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Premium financing involves the lending of funds to a person or company to cover the cost of an insurance premium. Premium finance loans are often provided by third party finance entity known as a premium financing company; however insurance companies and brokerages occasionally provide premium financing services through premium finance platforms. Premium financing is mainly devoted to financing life insurance which differs from property and casualty insurance.
To finance a premium, the individual or company requesting insurance must sign a premium finance agreement with the premium finance company. The loan arrangement may last from one year to the life of the policy. The premium finance company then pays the insurance premium and bills the individual or company, usually in monthly installments, for the cost of the loan.
Typically, clients that engage in this transaction are age 29 to 75; with net worth of $5MM or greater. Younger clients benefit in the current environment due to the advent of premium financed indexed universal life policies.
There are a number of benefits to financing insurance premiums. These include:
Factors to consider:
Since the interest due on the money lent to pay premiums is tied to an index, usually the LIBOR (London Interbank Offered Rate) or Prime if interest rates rise, the total interest charge will rise as well. If the policy owner can't afford to pay interest payments then they stand to lose their insurance and be left with significant debt if the surrender value of the policy is less than the balance owed. If this becomes the case the client would have not been able to pay the premiums on a non financed policy in any event so as with anything else make sure your can afford the policy. Responsible lenders take this risk into account when they do their financial underwriting. Typical loan rates are pegged to 1 year LIBOR [] with a competitive spread of ~ 180 bps. Most borrowing rates can be anticipated from 2.5% to 6%; depending on the fluctuation of 1 year LIBOR + the fixed spread.
The lender may have the right to call the loan at the end of the term. Virtually all premium financing loans have terms of a duration less than the life of the policy.
Financing terms are sensitive to the credit rating of the carrier holding the financed policy. Carrier downgrades may result in the lender choosing to not pay additional premiums, requiring the borrower to post additional collateral or call the loan and collapse all the collateral to cover any moneys due to the Lender. Most premium finance platforms require carriers to be S&P rated A or greater.
Carriers choose the crediting rate of in-force blocks of business at-will. Current crediting rates are not guaranteed. As such, any illustrated arbitrage in interest rates between the policy crediting rate and the loan interest rate may not exist in the future.
Life insurance carriers and premium finance lenders use the same fundamental financial instruments. Carriers fund insurance contracts with corporate debt. Lenders provide liquidity at personal debt rates. Corporate debt yields are less than personal debt rates. As such, premium financing may carry a negative spread for the client financing the premiums. There is no historical support for a long-term positive arbitrage between a loan rate and a life insurance contract.
Most premium financing arrangements that are designed to provide liquidity to the client at death are 100% collateralized. In most cases, the client must either post a Letter of Credit (LOC), securities accounts, other non-financed life insurance policies, annuities or any other hard assets approved by Lender to satisfy collateral. Collateral requirements may vary with economic conditions and could force the client to liquidate positions in order to post collateral. Furthermore, a decrease in the value of collateralized assets (such as real estate or securities) may require the insured or their estate to post additional collateral.
(Note - Settlement Risk pertains to Life Settlement Transaction, Not all Premium Finance Transactions)
Some premium financing programs are sold under the assumption that the policy will have a substantial market value at the end of the term. The client can then exit financing arrangement and realize a gain on investment. The secondary life insurance market is highly volatile. Settlement offers will vary with the interest rate environment and the degree to which capital will "wait" for a return. Any premium finance program or broker that induces you to enter into a premium finance transaction with the sole purpose of selling the policy after the policy is no longer contestable by the issuing carrier (generally two years) may be illegal and violate a state "insurable interest laws".
Insurable interest is a concept that dates back to the English legal system. Wagering on the life of an insured was common, and many times a person with no interest, economic or otherwise, would take out a life insurance contract on a sea captain running dangerous routes, a boxer facing a deadly opponent, etc.
This caused the English courts to declare that an individual taking out a life insurance contract on the life of an insured must have an "Insurable Interest" in their life. This means, in its simplest terms, you must benefit more by having the individual insured alive, than dead. Direct blood relatives certainly have an insurable interest in a family member. A business partner can have an insurable interest in another business partner.
This is a very mis-understood concept. Insurable interest either exists when a policy is issued, or it does not. If an insured is premium financing a policy, and his direct blood relatives are named as the beneficiaries when the policy is issued, then insurable interest is never an issue. If an insured changes ownership of the policy as soon as it is issued, but the beneficiaries are related by blood when the policy was issued, there is no insurable interest issues.
Life Insurance is personal property. It is like a car, a home or any other asset that you own. You have the right to pledge it, sell it or change ownership of it as long as it was issued with the death benefit going to a blood relative or related party, that benefits by having you alive, rather than dead.
Recent court cases have been hearing arguments from insurance carriers regarding the sale, or transfer of ownership of policies in courts around the nation (circa 2010) by insureds that have sold their policies to investors. The courts have overwhelmingly found in favor of the insureds, finding that insurable interest existed at the time the policy was issued, and there for the right to sell or transfer the policy after issuance was the choice of the insured enjoyed by any asset holder. Many life insurance carriers have tried, and generally unsuccessfully, to challenge these sales based on insurable interest or by trying to prove that the insured "intended" to sell the policy. The courts have found that "intent" is irrelevant, when insurable interest exists at policy issuance.
Premium financing arrangements are currently under intense pressure. Lenders often obtain capital from hedge funds and private sources, which are particularly sensitive to convulsions in the credit markets. Many lenders have ceased financing or added substantial fees to new programs. In-force financed policies are being called for collateral in large numbers. Clients who are "underwater," where the loan balance exceeds the policy cash value, are being forced to post additional collateral at low risk-weighted rates and/or surrender the policies and pay the outstanding loan balance out of pocket. Additionally, several carriers who were active in the financing marketplace have been downgraded, causing large-scale exchanges or surrenders from in-force policies.
Currently, premium financing is becoming a more regulated industry. All financing sources must be carrier approved, and most lenders have substantial (billions) in assets. Some are specialized premium finance lenders and most are large institutions. Advisers generally use a preferred premium finance platform to assist in properly structuring and maintaining (servicing on an annual basis) life insurance premium finance cases.