Article, originally published at HedgeCo
By David Drake
Premium financing, when you borrow money from third party funders to pay for your insurance premiums, has been embraced as an alternative for people seeking to lighten the burden of paying for their life insurance. And while this may seem like a good path to take, many are questioning whether or not it’s worth the hassle, or would it be better to just pay the lump sum for the premium all at once and be done with it? While borrowing costs might be initially low, they will soar with the rising rates, which could leave the premium holder in debt, and with an unpaid life insurance policy.
On the other hand, borrowing money from third parties in order to finance life insurance is always appealing, especially for wealthy people who do not wish to liquidate their assets. Repaying the borrowed funds by installments may seem like a practical solution, especially when knowing that the cost of the policy has already been covered. However, financial planners are skeptical about this kind of arrangement. They warn that it is prone to abuse, especially with elderly premium holders. With this in mind, people need to be wary of premium financing by weighing out its pros and cons when approaching it.
How does premium financing work?
A good scenario for life insurance premium financing is somebody who is employed and is in need of a life insurance policy but is unwilling to sell his assets to cover for the premium. For instance, someone who is 65 (let’s call him Dennis) might want to leave an inheritance worth $4 million for his immediate family. He owns a business that is worth millions, yet he is unwilling to liquidate it.
Generally, for a healthy 65-year-old man, the premiums payable for a $4 million dollar insurance policy would be around $100,000 annually. Instead of paying this money all at once, Dennis might think of getting a premium finance loan from a financier who could either be an insurance broker (this is rare) or a top financing company.
Premium financing doesn’t differ much from other forms of borrowing. Yet it allows affluent people to borrow at rates that are close to the interest rates charged by leading banks for short-term loans. Furthermore, the “borrower” enjoys keeping one’s illiquid assets.
Advantage of financed life insurance
One of the major benefits associated with life insurance policies is that they will eventually accumulate value, therefore becoming income-producing assets. This means that the policy could be used for a bank loan as collateral. In other words, someone can have a premium financing arrangement to have the cash value attached by the bank in case they die before the loan is fully repaid. They could also have the bank receive a percentage of the death benefits to cover for the remainder of the loan.
All this notwithstanding, premium financing is always a legitimate option for people who need huge amounts of money to cover large premiums of life insurance. Premium financing has always been a business deal that requires wealthy people to be insured for purposes of borrowing. Nonetheless, it comes with its own share of risks.
Potential risks associated with premium financing
Financing your life insurance will always come with renewal risks. Many financing contracts do not have terms which cover the entire policy life and will, therefore, need periodical renewal, something that calls for refinancing.
When dealing with someone like Dennis, this kind of arrangement will open up the possibility of losing other assets. Initially, the loans were secured which means that the financier couldn’t seize his other assets. However, this is no longer the case. Today, a lender can attach Dennis’ personal assets in case his loan relapses after a certain time period decided on by both parties. This is when things can really get out of hand.
With this in mind however, it is important to note that financing an existing, or new, life insurance premium policy also has its own share of advantages from which you could benefit.
Here are some things that might make premium financing enjoyable and well worth your time:
-It allows you to fund your existing premiums, or acquire a new life insurance policy, without liquidating your assets.
-It lessens the impact on your present cash flow.
-It reduces the amount of gifts made to finance life insurance policies which you may have outside your estate.-Helps in general estate planning while at the same time guaranteeing that your assets are protected for your beneficiaries.
-It allows you to borrow cash without liquidating your taxable investments. Another upside to borrowing is that it comes with highly attractive interest rates.
The premium financing arrangements are normally arranged and negotiated for by the insurance brokerage company, and certain conditions must be met before the financing is approved. In normal cases, the funder will ask for the client’s medical and financial records, as well as their tax returns, to help assess their suitability for funding. They may also ask for the authorization to run a credit check.