Premium Financing – Introduction

Speaker 1 (00:00):

I’m Bill Borsema, and thank you for joining me for an introduction to premium financing. Historically, premium financing has been a way for wealthy individuals to purchase life insurance for business and estate planning without having to liquidate investments or business assets that may be performing very at attractively. Fundamentally, rather than paying premium out of pocket, a policy owner is borrowing money to pay the life insurance premium with the idea that he has taken advantage of some spread or arbitrage. Traditionally, the spread has been between the borrowing costs and the opportunity cost of the policy owner’s assets. More recently, however, with the introduction of new life insurance products with higher perceived crediting rates and the extremely low LI b o rates following the most recent recession, this has changed. Now the spread is being touted as the difference between the borrowing rates and the crediting rates of the life insurance policies themselves. 

Speaker 1 (01:03):

This allows illustrations and spreadsheets to be created, showing the policy accumulating enough value to pay the loan off without additional contributions from the policy owner. Many financing programs today do require interest payments to be paid out of pocket, and this is touted as being less expensive than paying premiums out of pocket. However, does this really work as proposed? Most premium financing programs are built around indexed universal life, although there are a meaningful amount of them built around whole life, even after regulations implemented to make illustrations more realistic, six to 7% crediting rates have been assumed in the illustrations behind these programs when paired with extremely low L I B O R based borrowing rates. The spread looks fabulous, but is it real? I’m gonna suggest there’s more to it than meets the eye. Just because the illustrations assume a given rate doesn’t mean the premium in cash values are actually growing at that rate. 

Speaker 1 (02:08):

There are premium taxes, overhead expenses, commissions, and costs of insurance that make the internal rate of return on premium to cash value negative for quite a few years, even 15 to 20 years down the road. The rate of return on premium to cash value will never equal the advertised crediting rate. That may be the reasonable nature of life insurance policies, but it is not the nature of the understanding of policy owners. Given this reality. The actual spread between borrowing rates and crediting rates is much lower than assumed. In addition, with rising borrowing rates and lowering crediting rates, these numbers simply won’t pan out. It is exceedingly important for independent analysis on these programs both enforce and proposed, and for stringent stress testing on both the 

Speaker 2 (02:58):

Borrowing and the crediting sides. Clients need to be intimately familiar with the risks in these transactions, including market risk financing risks, risks within the policy itself, collateral risks, and others. This all being said, premium financing might be a wonderful opportunity given the assumption that everything is objectively laid out and the misrepresentations I too often see are absent. Furthermore, we have to define what a successful transaction actually is. If success is defined as free or low cost life insurance as a result of arbitrage between borrowing rates and policy crediting rates, I would urge you to hit the pause button. However, if success is defined by someone who actually needs life insurance and has the ability to pay for it out of pocket, but understands the value of low cost borrowing in order to keep high producing assets in the game, well, then we have something to talk about. In summary, premium financing can be a fantastic tool if thoroughly understood, well designed and managed, and has a realistic definition of success, but unfortunately, too often it is inappropriately pitched to inappropriate candidates for the wrong reasons. It doesn’t have to be that way as usual. Feel free to call, email, or check out our websites listed here. Thank you and enjoy your day.

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