Borrowing the money from a third-party lender to pay for a large life insurance policy is becoming more popular as lenders look to capitalize on this segment of business and insurance companies are certainly willing to accept premium financing.
The purpose of financing life insurance premiums is pretty straightforward. The applicant wishes to purchase a large insurance policy but is reluctant to liquidate current assets to pay the premium on the policy.
Who is a Good Candidate for Premium Financing?
Generally, premium financing is a great option for a certain segment of consumers that:
- Require a considerable amount of life insurance that may be used for asset protection, wealth accumulation for retirement, or business purposes.
- Are reluctant to use existing capital or liquidate assets to pay the insurance premiums
- Would qualify as a standard risk or better
- Can satisfy the insurance company’s underwriting rules and guidelines
Premium financing works well for all participating parties and as such, lenders are now competing for business which benefits the insurance applicant and the insurance company. The applicant (borrower) likes premium financing because they don’t have to use assets that would likely earn higher returns than the cost of financing.
Insurance companies like premium financing because it provides a market for very large policies that require substantial premium. Lenders love it because they are making a long-term loan that is secured by the insurance policy. Every party wins since while every party accomplishes their objective.
How does Financing Life Insurance Premium Work?
When a high net-worth individual needs a large insurance policy to cover estate taxes, accumulate wealth for retirement or leave a large financial legacy to heirs.
Here’s an example: John wants to secure a $5 million life insurance policy to cover estate-taxes when his business is passed on to his heirs. John can use a premium finance company to pay the premium on the policy rather than using current assets that are earning a higher rate of interest than the lender (premium finance company) will charge for the loan. The loan is collateralized by the cash value in the insurance policy. If John purchased an Indexed Universal Life policy, the cash value in the policy will likely earn more interest than the loan interest and John can eventually pay back the loan using the cash accumulating in the policy.
Using this method of premium financing, John’s death benefit will cover the estate taxes that he expects to be levied on his passing his business on to his heirs.
The logic of premium financing is fairly simple. Why would you use assets that are earning 10% to pay insurance premiums when you can borrow the money at 5%?
Which Type of Life Insurance Works Best with Premium Financing?
When it comes to earnings from a life insurance policy, the product that continually comes to the surface is Indexed Universal Life (IUL). Earnings on cash value are most important if you want your insurance policy to earn more than your cost of the premium financing thus allowing you to pay off the lender using the cash that has accumulated in your life insurance policy.
To understand how indexed universal life policies can accumulate substantial cash and not lose money, let’s take a look at historical earnings for the NASDAQ 100, one of the most popular indices used in indexed universal life policies:
| Year | NASDAQ 100 | With 12% Cap and 0% Floor |
|---|---|---|
| 2008 | -49.10% | 0.00% |
| 2009 | 53.50% | 12.00% |
| 2010 | 19.20% | 12.00% |
| 2011 | 4.70% | 4.70% |
| 2012 | 16.80% | 12.00% |
| 2013 | 35.00% | 12.00% |
| 2014 | 17.90% | 12.00% |
| 2015 | 8.40% | 8.40% |
| 2016 | 6.90% | 6.90% |
| 2017 | 33.90% | 12.00% |
| Average without Cap and Floor | 14.72% | |
| Average with Cap and Floor | 9.20% |
As you can see the average rate using a 12% Cap and 0% Floor shows a lower earnings average over 10 years than without the Cap and Floor, however, the account was protected from a 49.10% loss in the first year.
Certainly, there would be enough cash built up (except in the first year) to pay the interest on the loan when you consider 9.20% earnings over 10 years versus a typical 5% interest rate on the loan.
The manner in which an IUL earns interest is fairly straightforward. Cash in the policy is invested in the indices you select. The returns on each index are limited by the Cap in the policy but are also protected by the Floor in the policy.
The Cap and Floor allow the policyholder to invest in the market without suffering from the volatility that typically accompanies it. You are earning from the market without being in the market.
What are the Benefits of Financing Life Insurance?
Premium financing your life insurance will allow you to purchase a large amount of life insurance without the need to liquidate your investments or assets that are already working for you. Typically large insurance policies are a perfect solution for:
- Providing funds for heirs for income replacement or to pay estate taxes.
- When the life insurance policy is owned by an Irrevocable Life Insurance Trust (ILIT), your heirs will be protected from paying estate taxes on life insurance proceeds.
- When a large insurance policy is needed for business continuation plans such as buy/sell agreements or key-person insurance, using premium financing allows the business to attain the coverage without having to tie up capital or liquidate profitable investments.
What are the Downsides to Financing Life Insurance?
It certainly wouldn’t be fair to discuss all of the good things that can come from financing your life insurance premium without discussing the things that could go wrong with the transaction.
As an independent insurance agency, we certainly understand that life insurance can be confusing and adding a loan to it can make it even more so. If you are interested in discussing your options for purchasing a large insurance policy for personal or business needs, please give us a call at your convenience 1-800-712-8519 or contact us through our website.
