral and maximize returns. This allows individuals and businesses to leverage current assets, maximizing returns via a predetermined cash flow.
Every premium finance strategy is tailor-made for each client, with all strategies following a similar path:
1. The process starts with determining insurance coverage needs and financial suitability.
2. A preliminary case design is developed and discussed between all parties involved.
3. Many iterations of the design are run until the optimal plan is picked by the client.
4. Formal bank and insurance carrier underwriting is initiated.
5. The policy is issued by the insurance carrier. Ownership can mirror the standard guidelines of a life insurance policy, though it is strongly recommended that the strategy is initiated inside of an Irrevocable Life Insurance Trust (ILIT).
6. The client provides collateral for an insurance loan provided by a large bank or institution. The collateral is usually comprised of policy cash value, plus additional shortfall collateral made up of cash and cash equivalents. Then the bank pays the life insurance premiums to the insurance company.
7. Annual reviews and analysis should be performed to evaluate insurance policy performance and ensure successful renewals. This is not a “set it and forget it” type of transaction.
8. After the policy utilized generates enough cash value, i.e. “soaks,” the policy owner, which could be a trust, refunds premiums plus any outstanding interest to the bank to repay the loan.
Premium financing is widely accepted by many insurance companies and is reserved for qualified clients. An ideal client would have a minimum net worth of $5 million, although the sweet spot is $25 million, and could include:
- Real estate owners
- Privately held business owners
- Multifamily offices
- Corporate executives
- Hedge fund owners and managers
- Private equity firms
- Successful professional advisors
Why is premium financing such a valuable financial tool? In addition to the death benefit, the retained capital from not having to liquidate other assets to pay insurance premiums can allow for additional investment opportunities. Other advantages can include:
- Reducing or eliminating the out-of-pocket cost for life insurance
- Taking advantage of an insurance company’s crediting rate that may outperform the borrowing costs
- An opportunity for money saved by not paying the premiums to outperform the borrowing cost
- Given a set cash flow, an opportunity may exist to purchase more life insurance than if the client paid the premiums out of pocket
- Reducing or eliminating gift taxes
With all of these potential benefits, premium financing could be a valuable addition to your current client offerings. However, it is important to consult with qualified financial, legal and tax experts when setting up a premium finance strategy due to its complexity in nature.