Frequently Asked Questions

Concerning Premium Financed Transactions

1. What is Premium Financed insurance?

By financing the premiums through a major lending institution, affluent clients can achieve the advantage of life insurance without the disadvantage of paying premiums with after-tax dollars. As a result, the client's cash flow and/or investments need not be liquidated to fund the policy and the client's investment portfolio can continue to grow without interruption.

2. What type of insurance is used in Premium Financed transactions?

The purchase of life insurance to meet a long term death protection need generally entails the use of permanent life insurance (universal life, index universal life or whole life).

3. How does Premium Financed insurance work?

The bank will finance the premiums for the insurance policy, taking an assignment on the death benefit to cover the loan plus interest. The policy is owned by an irrevocable trust or ILIT that designates the beneficiaries of the death benefit over and above the assignment to the lender. The bank pays the premiums directly to the insurance company. The insured will post collateral to any extent there is a difference between the policy cash value and the loan balance. In most cases, the principal of the loan is repaid to the lender at the death of the insured although there are generally no prepayment penalties should the client wish to retire the loan either with funds from the cash values in the policy or from estate transfer techniques. Alternatively, the owner may consider (a) refinancing the loan, (b) creating a lifetime income stream from the cash value during the life of the client, (c) using the cash value to purchase a single premium immediate annuity, or (d) converting the policy to a paid-up policy for a lesser face amount.

4. Who qualifies for Premium Financed insurance?

An individual or lawful entity with a minimum net worth of $10 million--

    Who can afford to pay premiums to meet the need for insurance, but is invested in a vehicle that has the potential to produce higher returns than the cost of borrowing funds to pay the premium, creating arbitrage;

    Who is willing to have a medical exam for underwriting;

    Who will cooperate with lender for financing and is willing to pledge personal assets as collateral;

    Who has a significant insurable need for estate planning, for business succession planning or for charitable giving.

5. What are the risks associated with Premium Financing?

This is not "free insurance". There are risks associated with the concept including loan interest fluctuations, failure to requalify for the loan if the loan has not been repaid by the end of the original loan term, and the fact that actual policy values may differ from the non-guaranteed policy values originally illustrated.

6. How do interest rate fluctuations affect Premium Financed transactions?

In a rising interest rate environment, bank loan rates will likely rise more quickly than the universal life crediting rate. If the loan rate rises significantly above the crediting rate, a negative arbitrage is created resulting in increased exposure to the insured that must be covered by an increased letter of credit. In addition, in this type of rising interest environment, policy values may not keep up with the growth of the loan balance, especially when interest is being accrued on the loan, leaving a shortfall that the policy owner may be required to make up at the end of the loan term.

7. Do rising interest rates mean the client is exposed?

It's important to understand that it isn't simply the interest rate, it's the relationship between the interest rate and the crediting rate that is critical to premium financing. There may not necessarily be, in any given year, a close correspondence between the borrowing and policy crediting rates, but the two generally move in tandem. LIBOR rates represent a short-term borrowing cost which is historically lower but more volatile than long-term rates. The crediting rate in the policy is based upon the economic performance of an insurance company's general account, comprised primarily of fixed-income securities such as corporate or government bonds and mortgages. A characteristic of the general account is that, from the standpoint of the policyholder, the principal value does not fluctuate and the interest-crediting rate is based upon the fixed value of the investments on the company books. In a declining interest rate environment, the nominal rate credited to the account will decrease as older high-interest investments mature or are otherwise liquidated and replaced with new lower-interest investments. As a result, even if market rates have stabilized at a low rate, the general account rate may continue to decline, so long as higher-rate investments continue to mature. Correspondingly if current market rates increase, the general account rate may for a time be lower as lower-interest rate investments mature.

The "actual exposure" is limited to the difference between the loan balance and cash value in the policy. This figure is typically a portion of the collateral.

8. How can the client insulate against the worst case scenario - like an upside-down interest rate-crediting rate environment or failure to refinance the loan at the end of the loan term?

The Burgess Group is invested in finding ways to minimize client exposure to collateral calls. Whether by demanding product from insurance carriers that will decrease the impact on the insured or by utilizing methods to eliminate the impact of interest rate fluctuations, TBG is peerless in reducing risk. TBG has developed several collateral wrap and hedge strategies -- coupled with some unique product design -- to further eliminate collateral and interest rate risk. Moreover, all clients are encouraged to closely evaluate exit strategies or firewall strategies in planning. An exit strategy is a technique for reducing risks by creating a resource of funds that can be used to repay the loan at the end of the original term to ensure completion of the financial strategy. TBG integrates various estate freeze and capital transfer techniques in which to create pools of funds used to reduce or eliminate loan balance without incurring any additional gift taxes. Planning for these risks up front demonstrates a long term commitment to the client.

9. What type of collateral is acceptable to the lender?

Collateral acceptable to the lender includes the following: cash valued at 95-100%, cash equivalents such as bonds or fixed income investments margined at 75-85%, and other securities margined at 50%. On a case-by-case basis, lender will consider other forms of collateral including the cash value of an additional life insurance policy (carrier must meet the lender's minimum rating requirements). Real estate may also be a potential source of collateral if the value is converted to a liquid instrument like a letter of credit or a line of credit that can be drawn on.

