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June 08, 2008 at 04:00 PM
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.
