In estate planning, the cost of insurance coverage is often not the roadblock to completing the sale; rather it is the unwillingness of the individual to reallocate high performing assets to pay for the coverage. Using somebody else’s money (premium financing) aids in addressing that objection by enabling clients to more cost effectively obtain coverage needed to pay estate taxes.
With traditional premium finance solutions, the client pays interest on the loan out of their assets. While this method can initially save the client money, after about 7 years the client often will have paid more in loan interest than in life insurance premiums. As a result the traditional strategy has had limited appeal to the corporate market, especially for small to medium-sized privately-held businesses, and for those whose principals are younger.
But as the premium financing concept evolves beyond the typical estate planning market into other areas, suppliers continue to contribute ideas. In addition, new life insurance products introduced in recent years can enhance traditional premium financing programs. For example, instead of paying interest annually, clients can leverage the potential for interest rate arbitrage through products with high interest earnings potential, such as indexed universal life.
Premium financing is not a risk-free concept, but for the right client the approach has great attraction. For young people with large insurance needs, the technique enables them to maximize insurance purchases, minimize out-of-pocket costs and protect the benefits of the client’s outside investments.
Applications for business
Organizations have long used life insurance-funded buy-sell agreements and key person insurance to provide liquidity needed after the death of a principal or top executive. Premium finance products address the typical insurance needs, but also create a substantial asset pool with which to provide additional benefits to a business’s employees.
A highly funded indexed UL contract may provide a death benefit for employees, as well as a pool of cash for long-term income benefits. Of course, any distributions from the policy will reduce the policy’s cash values and death benefits.
How it works
Executives or employees (in privately held firms) apply for life insurance as a group. Each person is underwritten, allowing for the benefit of an individual insurance policy, as opposed to a group contract with no cash value component. However, a different life insurance product is needed if the premiums are to be financed and the interest capitalized annually. We use an indexed UL contract that offers potential for interest rate arbitrage.
While a number of companies offer indexed UL, from a financing perspective it is important to use one that has the key benefits of an indexing engine, providing the ability for interest rate arbitrage, as well as an annual reset of its cash value to lock in any interest credited. Additionally, the indexed product should not only protect the customer’s cash value against indexing losses, but also be able to “catch-up” in the event of several consecutive years of a market decline.
What’s necessary, from a design approach, is for the policies to be highly funded (which they typically are), maximizing their ability to increase the cash values. They would be most effective for the 30-55 age range. Volume in this age range alone should appeal to many carriers who have had a disproportionate amount of their business coming through in the older ages.
Premium financing in action
If a group of executives from a small company fund life insurance contracts and “combined” their financing as a group, the loan likely could be retired using excess cash value in 15 or 16 years. In the event the corporation wants to pay some interest or principal annually, the loan could be repaid even more quickly.
For example, let’s assume the executives funded their individual contracts at $500,000 per year for 10 years. The owner and beneficiary of the contracts is the company. Should an executive die prematurely, the death benefit can pay off the loan; any remaining death benefit can be distributed to the corporation and the executive’s family. If the executives are young and live to retirement age, once the loan is repaid using policy cash values, those values will likely continue to grow because the executives are still young enough to have reasonably low mortality rates.
Such potential results open an interesting paradigm shift. Now, instead of a cost, the executives have an income-producing asset. To create that asset they used leverage–just as they do with most business activities–rather than cash flow needed for other business purposes.
Yes, this concept has risk, but no more so than most business investment decisions. The key to success is having the optimal combination of well designed loans, insurance products and case design.
Grace Barnard is president and co-founder of NIW Companies Inc., a Dallas, Texas-based insurance marketing concern specializing in premium finance. You can e-mail her at