Premium Financing Life Insurance

us premium financeMore likely than not, every person over the age of 18 has used some type of leverage to purchase an asset.  Almost everyone uses the power of leverage when they purchase a home.  What is the leverage in this case?  It’s the mortgage.  Instead of paying the total amount out of pocket to purchase a home, or even a rental property, we often put down 10 to 20% of the purchase price, and a lender pays the remaining amount.  Even if the buyer could pay the full purchase price, it is not always advantageous.  By paying the full purchase price, the buyer has increased his or her underlying risk of loss—if something occurs on the property—and the buyer has also devoted a larger amount of assets to acquire one property.  Therefore the use of leverage is very common for real estate investors.  Why pay the purchase price of $100k for one property when the buyer can purchase five properties with $20k down for each.  The buyer has now used the power of leverage to minimize the loss for each and has increased growth opportunities by purchasing five instead of one property.  What most people are unaware of is we can use leverage in the exact same manner when using overfunded cash value insurance.  This strategy is called premium financing.

Standard Premium Finance

prime rate premium financeWith premium financing, a lender pays roughly 75% of the premiums for the first ten years of the policy, and the insured pays 25%.  Why is this such a powerful planning tool? It is because we now have 3/1 leverage on funding the policy for capital growth.  The following is a simple example of the power of leverage.  A policy is structured so the buyer pays $1 a year for the first five years and then is done paying premiums.  During the first five years, the lender is matching the $1 and then will pay $2 a year in years six though ten.  After year ten, all premiums cease.  If the buyer was personally funding the policy, she would have paid $5 over the five years, but with premium finance the total premium paid is $20 because the lender is paying the additional $15.  At year 15, the lender is paid back using the cash value of the policy, and owner walks away with her policy to use the capital as she sees fit.    The only asset used as collateral for the loan is the policy itself.

So, what’s the catch?  There are requirements to be eligible for premium finance.  The first is that the buyer must be between the ages of 18 and 65.  There are also income requirements.  With most companies, the buyer (insured) needs to be earning around $150k per year. The minimum death benefit amount is typically $1,500,000, and the insured needs to have a health rating of standard or better. Finally, access to the cash value is restricted until the lender is paid back, which typically occurs in year 15.

Whole Life Or Indexed Universal Life Policy

top premium financeLet’s take a look at some numbers, strictly from a tax-free retirement income standpoint, for a client of mine. She is a successful 36-year-old non-smoker wanting to pay an annual premium of $30k for five years.  Using the premium financing, the lender will also be paying $31,088 for the first five years.  In years six through ten, the lender will pay $59,588.  After year ten, the premiums cease, and the lender is paid back from the policy’s cash value in year 15.  Starting at age 65, the policy is projected to provide $192,000 annually as supplemental retirement income to age 90.  The total projected supplemental retirement income is a staggering $4,992,000.  Even stress testing the projected supplemental income to the returns during the Great Depression, the supplemental income is still projected to be $131,000.  If my client was to pay the $30k for five years without the premium financing, the projected supplemental retirement income would be $82,000, which is still great but $110,000 less per year without the premium financing.

Premium financing isn’t necessarily for everyone, but it does provide the opportunity to leverage your policy funding while freeing up capital to use for investments or other purposes. There is never a one-size-fits-all, but if you are looking to create an overfunded cash value policy, looking at premium financing is time well spent.