First-Class Financing
July 5, 2011 by Bob Calandra
Published 6/30/2011
For many insurance agents, premium financing must seem like the industry’s equivalent of a riddle wrapped inside of an enigma.
Premium financing is, after all, a notoriously niche solution. Most agents will
probably only encounter a few potential candidates over the course of their
career. But when the client and product do mesh, premium financing can be
richly rewarding for everyone.
“Even though an agent may run into very few of these, the premium finance cases are
substantial and they are worth the effort,” says Chris Layeux, a member of
ING’s Advance Sales Team. “The average fee amount is excess of $10 million so
they are a substantial business to be involved in, even though they may be more
complex and need additional time to complete.”
Since around the mid-1990s, premium financing has allowed an individual or company to
borrow money to cover the cost of an insurance premium. The premium financer
pays the insurer and then bills the insured on a monthly basis.
Premium financing is more commonly used in business because professional liability and
other similar insurances don’t offer installment payments. Consequently, it’s
not unusual for a large company to have several policies worth millions in
premiums due simultaneously every year. So, companies bundle the policies
together into a premium financing plan. Generally the company will pay the
premium finance company 10–20 percent of the total amount up front. The company
then makes 10 to 12 monthly payments.
Liquidity when needed
“It really helps out with cash flow,” said Vicki Sternfeld, a Property and Casualty
agent with Poms & Associates. “It may make sense, especially now with
interest rates fairly low, to pay a little interest on the loan payment and pay
off the loan monthly, as opposed to coming up with a couple of hundred thousand
or a million dollars all at once.”
Sternfeld has closed $1 million premium finance deals, and she has done deals for a lot
less. For instance, one of her clients recently had to pay out an unexpected
$70,000 in addition to its usual expenditures. Rather than create a cash-flow
problem, Sternfeld recommended that the company premium finance the audit
amount.
“It gave them the ability to pay the audit off over a period of time as opposed to
coming up with $70,000 they didn’t have at the time,” Sternfeld said.
Financing for individuals
Commercial premium finance companies are designed to accommodate
business’s wide range of needs. But personal premium financing is all but
exclusively the domain of the extremely affluent, those with a net worth north
of $5 million.
“The lenders are going to scrutinize these people and make sure
that the person fits within the bank’s fiscal profile for the type of client
they want for that loan,” Layeux says.
Individual premium financing almost always starts when a client
needs a large life insurance policy, usually $5 million and up. Clients in this
market can afford to pay the premium outright, unless, of course, they have a
liquidity issue. But even if they have the money available, should they dole
out several hundred thousand dollars a year, which could otherwise be invested
to create more wealth? And given today’s low interest rates, doesn’t borrowing
the money make smarter fiscal sense?
“A lot of affluent clients are asset rich, but they don’t just
have their assets sitting there,” said Layeux, who has seen premium financing
work for people as young as 40, and for others well into their 80s. “For them
to take their money out of their business or their investment might not be
economically advantageous. So they are looking for that external force so they
don’t disrupt what they’re doing with their money. It really has driven a lot
of clients to perhaps seek a solution where they can continue to keep control
of their assets.”
For the next two years, those assets can be donated to the trust
funding the premium finance loan. Under federal law, married couples can donate
up to $10 million into their trust fund without incurring any gift tax. Those
assets, while being protected, can also be used to help manage a premium
financed loan.
In 2013, however, this window will close and the law will revert back to
allowing only a million dollar exemption.
Pitfalls and promises
Even with all the advantages, the decision to premium finance a life insurance
policy should not be taken lightly. The client, working with their insurance
agent, accountant and lawyer, should evaluate multiple loan scenarios to make
sure they understand all the pitfalls and promises. If the insurance agent is
unfamiliar with premium financing, Layeux recommends they consider working with
a more experienced colleague.
“An agent with a good prospect for premium financing but who doesn’t have the
experience needs to not only educate himself, but should consider working with
very experienced professionals that have done this before,” Layeux said. “I
think it might be a challenge for an inexperienced producer to successfully
navigate a premium financing structure if you have not done one before.”
Wealthy clients purchase life insurance through a trust. The trust then applies for the
loan, which can be either five or 10 years. The bank then pays the life
insurance policy premium. But before a bank will fund a policy, it will examine
every aspect of the client’s financial and physical well being, because the
policy is, after all, life insurance. The bank will then require the client to
pledge the appropriate amount of collateral to cover the difference between the
premium cost and policy value.
For instance, Sternfeld had a client who needed to premium finance a $10 million
life insurance policy that carried an $188,000 annual premium. The terms he
wanted were 10 monthly installments. Sternfeld solicited quotes from three
premium financers, including the insurance company.
“They came back and said, `We need 15 percent down. The monthly payment is this, the
finance charges are this and the APR is this,’ ” she explained.
The 15 percent down that Sternfeld’s client paid can be a significant wad of money. Let’s say your client needs a $1 million life insurance policy. The trust takes the loan to cover the $100,000 annual premium, which will be repaid in 10 or 12 monthly installments. However, the policy surrender value for the first year of the loan is only $75,000. So, the premium financer will require the client to pledge collateral that will cover the $25,000 difference between the annual premium and policy value. And you can’t use your house as collateral.
“The capital environment has changed dramatically over the last few years, and banks
are less comfortable with fixed assets as collateral,” Layeux said. “They are
more comfortable with something that is liquid, like cash equivalents, letters
of credit. The bank will determine what is acceptable to them.”
The most successful premium finance loans are prepared for a worst case scenario.
If things don’t go according to plan, the client will want to pay off the loan
early. For instance, since the loan’s interest rate is tied to an index, if the
index rises, so too will the interest payment. Or, if the client outlives the
loan period, the balance might grow to become unmanageable. So, the client, in
concert with their broker, accountant and lawyer, should develop a contingency
plan.
“It might be a separate technique such as a grantor, or an annuity trust,” Layeux
says. “Or maybe give an income-producing property to their trust, so they can
use the income from that property to perhaps manage the loan. That’s what I
think makes a very successful case.” «
Bob Calandra is a freelance writer based in Wyndmoor, Penn. He can be reached at Rotoca@comcast.net.For many insurance agents, premium financing must seem
like the industry’s equivalent of a riddle wrapped inside of an enigma.
