Because of its tax-favored treatment, permanent life insurance has long been touted as an ideal vehicle with which to retire estate tax liabilities. But purchasing a large enough policy to cover those liabilities can come at a steep cost: Upwards of hundreds of thousands of dollars in annual premiums to fund a death benefit running into the millions of dollars.
For affluent individuals who don't have sufficient liquid assets to cover those premiums–or, more typically, for clients who have the assets but are better off keeping the assets invested in a high-yield portfolio to meet long-term retirement planning objectives–paying for such expensive premiums out of pocket might seem like a less than appealing option.
Enter premium financing. A growing number of affluent clients are turning to this technique–taking out a loan from a bank or other financial institution to cover the premiums for a period of years–to meet short-term cash flow or investment objectives. But for the strategy to be employed successfully, sources tell National Underwriter, a sound exit strategy for retiring the loan is essential. Without one, the client might ultimately be forced to sell the policy to pay off the rising interest costs on the loan leaving his or her estate planning in tatters.
"Like any good financial strategy, the exit strategy must be thoroughly thought out before getting into premium financing," said Michael Babikian, vice president of strategic marketing services at Transamerica Insurance and Investment Group, Los Angeles. "Every year that premiums are paid, the loan gets bigger. If you're paying premiums for the next 25 years, it might be difficult to pay off the loan with just the death benefit. There are ways around this logjam, but deciding on an appropriate course of action requires a lot of upfront planning."
It's difficult to say how much premium financing is taking place because the evidence so far is largely anecdotal. In a June 2006 report, Windsor, Conn.-based LIMRA International attributed 15% rise in first quarter life insurance sales to several factors including "a stronger equities market, as well as premium financing and investor- and corporate-owned life insurance." Insurers interviewed for this article also noted a surge in recent years of premium-financed sales, but did not provide supporting data.
However large in dollar terms, the market is attracting a broader spectrum of the affluent than was the case in recent years. Matt DeSantos, vice president of marketing and business development, life and annuities companies at National Life Group, Montpelier, Vt., said the premium amounts being financed have dropped "from hundreds of thousands of dollars per year to tens of thousands of dollars. He attributes the evolution to a rise in the number of lenders vying for market share–and sweetening deals to capture more business. Transamerica's Babikian also observes a rise in the number of producers marketing the packages.
The heightened activity has seen a rise in abuses. Frequently cited are unscrupulous premium financing companies that, acting as middlemen between the insured and the lenders financing the premiums, market packages with hidden fees or high interest rates that ultimately prove too expensive for policy holders. The result: A call-in of the loan and the sale of the collateralized insurance policy on the secondary market.
Producers also share some blame. Too often, observers say, advisors promote financing as a way to ease the sale of an expensive policy to prospects who otherwise would be disinclined to pay out of pocket for costly premiums. The fact that a premium-financed contract may not be suitable in light of the client's insurance need, cash flow or estate planning objectives is given marginal consideration, if not altogether ignored.
"Some life insurance agents like the idea of premium financing because it lets them distract the client from the real cost of the insurance," says Peter Katt, a certified financial planner based in Kalamazoo, Mich. "The technique may smooth the way to a sale and boost the agent's commission, but ultimately can be detrimental to the client."
Adds DeSantos, "A common mistake of advisors is to believe that premium financing fits every case involving a large life insurance sale. But it's just a tool–an arrow in the quiver."