10. Will lenders accept a letter of credit as collateral?

Some lenders will accept a letter of credit posted as collateral to cover any shortfall. This is approved on a case by case basis and the issuer of the letter of credit must meet the lender's minimum rating requirements. This letter of credit is considered "stand-by" because it need only represent the ability to pay.

11. What conditions cause a stand-by letter of credit to be called?

Generally speaking, there are three circumstances that could result in a call of the stand-by letter of credit: (1) insured walks away from the transaction prematurely (before end of loan term); (2) insured fails to increase collateral if necessary; or (3) the insurance company collapses or is significantly down-graded.

12. What is the interest rate charged in typical Premium Financed transactions?

The interest rate varies from lender to lender but there are certain aspects each has in common: First, most use LIBOR or Prime- rate index; second, each adds an individual "bank spread," usually between 100-150 basis points.

13. What is the origination fee and when is it required?

The origination fee is the lender's transactional fee for the loan. It is typically one percent (1%) of the first two years' premiums and is paid directly to the bank. This one-time fee can either be rolled up into the loan transaction or paid directly by the client. If the client elects to capitalize the fee in the loan, the collateral number will increase commensurately.

14. Can clients take advantage of lower interest rates internationally?

For qualified clients (with investable assets of at least $2m and with strong finance experience) TBG's bank partners have the ability to borrow in any one of the strongest international currencies (i.e., Yen, Swiss franc, British pound, Euro dollar, Canadian dollar, Australian dollar and US dollar). Tracking the historical data on these indices it is clear that these currencies do not move at the same rate. Clients have the ability to take advantage that exists in the market. Further, clients can use a fraction of the monies on deposit as collateral to hedge the currency fluctuation. Specialists take advantage of Fx movement and the client can benefit from the arbitrage created.

15. Who determines the loan term?

Our lenders will go 2 years, 5 years, and even 7 years. Because the cross-over point is generaly within the first few years, these loan terms are ample. There are generally no prepayment penalties so TBG can take advantage of improvements in the industry as they develop.

16. Who manages the loan?

The bank's lending committee manages the loan. The premiums are paid, the collateral is determined, and the assets on account (over-and-above the collateral required) are all managed internally. The margin account that is invested to mitigate interest rate fluctuations (if a floating LIBOR rate is used) would be managed by specialists in currency trading.

17. If TBG is gone tomorrow, what happens to the cases?

TBG has a strong infrastructure in place. Clients are protected. We have teams assigned to cases and account executives assigned to manage the financing pieces. Moreover, TBG is a family business with the two principals backed by teams with over 100 years of combined experience working in the insurance and estate planning space.

18. Which carriers have approved the model?

Currently we have more than 20 companies that have either formally or informally identified the TBG financing chassis as a "preferred" model for long-term funding. The TBG model is just what the industry is asking for: it is traditional recourse premium financing; it is not investor-owned or derived; and clients are typically well under age 70. Due to our lean loan rates, the cases stay on the books. Clients have coverage for life without worrying about the financing of the policy imploding or being forced to sell the policy on the secondary market.

19. What are some of the tax considerations relating to premium financing?

These materials do not constitute opinion or advice on legal, tax, accounting or investment matters. Please understand that The Burgess Group, its agents or employees, may not and do not give legal or tax advice. We recommend clients obtain and rely on the advice of their own professional advisors in applying this general information to specific situations.

Subject to the foregoing limitation, the following tax considerations should be considered by clients and addressed by clients' legal and tax advisors:

  • Leveraged gift tax strategies by having only the annual interest payments be considered transfers to an irrevocable trust rather than the full premium amount
  • Loan interest paid to finance life insurance is generally non-deductible for income tax purposes
  • Life insurance proceeds are included in an insured's estate if, at the time of death, the insured possessed any incident of ownership in the policy but because the policy is owned by an irrevocable trust the policy proceeds are not considered part of the insured's taxable estate
  • Generally, if a person guarantees another's debt (e.g., the donor of an irrevocable life insurance trust-owned policy guarantees the loan), the value of the guarantee may constitute a gift by the donor; however, there is no clear authority on this issue and some have argued that it is premature to impose a gift tax on a contingent liability that does not reduce the guarantor's net assets unless or until a guaranty payment is required
  • In any case, the measure of the gift is based on interest and not on the premium payment
  • Cash value accumulation in the policy is tax free or tax deferred
  • Cash value can be withdrawn up to cumulative premiums income tax free
  • Cash value can be borrowed income tax free
  • Client avoids income tax liability from liquidating assets to pay premiums

20. What about potential gift tax exposure for the party pledging collateral?

These materials do not constitute opinion or advice on legal, tax, accounting or investment matters. Please understand that The Burgess Group, its agents or employees, may not and do not give legal or tax advice. We recommend clients obtain and rely on the advice of their own professional advisors in applying this general information to specific situations.

There is no clear opinion on this question but it is the position of some that there may be gift tax exposure based on the collateral pledged on behalf of the trust. Conservative advisors recommend that as a precaution, the equivalent of the cost of a letter of credit (some small percentage of the collateral figure) should be gifted into the trust.