Around since the 1980s, Premium Financing is a strategy used by High-Net-Worth Individuals (HNWIs) to cover the expense of large life insurance premiums by taking out a third-party bank loan to pay for the policy’s premiums. Many HNWIs are often hesitant to divert cash-flow or liquidate assets to pay for life insurance premiums out of pocket, so premium financing provides them with a different and more efficient option to maintain their liquid assets and receive life insurance coverage.
Why You Should Consider
Typically, people with a net worth of $5 million and above should think about premium financing when purchasing life insurance. There are quite a few reasons why High-Net-Worth Individuals should consider premium financing to pay for their life insurance.
- They can obtain and secure life insurance coverage, which everyone should always consider. As the cost of premiums for people of great wealth can be staggering, premium financing offers similar or greater coverage for a fraction of the cost. It also offers clients significant opportunity cost, allowing them to maintain their current investment strategy, that may be yielding a higher rate of return (ROI) while obtaining the appropriate amount and type of life insurance.
- They can avoid triggering a capital gains tax on any assets they would have liquidated to pay for the premiums.
- They could protect their family and financial future, creating liquidity to pay off any liabilities and/or estate taxes as well as protect their current assets.
Business Owners Can Benefit
Premium financing can be beneficial for business owners as well. Cash flow is always a concern for businesses, especially when they start out. Having the option for using third-party bank loans can help business owners obtain insurance coverage and peace of mind without sacrificing their assets and negatively affecting the operation of their business.
Once the decision is made by High-Net-Worth Individuals or a business owner to obtain premium financing, it’s important to understand how the process works. Usually, a borrower will create a separate entity in the form of an Irrevocable Life Insurance Trust (ILIT) or a Special Purpose LLC. Those entities will hold the life insurance as owner and beneficiary and every year they will borrow funds from a third-party lender to pay the policy premium.
Risks Involved
With all financial endeavors, there is always risk. There are three areas of risk to consider:
Qualification Risk
The risk associated with qualification surrounds the fact that these loans are always 100% collateralized. Lenders typically require borrowers to re-qualify every year the loan is renewed. That means it’s possible you would need to offer more collateral throughout the length of the loan
Policy Earnings Risk
Policy Earnings Risk focuses on the potential hazard that the policy’s cash surrender value or the assets posted as collateral are underperforming. Again, this would mean more collateral is needed on behalf of the borrower to continue the loan.
Interest Rate Risk
Interest Rate Risk is the most prevalent of all three risks. If the rates rise, the loan rate also increases thus increasing the out-of-pocket cash flow for the client.
There are ways to mitigate these risks and a financial professional is equipped with the tools to guide you through the process of premium financing. If you’re attentive to the ways how you can avoid these risks, then premium financing is a great way to save money and obtain life insurance coverage at the same time.