Life insurance premium financing can help savvy investors leverage their portfolio for sizable returns. Some choose to finance in order to take advantage of higher-yielding investments. Others use that strategy to address a lack of cash flow or liquidity.
(Related: 3 Alternatives to a Life Settlement)
Navigating the rules and regulations that govern life insurance can be complex, even for the most adept advisors. This is particularly true when it comes to premium financing.
Think about federal regulation.
Premium financing is not subject to federal statutes or regulations any more than traditional financing may be. While certain federal laws will apply, such as anti-fraud provisions and truth-in-lending disclosure requirements — which detail payment rates and schedules, life insurance premium financing is largely governed on a state-by-state basis.
One federal rule to pay close attention to, however, is taxation. It’s here that life insurance premium financing has a major advantage over its alternatives, including the potential sale of a life insurance policy. The tax-free nature of loan proceeds is a substantial benefit. The proceeds from a life settlement, on the other hand, are usually taxable.
Know your state regulations.
Life insurance premium financing becomes much more complicated on the state level, as individual states have different rules and approaches.
The majority of states in the United States regulate financing, focusing on elements such as minimum disclosures and the lender’s enforcement rights upon default. Each state also sets its own limits on maximum interest rates for premium lenders, and those rates may vary significantly. In California, rates can be as high as 24%, while in Delaware, rates max out at a little more than a third of that — 9%.
There is even greater regulation when a lender chooses to obtain a state’s premium finance license. While becoming a licensee can prove onerous, there are benefits to doing so, like access to higher interest rates. Regulations for licensed premium finance lenders are usually consistent across state borders since they are built on the same model statute.
Some lenders choose to avoid licensure by operating below the state’s interest rate limit. This limit is generally less rigid, or even inapplicable, for large-sized loans because states are more protective of smaller loans — they assume small-amount borrowers are less knowledgeable about the process and thus need added protection.
Rules and regulations are always subject to change. So what’s the best way to stay up to date? There isn’t a single one-stop shop or resource for life insurance premium finance information. Instead, advisors can seek out relevant content across the web and also read up on each state’s usury laws.
Advisors might also join relevant trade groups. For example, the National Premium Finance Association (NPFA) does work across the United States pursuing conformity among state statutes. (Although, it’s worth noting that the NPFA focuses less on life insurance premium financing and more on property and casualty policies.)
Some states, such as Alabama and New York, have mentioned premium finance arrangements in COVID-19-related guidance and emergency regulations.
The lenders fall into two categories.
Mastering premium financing for life insurance policies can be a complex task. State and federal rules are just one part of the equation. In addition to adhering to all regulations, advisors and borrowers should also ensure they are interacting with an established, reputable lender that has a strong pedigree.
Generally, life insurance premium finance lenders fall into two categories. The first is comprised of big commercial banks, which offer competitive interest rates (usually in the single digits) but have limited flexibility. These commercial banks typically rely on a policy’s cash value to secure the loan, but they will sometimes accept other assets (like personal guarantees, portfolios, or marketable securities) to collateralize the loan.
The companies in the second category, private premium finance lenders, charge much higher interest rates (usually in the low to mid teens) but are much more flexible when it comes to collateralizing the loan. For example, many private lenders will look at a life insurance policy’s death benefit, rather than its cash value, in order to secure the loan. This means borrowers don’t have to present a personal guarantee or other liquid collateral. Further, private lenders will often defer interest payments until the loan’s maturity. In the current economic environment, with unemployment skyrocketing and personal liquidity dropping, using a life insurance policy as collateral is a critical alternative to what may be dwindling assets and personal net worth.
When it comes time to make life premium financing arrangements, be sure you do your due diligence — from meeting federal rules and navigating state regulations to choosing the lender that’s right for your client.
Scott Rose is the vice president of Fifth Season Financial, a specialty lender that serves clients who are dealing with advanced-stage illness. The firm operates the Funds for Living and Giving (FLAG) program, which gives a client the ability to receive an advance on a life insurance policy. He can be reached at (866) 459-1271.