My ChatGPT Conversation on Premium Financing

By Bill Boersma

I don’t know why I get a kick out of having conversations with ChatGPT, but I do, so here’s another one. I’m pleasantly surprised by how often I’m in agreement with what results, though I don’t know how to take it that I’m in agreement with the internet. However, I have seen some things slip by it, as well as outright mistakes. In one exchange it kept referring to the estate tax exclusion decrease in the OBBB Act, rather than the increase. Keeps you on your toes.

I presume AI will get better and better over time, though I read an article that reminds us that AI creates from what it finds on the internet, some of which is incorrect, and then what it creates goes back to the internet to be fed on again, creating a circle of life that’s not necessarily going in the direction we want it to be going. It referenced the idea of (in the old days) faxing a copy of a fax over and over again. Eventually, there’s nothing on the page anymore.

Most of you already understand I’m not a fan of premium financing as I generally see it designed and sold in the market. This doesn’t mean it’s fundamentally wrong or inappropriate, just that I run across a lot of misrepresentation and fraud with disastrous consequences.

Let’s see what ChatGPT has to say.

Me: When is life insurance premium financing appropriate?

ChatGPT: Life insurance premium financing can be appropriate in certain situations, but it’s a complex strategy with risks as well as benefits. Here are the main conditions under which it may be suitable:

1. High Net Worth Individuals

• Premium financing is usually designed for wealthy clients who have a large need for permanent life insurance (estate planning, business succession, tax liquidity) but don’t want to liquidate assets to pay the sizable premiums.
• Typically, this means individuals with a net worth of $10 million+, though some programs target slightly lower thresholds.

2. Liquidity Preference

• A client might have illiquid wealth (real estate, business holdings, concentrated stock positions) and prefer not to sell assets or disrupt investments to fund insurance premiums.
• Borrowing allows them to keep capital invested elsewhere while still acquiring the needed coverage.

3. Leverage Opportunities

• Financing allows the client to leverage low borrowing costs (if favorable loan terms are available) to cover premiums while the policy’s cash value grows.
• If the policy’s crediting rate outpaces the loan interest rate, this can create a positive arbitrage.

4. Estate and Tax Planning

• Often used to fund large irrevocable life insurance trust (ILIT) policies for estate tax coverage.
• Allows the estate or heirs to preserve liquidity for taxes without draining business or investment assets.

5. Business Succession or Key Person Needs

• Corporations sometimes use premium financing to secure coverage for buy-sell agreements, key employee coverage, or executive benefits when the business doesn’t want to use working capital for insurance.

6. Client Profile

Appropriate only when the client:

• Has strong creditworthiness and can qualify for large loans.
• Has multiple exit strategies if assumptions don’t hold (e.g., higher loan rates, lower policy performance).
• Understands risks: rising interest rates, collateral requirements, policy underperformance, or lender calling the loan.

7. Advisory and Fiduciary Suitability

• It is not appropriate for clients who cannot afford premiums without financing or who don’t understand the leverage risks.
• Works best when there’s sophisticated financial oversight (attorneys, CPAs, fiduciary advisors).

✅ In short:

Premium financing is most appropriate for ultra-high net worth individuals or businesses that need large amounts of permanent life insurance, want to preserve liquidity, can accept leverage risk, and have the resources to manage collateral and long-term monitoring.

Me: What are the risks of premium financing

ChatGPT: Great question – this is where premium financing really needs to be weighed carefully. While it can be an elegant solution for certain wealthy clients, the risks can undermine the strategy if not fully understood and stress-tested. Here are the main risks of premium financing for life insurance:

1. Interest Rate Risk

• Loan rates can rise (especially for variable rate loans tied to SOFR or prime). If the cost of borrowing exceeds the policy’s credited return, the strategy can become cash-flow negative.
• Rising rates mean higher collateral requirements and more out-of-pocket costs.

2. Policy Performance Risk

• Life insurance illustrations often assume crediting rates that may not be achieved.
• If the policy underperforms (e.g., due to low index returns, dividend reductions, or insurer adjustments), there may not be enough growth to cover loan interest.
• This can lead to needing additional out-of-pocket funding or risk of policy lapse (with a big taxable gain).

3. Collateral Risk

• Lenders typically require additional collateral beyond the policy’s cash value, especially in the early years.
• If loan balances grow faster than policy cash value, the client may need to pledge outside assets (real estate, securities, business equity).
• In a market downturn, this can create a liquidity crunch or force asset sales.

4. Loan Renewal Risk

• Many financing arrangements are shorter-term loans (e.g., 1–3 years) that must be renewed.
• If the lender exits the market, tightens credit standards, or refuses to renew, the client may have to refinance elsewhere or unexpectedly repay the loan.

5. Exit Strategy Risk

• The plan usually assumes that eventually the policy’s cash value will repay the loan (or that heirs will pay it off at death).
• If projections don’t hold, the loan may outgrow the policy.
• Without a clear exit strategy, the client could face large loan repayment demands late in life.

6. Tax Risk

• If the policy lapses or is surrendered with a loan outstanding, the loan balance is treated as taxable income to the extent of gain (phantom income problem).
• Policy loans combined with premium financing can create complex tax traps if mismanaged.

