Let’s start by discussing what premium finance is not.
It is not a tactic whereby you can get “free” insurance. This past year there have been some organizations marketing premium financing and touting it as a way to get get free insurance. That is not the way it works nor is that the reason for the concept. It is meant to be used for large multi-million dollar policies for higher net worth and ultra high net worth persons. Some of these organizations are marketing premium finance for much smaller policies as low as 100,000 in death benefit and many of those are mortgage protection type policies. Nothing wrong with a policy built to protect your mortgage if that works for you. But using premium finance is not a good idea. There are too many variables and concepts involved that have not been thoroughly tested enough. Even some of the larger policies that have utilized premium finance are having issues because the policy was not properly constructed nor was the financing properly built. Many of these policy owners are getting surprise collateral calls. More on that in bit.
So it is not a way to get “free” insurance. It is also not a way to make it more affordable. Very similar in concept as free insurance but some marketers are offering it as a way to make it more affordable and/or as a way to get it free.
Well then, what exactly is premium finance? It is a way to collateralize premiums while using capital to capitalize other projects. As an example, let’s meet Jon. Jon owns a business. He recently won a defense contract. To meet specifications he needs to upgrade some machinery and some enterprise software. Jon also recently met with his attorney to do some estate planning. His attorney suggested a large life insurance policy for estate planning and future income purposes. Jon agreed but he really needs the money right now to invest in the business. It was calculated that his ROI would be around 18% if he invested in the equipment. The attorney suggested looking into premium financing. They met with an advisor and were able to institute a 10 pay plan with little collateral and a competitive rate of interest. This permitted a 1.25% positive arbitrage between the loan interest and the policy declared rate. In turn, he earned a net 13% on the upgrades after taking the loan costs into account. Jon was able to make the need upgrades and get the necessary policy to take of his family and future. He capitalized the business improvements and collateralized the premiums. Obviously, there are a lot more details, but this is a simplified example of how premium financing was designed to work.
A similar end result as premium finance but a very different route to get there. Briefly:
- Premium Funding uses leverage with no out-of-pocket outlay to purchase large amounts of life insurance.
- Bypasses banks capital markup allowing a better rate
- Money borrowed is completely off the balance sheet of the guarantor
- No interest accruing. It is paid monthly.
- No personal guarantee required
- Utilizes a Direct Pay Letter of Credit
- It is an investment banking structure utilizing insurance not insurance using investment banking
- It is a 50 year term whereas most premium financed terms are 10 years
- It is a longer process than premium finance but much more powerful
- People who understand money and how it works are often very interested in this concept
This has been a very brief survey of these concepts. As always, if you think either of these plans could be useful to you, it is imperative to seek the advice of those well versed in these concepts.
Please note: All charts and numbers are for illustration purposes only. Accuracy is neither warrantied nor implied. We are not attorneys or tax advisors. This information is educational only. Not to be considered as advice or recommendations. It is imperative that you consult with a tax advisor and/or attorney when considering any of these concepts. In addition, it is critical that the attorney, tax advisor, and financial advisor are knowledgeable and practiced in these areas.
If you would like help finding such an advisor, we will be glad to introduce you to an experienced planner with your best interest in mind. Please give us a call at 1-800-522-4324