Life insurance premium financing: How does it work?
Here is a brief summation of what the traditional life insurance premium finance process looks like.
How are high-net-worth clients who have an estate planning need for large life insurance policies (but don’t want to or can’t use current assets to pay the necessary premiums) being serviced today? Fortunately, traditional life insurance premium financing has never been stronger. High-net-worth clients who have a liquid net worth of $2 million or more, a total net worth of $10 million or more and annual income of $200,000 per year can qualify for premium finance loans with lenders who do this kind of business.
Lenders will require the client to post the cash value within the life insurance policy as the primary source of collateral against the loan with an additional percentage of collateral to make up the difference in the premiums borrowed from the lender. This solution will only work when a client uses a cash value life product such as a whole life or equity indexed policy. In addition, the policy must be structured using a short pay scenario in which the policy is front-loaded with the maximum non-MEC annual premiums with the shortest term possible, which builds the cash value in the policy to help offset any additional collateral that may be required by the lender. Lenders set minimum premiums borrowed and may be flexible about the terms of the loan.
Some lenders currently base the rate of the loan using London InterBank Offered Rate (LIBOR) plus a spread; others use Prime plus a spread. The spread will usually be determined by the size of the loan and the term. Lenders will vary the term and will set up loan terms between one and five year renewable loans as long as the client continues to meet the collateral requirements on the loan.
There are several steps that must be taken by all parties involved when this solution is chosen for the purchase of life insurance. Here is a brief summation of what the traditional life insurance premium finance process looks like.
The first step is the client working in coordination with his insurance agent, wealth manager and attorney to appropriately determine the amount of life insurance needed, what collateral will be pledged and what assistance is needed to set up a life insurance trust. This party is the catalyst to the beginning of the process and ultimately ends to appropriately insure the client and meet all of their estate planning, tax planning and trust needs. My experience has taught me that this is almost always the part that takes the longest to complete because of the intricacies involved in making sure the client completely understands how the solution works and is in agreement. The next step is getting the wealth manager to buy into the process and understand that some of the clients' assets will need to be pledged in order to secure the financing. The attorney must be involved in order to make sure the trust and estate planning issues are covered as well as the understanding of any tax liabilities that may befall the estate if this solution is done the wrong way.
The second party involved is the lender, who will begin the process by verifying that all of the appropriate information has been gathered in order to make a determination as to whether or not the client will qualify for the loan. He or she will also begin the process of determining the structure of the loan, the term, whether it be renewable or whether the client will have to requalify at the end of the term, if the collateral provided is valued appropriately, if it will be sufficient to carry the loan in case the policy’s cash value performs, if the trust set up and if all fees been paid to both the attorney for structuring the ILIT and the lenders fees for originating the loan.
The lender will also verify all of the information provided on the third party financials to make sure the CPA is licensed and certified to supply the financials. In addition, he or she will review the numbers on the financials, verify true ownership of the collateral to be posted and require the borrower to provide their banking contacts and their ability to get a letter of credit if required by the lender. The lender will also verify that the life insurance policy being applied for is qualified by the life insurance carrier for premium financing.
The third party involved is the life insurance carrier. The carrier will ultimately determine if the client applying for life insurance will qualify for a policy, what underwriting rating they will receive and whether or not this policy will qualify for any premium finance programs.
Today’s life insurance carriers are aware of premium financing programs available in the market place, but many of them shy away from this type of transaction, leaving the few who do participate to accept the risk that comes with this type of transaction as well as the large reward and very large premiums.