Premium financing can be a valuable financial tool, but the strategies behind it can be complex. Before you discuss the topic with a client, you need a clear understanding of premium finance options because this must be set up and managed correctly.
What is premium finance?
Premium finance is an arrangement where an insured borrows money from a bank to pay premiums on needed life insurance. This method of paying premiums is popular because leveraging current assets reduces the cost of obtaining coverage.
However, premium financing is not for everyone — in the past, the typical ideal client was someone with a high net worth (in the $5 million to $50 million range) who had concerns about a substantial federal estate tax liability. Today, the market has broadened to include those who own or are a key person in small to medium-sized businesses, such as doctors, attorneys, accountants, or executives. The guidelines outlined below can help you determine if a client could be a fit for one of these life insurance premium finance options.
Premium Finance Guidelines
Traditional Estate Planning-Oriented Premium Finance Guidelines:
- The insured must have a net worth of at least $5 million and have the capacity to pay the premiums out of pocket if need be.
- The insured must post collateral to cover loan amounts not covered by the policy value, which can vary over time due to interest rate and policy performance variability.
- There must be a bankruptcy remote entity like an Irrevocable Life Insurance Trust (ILIT) or LLC to hold the policy.
- Premiums should be $200K at minimum but preferably in the $500K range for an attractive loan. And the client must pay enough interest to complete the exit strategy.
- Carriers may have specific age, citizenship, loan, interest rollup and collateral requirements as well.
Executive Premium Finance Guidelines:
- Qualifications are income, rather than net worth, based. This could make the strategy available to someone younger who hasn’t amassed a high net worth, but makes a substantial salary —a doctor, for example, with at least $200k of income could qualify. At this annual salary, lenders would still feel comfortable the individual could repay the loan.
- Collateral outside the policy would not be required under normal business conditions.
- Favorable interest rates are negotiated, and modest commission splits are the norm.
- The policy can be personally owned or placed in a trust.
- Out of pocket expenses start at approximately $30K for either a 5-year or 10-year period.
- Can be structured as either a split dollar with interest paid by the client or as a hybrid plan where the client pays part of the premium for 5 years and finances the remainder.
- Typically provides 30% more protection and retirement income than a traditionally- funded plan.
Choosing an appropriate carrier and type of policy is also essential to successfully execute one of these premium finance strategies.
- In terms of cash value accumulation potential, an Indexed Universal Life (IUL) policy is competitive with Whole Life a strong second for risk-averse clients.
- Early cash value and waiver of surrender charge riders are used to build cash value, provide access to cash value and to reduce the damage if the plan fails for any reason. These riders can also be effective in controlling collateral requirements.
- Overfunded and limited pay strategies can be used to build cash value for loan exit and retirement income.
- Policy loans and or distributions are used to provide an exit strategy where the borrower is able to pay off the loan. This is generally between year 13 and 15 when the policy has had time to accumulate cash value.
- Over loan protection riders are the norm and are designed to protect the policy from lapsing with an outstanding loan.
While the 22.4 million unified gift and estate tax exemption for married couples limited the number of families needing estate planning, proposed federal estate tax changes could broaden the need for estate planning oriented premium financing significantly.
But there has been a strong move in the premium finance space towards the executive plans. There are many underserved business owners who want to protect their families and plan for retirement who could utilize this strategy.
If you would like to explore the business market using this powerful strategy, let’s talk about your contacts and potential cases.