Q: What is Premium Financing?
A: Premium financing works in such a way that instead of making direct premium payments, these payments can be financed through a lending institution, clients with significant net worth can achieve the advantage of life insurance without the disadvantage of paying premiums with after-tax dollars. The result of premium financing is that client's cash flow and/or investments need not be liquidated to fund the policy and the client's investment portfolio can continue to grow without interruption. This works great for clients that have enough net worth and want to either buy significant amounts of life insurance or significantly donate to charity for non-profit organizations, foundations or universities.
Q: How does Premium financing work?
A: First of all a financial institution such as a bank will finance the premiums for the insurance policy, taking an assignment on the death benefit to cover the loan plus interest. The policy is owned by an irrevocable trust or ILIT that designates the beneficiaries of the death benefit over and above the assignment to the lender. The beneficiaries can be the donor's family, a non-profit organization, foundation or university or whoever the client decides. The bank pays the premiums directly to the insurance company. The insured will post collateral to any extent there is a difference between the policy cash value and the loan balance. In most cases, the principal of the loan is repaid to the lender at the death of the insured although there are generally no prepayment penalties should the client wish to retire the loan either with funds from the cash values in the policy or from estate transfer techniques. Alternatively, the owner may consider different options with the program: (1) refinancing the loan, (2) creating a lifetime income stream from the cash value during the life of the client, (3) using the cash value to purchase a single premium immediate annuity, or (4) converting the policy to a paid-up policy for a lesser face amount.
Q: What are the risks ?
A: It is important to note that premium financing its not consider a free insurance policy. Like any other insurance product there are certain risks involved. The risks associated with premium financing include loan interest fluctuations, failure to requalify for the loan if the loan has not been repaid by the end of the original loan term, and the fact that actual policy values may differ from the non-guaranteed policy values originally illustrated.
Q: How do interest rates affect premium financing?
A: In a rising interest rate environment, bank loan rates will likely rise more quickly than the universal life crediting rate. If the loan rate rises significantly above the crediting rate, a negative arbitrage is created resulting in increased exposure to the insured that must be covered by an increased letter of credit. In addition, in this type of rising interest environment, policy values may not keep up with the growth of the loan balance, especially when interest is being accrued on the loan, leaving a shortfall that the policy owner may be required to make up at the end of the loan term.
Q: Do rising interest rates mean the client is exposed?
A: It's important to understand that it isn't simply the interest rate, it's the relationship between the interest rate and the crediting rate that is critical to premium financing. There may not necessarily be, in any given year, a close correspondence between the borrowing and policy crediting rates, but the two generally move in tandem. LIBOR rates represent a short-term borrowing cost which is historically lower but more volatile than long-term rates. The crediting rate in the policy is based upon the economic performance of an insurance company's general account, comprised primarily of fixed-income securities such as corporate or government bonds and mortgages. A characteristic of the general account is that, from the standpoint of the policyholder, the principal value does not fluctuate and the interest-crediting rate is based upon the fixed value of the investments on the company books. In a declining interest rate environment, the nominal rate credited to the account will decrease as older high-interest investments mature or are otherwise liquidated and replaced with new lower-interest investments. As a result, even if market rates have stabilized at a low rate, the general account rate may continue to decline, so long as higher-rate investments continue to mature. Correspondingly if current market rates increase, the general account rate may for a time be lower as lower-interest rate investments mature.
Q: How can the client insulate against the worst case scenario - like an upside-down interest rate-crediting rate environment or failure to refinance the loan at the end of the loan term?
Q: What type of collateral is acceptable to the lender?
Q: Will lenders accept a letter of credit as collateral?
Q: What conditions cause a stand-by letter of credit to be called?
Q: What is the interest rate charged in typical Premium Financed transactions?
A: Our strategic partners have developed several collateral wrap and hedge strategies -- coupled with some unique product design -- to further eliminate collateral and interest rate risk. Moreover, all clients are encouraged to closely evaluate exit strategies or firewall strategies in planning. An exit strategy is a technique for reducing risks by creating a resource of funds that can be used to repay the loan at the end of the original term to ensure completion of the financial strategy. Our strategic partners The Burgees group are experts on premium financing and they integrate various estate freeze and capital transfer techniques in such a way that can be used to create pools of funds used to reduce or eliminate loan balance without incurring any additional gift taxes. Planning for these risks up front demonstrates a long term commitment to the client.
A: There are several types of collateral that are acceptable to the lending institutions. Some of these include the following: cash valued at 95-100%, cash equivalents such as bonds or fixed income investments margined at 75-85%, and other securities margined at 50%. On a case-by-case basis, the lending institution will consider other forms of collateral including the cash value of an additional life insurance policy (carrier must meet the lender's minimum rating requirements). Real estate may also be a potential source of collateral if the value is converted to a liquid instrument like a letter of credit or a line of credit that can be drawn on.
A: Some lenders will accept a letter of credit posted as collateral to cover any shortfall. This is approved on a case by case basis and the issuer of the letter of credit must meet the lender's minimum rating requirements. This letter of credit is considered "stand-by" because it need only represent the ability to pay.
A: Generally speaking, there are three circumstances that could result in a call of the stand-by letter of credit: (1) insured walks away from the transaction prematurely (before end of loan term); (2) insured fails to increase collateral if necessary; or (3) the insurance company collapses or is significantly down-graded.
A: The interest rate varies from lender to lender but there are certain aspects each has in common: First, most use LIBOR or Prime- rate index; second, each adds an individual "bank spread," usually between 100-150 basis points. In addition, our strategic partners the Burgees Group has created the ability to borrow in any G7 currency which often creates a favorable arbitrage.
Q: What is the interest rate charged in typical Premium Financed transactions?
Q: Can clients take advantage of lower interest rates internationally?
Q: Who determines the loan term?
Q: Who manages the loan?
A: The origination fee is the lender's transactional fee for the loan. It is typically one percent (1%) of the first two years' premiums and is paid directly to the bank. This one-time fee can either be rolled up into the loan transaction or paid directly by the client. If the client elects to capitalize the fee in the loan, the collateral number will increase commensurately.
A: For qualified clients (with investable assets of at least $2m and with strong finance experience). Our strategic partners the Burgees Group can borrow in any one of the strongest international currencies (i.e., Yen, Swiss franc, British pound, Euro dollar, Canadian dollar, Australian dollar and US dollar). Tracking the historical data on these indices it is clear that these currencies do not move at the same rate. Clients have the ability to take advantage that exists in the market. Further, clients can use a fraction of the monies on deposit as collateral to hedge the currency fluctuation. Specialists take advantage of Fx movement and the client can benefit from the arbitrage created.
A: The lenders will go 2 years, 5 years, 10 years, even 20 years. Because the cross-over point is generaly within the first few years, these loan terms are ample. There are generally no prepayment penalties.
A: The bank's lending committee manages the loan. The premiums are paid, the collateral is determined, and the assets on account (over-and-above the collateral required) are all managed internally. The margin account that is invested to mitigate interest rate fluctuations (if a floating LIBOR rate is used) would be managed by specialists in currency trading.