Making premium financing work

"In many cases, most of the assets are in real estate," Wormser notes. "If someone would have to liquidate the real estate for less than full value, it may be more cost effective to borrow the premium, pay the interest and liquidate the real estate in a better market. If someone consistently earns high rates of return, it may be cost effective to retain those investments and borrow the premiums."

High-net-worth individuals, business owners and upper-level corporate executives are often suitable candidates for premium financing. A company, like an individual, may need to purchase a large amount of life insurance yet not wish to liquidate or involve other assets in order to do so. When high-level coverage is offered as a portion of an executive's compensation package, a company can turn to premium financing as a way to purchase desired coverage levels. Premium financing then becomes another tool to attract new talent and retain key employees as, in many cases, annual premiums will exceed $100,000 per year.

"Premium financing for life insurance originally was utilized in the corporate arena to fund large amounts of Corporate Owned Life Insurance (COLI), usually in a form of executive compensation," Farber adds. "Today, the market has matured into uses in the individual life insurance marketplace."

While the typical premium-finance prospect is either a single person or married couple over age 70, cases can be made for younger clients to consider it.

"You've got to know your client," says Jameson Ferney, vice president and financial advisor at Premium Financial Advisors Inc., in Idaho Falls, Idaho. "Is it someone who just inherited $5 million or is it a 40-year-old who may earn $5 million a year?" Ferney, who says making the case for premium financing can be challenging, notes that once a prospect is educated about his choices, he almost always is in favor of it. "It's easier to sell this than long term care insurance but it can take longer because a client's attorney and accountant need to be on board." Nevertheless, he reports that sales are increasing annually for his firm despite such hurdles as a flat yield curve.

"Market conditions can hurt even conservative illustrations as new loan rates can be higher than the policy interest rate." But this is only temporary, theorizes Ferney, who recently used premium financing for a 35-year-old client. "New products are making this more attractive for younger clients. Five years later, most clients are glad they did this."

Farber notes that in most instances the performance of outside investments will be equal to or greater than the cost of the financing. It really comes down to control and timing. "Depending on the mortality/life expectancy of the insured, it may be best to keep funds fully invested outside of the life insurance contract and use the portfolio's borrowing potential," Farber says.

Yet there are other points to consider when debating premium financing. "There should be an exit strategy other than death," Fliegelman says, pointing out that such an arrangement may impact other loan needs of a client. "There may be additional fees charged by the lender. Make sure the net death benefit (after payment of the loan) is what the business or trust needs."

Applying this technique to estate planning highlights other needs, most notably the need for a trust. "In estate planning, the most common arrangement is where the insurance policy is owned by an irrevocable trust so that death benefits are not subject to estate tax," Fliegelman says. "The insured who is usually the grantor of the trust simply has to make gifts to the trust so that interest can be paid on the loans."

In most cases, the client (grantor) will establish an Irrevocable Life Insurance Trust. "The Trust will purchase the appropriate amount of life insurance on lives of the grantor(s) to pay estate taxes or create liquidity at death," Farber says. As estate taxes are due at the death of the surviving spouse; a survivorship policy is often used.

Lukens advocates using a team of professionals when considering this approach. "There are many moving parts to these transactions," Lukens says. "You've got to work with top-rate professionals such as attorneys and accountants plus trust and insurance specialists to move this forward and be sure it's right for the client. Otherwise it's your phone that's going to ring."

Joseph Finora is a Laurel, N.Y.-based freelance writer who has written extensively about insurance markets and financial services. He has been a frequent contributor to Senior Market Advisor.