Your client has enjoyed a successful career but creating his estate plan may be complex. Cash flow is rigid and your client is not in a position to sell assets, yet he needs life protection.

Premium financing may hold the solution as it can make it possible for individuals, as well as businesses and corporations, to purchase a relatively large amount of coverage without selling assets, diminishing cash flow or reducing liquidity. This method is generally for high-net-worth clients and has some risks.

“Your senior client may not like liquidating assets,” says Philip D. Lukens of Lukens Financial Group in Denver. “While it really depends on the situation, for those who need a premium advancement and insurance, this can be an excellent option.”

Premium financing can help a client purchase more life insurance as well as raise funds from an existing policy. It is often positioned as a means to secure millions in benefits for beneficiaries with only minimal risk, no out-of-pocket costs and no personal guarantees, although a form of collateral is required. Whole life, universal life and indexed universal life insurance can be utilized. Tax and legal professionals are also commonly involved, in addition to a premium financing specialist, as there may likely be other complications and considerations.

“The client must qualify for insurance and then obtain a loan, usually from a bank or lender specializing in such arrangements, and the loan must be repaid,” Lukens notes. The lender pays the policy premium and the borrower pays interest on the premium loan. In some cases, the loan interest may be added to the loan.

“It really comes down to control and timing. Do you want your money tied up in a life insurance policy or would you like to use someone else’s money?” asks Dusty Farber, president of CBIZ Special Solutions Group in Los Angeles.

“Once the need for the life insurance is established, premium financing is offered as a way to pay the premiums. It is not a way to get free or ‘cheap’ insurance,” says Cindy Wormser, ChFC, CLU and assistant vice president in AXA Equitable’s Advanced Markets. “Most lenders will not finance a variable product.”

Under these scenarios, financing options are frequently favorable for the borrower, whether it be an individual or business, because the loan amount can be secured against the existing life policy. Typically, borrowers receive a much better rate of interest and overall loan terms when they choose secured instead of unsecured financing. However, individual needs and goals must be assessed in order to determine the most effective financing choice, as premium financing enables one to actually use the policy’s value as collateral to finance additional insurance. As a result, the range of available life insurance choices increases.

There may also be potentially favorable gift tax consequences common among large, frequently illiquid estates. Subsequently, it can also help defer or avoid capital gains taxes which would become payable once appreciated assets are liquidated. As a result, premium financing can be positioned as a way to help clients protect assets, continue business development and ultimately pass their wealth to heirs while keeping other financial objectives in place.

“Premium financing is a method to pay for life insurance by high-net-worth individuals and business owners so existing assets or income can be used for other needs,” says Michael H. Fliegelman, CLU, ChFC, at Innovative Planning Services, Inc., in Woodbury, N.Y. “Generally it is best used by a business or individual who has life insurance needs but does not have the cash flow to pay premiums, or has better use of money for business or investment purposes.”

Premium financing enables individuals with a high net worth to purchase life insurance without depleting other assets or changing their normal cash flow. They are able to protect net worth, continue business development and pass their financial legacy to future generations without altering other financial objectives. Not all can participate in such a strategy.

Generally those who could be considered for premium financing should demonstrate a need, as well as qualify for life insurance and have a net worth of $5 million or a minimal annual income of $200,000, as well as sufficient assets. Others demand that minimum net worth be $10 million.

The policy’s surrender value is the main source of collateral for loans but cash, securities, real estate and other commonly appraisable items such as fine art and collectables may also be used in some cases. Collateral amounts can vary among lenders and terms have changed. Some companies allow financing based upon a current policy. This may eliminate the need for other collateral. Similarly, it’s no longer necessarily to buy a new policy. Many lenders will finance existing policies and there is usually a minimum premium requirement. Should the insured die while the loan is in force, the loan and interest will be deducted from the death benefit. Beneficiaries then receive the remaining payment.

“In many cases, most of the assets are in real estate,” Wormser notes. “If someone would have to liquidate the real estate for less than full value, it may be more cost effective to borrow the premium, pay the interest and liquidate the real estate in a better market. If someone consistently earns high rates of return, it may be cost effective to retain those investments and borrow the premiums.”

High-net-worth individuals, business owners and upper-level corporate executives are often suitable candidates for premium financing. A company, like an individual, may need to purchase a large amount of life insurance yet not wish to liquidate or involve other assets in order to do so. When high-level coverage is offered as a portion of an executive’s compensation package, a company can turn to premium financing as a way to purchase desired coverage levels. Premium financing then becomes another tool to attract new talent and retain key employees as, in many cases, annual premiums will exceed $100,000 per year.

“Premium financing for life insurance originally was utilized in the corporate arena to fund large amounts of Corporate Owned Life Insurance (COLI), usually in a form of executive compensation,” Farber adds. “Today, the market has matured into uses in the individual life insurance marketplace.”

While the typical premium-finance prospect is either a single person or married couple over age 70, cases can be made for younger clients to consider it.

“You’ve got to know your client,” says Jameson Ferney, vice president and financial advisor at Premium Financial Advisors Inc., in Idaho Falls, Idaho. “Is it someone who just inherited $5 million or is it a 40-year-old who may earn $5 million a year?” Ferney, who says making the case for premium financing can be challenging, notes that once a prospect is educated about his choices, he almost always is in favor of it. “It’s easier to sell this than long term care insurance but it can take longer because a client’s attorney and accountant need to be on board.” Nevertheless, he reports that sales are increasing annually for his firm despite such hurdles as a flat yield curve.

“Market conditions can hurt even conservative illustrations as new loan rates can be higher than the policy interest rate.” But this is only temporary, theorizes Ferney, who recently used premium financing for a 35-year-old client. “New products are making this more attractive for younger clients. Five years later, most clients are glad they did this.”

Farber notes that in most instances the performance of outside investments will be equal to or greater than the cost of the financing. It really comes down to control and timing. “Depending on the mortality/life expectancy of the insured, it may be best to keep funds fully invested outside of the life insurance contract and use the portfolio’s borrowing potential,” Farber says.

Yet there are other points to consider when debating premium financing. “There should be an exit strategy other than death,” Fliegelman says, pointing out that such an arrangement may impact other loan needs of a client. “There may be additional fees charged by the lender. Make sure the net death benefit (after payment of the loan) is what the business or trust needs.”

Applying this technique to estate planning highlights other needs, most notably the need for a trust. “In estate planning, the most common arrangement is where the insurance policy is owned by an irrevocable trust so that death benefits are not subject to estate tax,” Fliegelman says. “The insured who is usually the grantor of the trust simply has to make gifts to the trust so that interest can be paid on the loans.”

In most cases, the client (grantor) will establish an Irrevocable Life Insurance Trust. “The Trust will purchase the appropriate amount of life insurance on lives of the grantor(s) to pay estate taxes or create liquidity at death,” Farber says. As estate taxes are due at the death of the surviving spouse; a survivorship policy is often used.

Lukens advocates using a team of professionals when considering this approach. “There are many moving parts to these transactions,” Lukens says. “You’ve got to work with top-rate professionals such as attorneys and accountants plus trust and insurance specialists to move this forward and be sure it’s right for the client. Otherwise it’s your phone that’s going to ring.”

Joseph Finora is a Laurel, N.Y.-based freelance writer who has written extensively about insurance markets and financial services. He has been a frequent contributor to Senior Market Advisor.