Premium Financing of Life Insurance

Most of us pay the premiums on our life insurance policies by simply writing checks to the insurer. But if you’re a high-net-worth individual, you may need a large amount of life insurance, requiring significant premium payments, and it may not make the most sense to pay those high premiums with cash. Premium financing may be an appropriate alternate strategy, allowing you to borrow the money from a third party to pay the premiums for the life insurance you need.

Suitable Candidates
The concept of borrowing money to pay life insurance premiums may sound simple in theory. However, the practical application can be complex and challenging. That’s why premium financing should only be used in particular situations. Generally, you’re a candidate if you:

• Are affluent (at least $5 million net worth)
• Are older (perhaps age 65 or above)
• Are insurable
• Are creditworthy
• Require a substantial amount of life insurance (with premiums in the 6- or 7-figure range)
• Meet the lender’s requirements (e.g., minimum collateral)
• Are knowledgeable of and comfortable with risk and leverage

How Does Premium Financing Work?
First, you apply to an insurer for a life insurance policy indicating that the premium will be financed. If the insurer offers a policy with financed premiums, you apply for a loan from a third party lender. The insurance policy and the loan are separate and distinct transactions–the insurer is not a party to the loan. You’ll generally be required to make a down payment, and the lender will make the remaining premium payments to the insurer. You agree to repay the lender the principal, interest, and other fees. You also must pledge collateral for the loan, which may include the cash surrender value of the policy plus additional collateral and/or a personal guarantee.

With some premium financing arrangements, you pay off the loan in installments over the original loan term. More commonly, however, the loan is continually renewed at the end of each term, and is repaid at your death out of the insurance proceeds. With the latter type of arrangement, you either pay the interest and fees to the lender annually (a noncapitalized loan), or the interest and fees are added to the loan principal (a capitalized loan).

The Risks
There are significant risks associated with premium financing, as there are with any leveraging strategy. These risks include:

Loan interest rate and requalification risk–Lenders usually require that you requalify for the loan at each loan renewal, and that the collateral be reevaluated. If your financial position has deteriorated, or the value of the collateral has declined, there is the risk that the loan will not be renewed or that it will be offered at a higher rate than the original loan. If rising interest rates cause the loan balance to exceed the value of the collateral, you may be required to post additional collateral. It’s also possible that the loan could be called for default.

Policy earnings risk–If the insurance policy cash values do not increase as expected, the loan balance may exceed the value of the collateral. If this happens, you may be required to post additional collateral. Also, if the policy values fail to keep pace with the loan, more of the death benefit will be needed to repay the loan, reducing the ultimate death benefit that will be available to meet your objectives, which may include providing for loved ones.

Plan design risk–The insurance policy and the loan are separate and distinct transactions, and they operate independently. The lender may decline to renew the loan at the end of the term (if, for example, you fail to requalify). This would put the insurance policy in jeopardy of cancellation for nonpayment of premiums if alternate funding can’t be found.

Because of these and other risks, and the complexities involved, be sure to consult your financial professional before entering into any premium financing arrangement.