7. Complexity & Oversight Risk

• Premium financing is not set-and-forget—it requires annual reviews, stress-testing, and professional management.
• Complexity increases the chance of misunderstanding by clients (and sometimes even by advisors).
• A misaligned or under-informed trustee in an ILIT can make poor decisions.

✅ In summary:

The major risks are interest rate spikes, policy underperformance, collateral calls, loan renewal challenges, and tax consequences if things go wrong. Clients must be able to withstand adverse scenarios and have contingency plans (liquidity, cash reserves, exit strategies).

Me: Can premium financing work if it’s based on the spread between life insurance policy earnings and lending rates?

ChatGPT: You’ve zeroed in on the central tension of premium financing. Many people pitch it as a “spread play”- borrow at X%, earn Y% in the policy, pocket the difference. While that sounds neat, in practice it’s risky and usually not a reliable foundation for the strategy. Here’s why:

1. Theoretical Spread Appeal

• If you could consistently borrow at 4% and the life insurance policy credited 6 – 7%, the arbitrage would look attractive.
• In that world, premium financing is a form of leverage—magnifying returns on money that isn’t yours.
• Some marketing illustrations lean heavily on this concept.

2. The Problem with Relying on the Spread

• Rates are variable: Most financing uses floating rates (SOFR + spread, Prime + spread). They can spike quickly, eating up any arbitrage.
• Policy returns are not guaranteed: Indexed UL, whole life dividends, and universal life crediting rates are subject to market performance, company discretion, and regulatory caps. They rarely behave in a stable “bond-like” manner.
• Timing mismatch: Loan interest accrues immediately, but policy growth is uncertain, uneven, and often lags.
• No margin for error: If the policy earns even slightly less than illustrated or the rate ticks up, the spread goes negative, and the client must step in with collateral or cash.

3. What Actually Makes Financing Work

Premium financing is most sustainable when:

• The insurance need itself justifies the policy. The client would reasonably buy the coverage even without financing.
• The client has liquidity or outside wealth to support the plan if the spread disappears.
• The arbitrage (spread) is treated as a bonus, not the core justification.
• There is a credible exit strategy—such as planned gifts to an ILIT, sale of assets later in life, or policy cash value pay down once it matures.

4. Regulatory and Fiduciary View

• Both regulators and fiduciaries warn against positioning premium financing purely as an “investment spread.”
• The SEC and state insurance commissioners have scrutinized illustrations that show rosy arbitrage scenarios without highlighting the downside risks.
• Advisors have a duty to stress-test: “What happens if loan rates are 8% and policy earnings 4%?”

✅ Bottom line:

Premium financing cannot safely be based solely on the spread between borrowing costs and policy earnings. The spread may help or hurt, but it’s too unstable to rely on. A well-designed financing case assumes little to no positive arbitrage, and the client must be prepared to carry the strategy even if the spread turns negative.

Me: I noticed in point one you make a comparison between the borrowing rate and the crediting rate, but the crediting rate is different than the net earning rate. Does that affect your response? 

ChatGPT: Excellent catch 👌 and yes, that distinction matters a lot. You’re right: the crediting rate on a life insurance policy (IUL cap, UL declared rate, whole life dividend interest rate, etc.) is not the same as the net earning rate available to offset borrowing costs. Here’s how that difference plays into premium financing:

1. Crediting Rate vs. Net Earning Rate

• Crediting Rate = the gross rate the insurer applies to policy values (before policy charges, expenses, cost of insurance, etc.).
• Net Earning Rate = what’s actually available inside the policy after those charges. This is the rate that matters when comparing against borrowing costs.

Example:

• An IUL might illustrate 6% crediting.
• But with COI charges, expense loads, and loan interest (if accessing cash), the net build in early years might be only 2–3%.

2. Why This Undercuts a “Spread Play”

• If someone says: “Borrow at 5%, earn 6% in the policy, positive spread!”—they’re comparing the wrong numbers.
• In reality: Borrow at 5% → Net policy earning maybe 2–3% → negative spread.
• This is especially pronounced in the early years, when policy charges are highest. The true breakeven may be decades out.

3. Stress Testing Matters Even More

• Long-term projections smooth out charges and can make the arbitrage look stable.
• But in practice, volatility + front-loaded expenses mean there may be many years of negative net spread.
• If loan rates rise at the same time that policy earnings dip, the leverage turns against the client very quickly.

4. Fiduciary & Suitability Implication

• Advising based on credited rate vs borrowing cost is misleading.
• Regulators and fiduciaries emphasize comparing borrowing cost to the net policy IRR—not the gross crediting rate.
• A financing case should be designed to work even if the net IRR is below the borrowing rate for long stretches.

✅ So to answer your question:

Yes—the fact that the crediting rate is not the same as the net earning rate strengthens the case against using “spread” as the foundation of premium financing. It makes financing even riskier if you’re relying on simplistic crediting vs borrowing comparisons, because the net IRR is almost always lower than the illustrated crediting rate, especially in early years.

Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.

Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor.

OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.

Indexes are unmanaged and do not incur fees. One cannot directly invest in an index.