Premium Financing

A loan is a strategy that can help your high-net-worth clients get the coverage they need without missing out on other investment opportunities.
Most agents catering to the high-net-worth segment are more than insurance salesmen — they are trusted advisors. As such, the most successful agents understand the extent to which their clients grew their net worth on the basis of leverage. Many of these agents are utilizing an important tool for selling more life insurance, and it’s one you may not know about. For more than 20 years, high-net-worth individuals have been successfully using leverage to acquire the life insurance they need. If you’re not using this planning strategy, and you should be, then let’s discuss what is the right move for you.

Top Reasons To Finance Life Insurance Premiums
1. LEVERAGE – Most self-made millionaires are comfortable leveraging their assets and have used that to create wealth.Premium finance permits clients to leverage their current assets and the policy’s cash surrender value to obtain the coverage they need.
2. TAX SAVINGS – By paying interest instead of premiums and structuring ownership of the life insurance properly, clients can minimize gift and estate taxes. Premium financing can help clients use more of their annual gifting exclusions rather than tapping prematurely into lifetime exemptions.
3. RETAINED CAPITAL – Many high net worth clients earn double-digit returns on their investments, be it in their business, real estate or investments. Premium finance allows those clients to keep their money working for them in those high returning asset classes.
4. INCREASED IRR – Utilizing premium finance reduces client outlay in the early years thereby increasing long term IRR.

How it Works
Those who don’t understand the true benefits of life insurance premium financing worry this is a tool dependent on interest rates or policy performance. But even when interest rates have been high and markets have been shaky, financially savvy brokers have been closing deals by funding life insurance premiums.

Why? Because in order for high-networth individuals to continue to grow and protect their wealth, they need to take advantage of leverage and actively look for investment opportunities that yield returns greater than the cost of capital. In other words, many need life insurance to address inheritance, business and tax issues, but they’d prefer to keep the funds they would spend on life insurance premiums in investments that yield more profitable returns.

The economy, although sluggish, is moving again, and with rates hovering at all-time lows, premium financing life insurance makes more sense than ever. The reason? Retained capital. In this instance, retained capital is the amount of money a client can hold on to — and ultimately invest elsewhere — by paying interest on a loan that covers the cost of a premium versus paying the premium itself. Many high-net-worth clients report that they earn 10 percent to 15 percent or more on their money. If that’s the case, why take funds out of profitable investments in order to pay a premium.

But let’s be clear. Premium finance is not a gimmick. It is not free insurance. It never was and never will be. It is not a play on the potential arbitrage between policy crediting rates and interest rates. Your client will have to pay interest to a lender and will have to post collateral equal to the difference between the cash surrender value of the policy and the loan balance. It is simply a tool to help your clients reduce the initial out-of-pocket expenses relating to the purchase of a life insurance policy and a way to keep their money working for them in their investments of choice.

To Finance or Not to Finance?
To better understand what an asset premium financing can be, we have to look at the potential profit our clients would lose out on if they don’t use it. In other words, the lost opportunity cost. So, let’s take a look at the numbers and consider the lost opportunity cost of paying a $100,000 premium out of pocket.

If an individual truly earns 10 percent on the funds he would use for a premium payment, then he would lose the opportunity to grow his net worth by $10,000 if he were to pay the premium himself. Utilizing the benefits of premium financing, if the client finances the $100,000 premium at 5 percent interest, his out-of-pocket cost in year one is $5,000, and his retained capital is $95,000. That client could re-invest the $95,000 in a vehicle that returns 10 percent and end the year with $104,500 and a life insurance policy to protect those assets. Over time, this growth compounds. This is the power of premium finance!

The True Cost of a Premium
Retained capital and lost opportunity costs are not the only reasons to consider premium financing. What is the true cost of a client’s premium payment? Again, let’s assume our client has agreed to write a check for the $100,000 insurance premium. From where will those funds come? What if our client has to liquidate assets and pay capital gains taxes? The actual “cost” of the premium payment just increased from $100,000 to $120,000.

Now let’s assume the insurance policy is held in trust. Unless clients have enough Crummey beneficiaries to utilize their annual exclusions, they may have to dip into their lifetime exemption or pay a gift tax of roughly $40,000. That would increase the client’s premium payment from $100,000 to $160,000! Compare that to financing the premium at just five percent. The true cost of paying the premium is more than the client bargained for.