Life Settlements and Premium-Financing Problems
What You Need to Know
Premium financing can maximize life policy performance in some situations.
But not, for many clients, in this environment.
One way out may be to sell the cash-value policy at the heart of the arrangement.
Life insurance premium financing involves using leverage or taking out a loan to pay premiums on a life insurance policy.
Like other loans such as those for a building, home, or car, the bank charges interest and the borrower(s) pay interest payments or installment payments to the bank.
Individuals will purchase, for example, a $10 million policy but don’t want to liquidate assets to be able to pay for the policy’s premiums, so they turn to a lender and finance the premiums.
Premium-Financed Life Insurance
There are a few reasons why individuals may want to finance premiums.
First, doing so may improve a policy’s performance by reducing or eliminating the policyholder’s annual out-of-pocket expense.
Premium financing can also increase the death benefit and/or cash value of the policy.
And sometimes it accomplishes all of the above.
It’s also a smart strategy for high-net-worth individuals looking to avoid costly tax implications for themselves or their policy beneficiaries.
It is, essentially, a creative way for these clients to minimize gift and estate taxes.
This is a popular strategy also because permanent cash value life insurance can have rapid tax-free growth within the policy and can even eventually pay off the premium finance loan, thus creating a large paid-up life insurance policy with millions in available funds inside the policy.
Premium-financed life insurance relies on the arbitrage between low borrowing rates and increased cash accumulation value within the policy.
Interest Rate Hikes
Like with any investment, there is risk.
Many financial advisors who wrote premium-financed policies — and the clients who bought such policies — are now being hit hard with interest rate hikes on their financed premiums.
Who could have ever predicted that there would be eight or more interest rate increases in a one-year time frame?
Most premium-financed loans are set at variable yearly rates because that allows for the lowest rate available, meaning many borrowers who have used this strategy are already paying much more in interest payments due to these rate hikes.
In addition, collateral requirements are increasing for these borrowers.
This along with a volatile stock market counteracts the arbitrage strategy of premium-financed life insurance policies.
The result?
Many premium-financed life insurance borrowers — unable to afford exorbitant premiums — are looking for an exit strategy.
A life settlement can be the solution.
Life Settlement Premium Finance Rescue
A life settlement is defined as the sale of an existing life insurance policy for more than its cash surrender value, but less than its net death benefit.
A life insurance policy is an owned financial asset and therefore can be sold to a licensed buyer, also known as a life settlement provider.
For millions of Americans who own a life insurance policy, letting it “lapse,” or surrendering the policy back to the life insurance carrier, means losing most or all of your investment in that asset.
