If recent global events have taught us anything, it’s that planning for the future is crucial. For many businesses and business owners, one of the best ways to safeguard their future plans is to secure quality life insurance for themselves and/or key personnel on their team. Since life insurance (as well as key person insurance) is an essential aspect of business succession planning, it makes sense why business leaders value it so much.
The only problem is that, sometimes, making payments on insurance premiums in the here and now may prevent a business or business leader from using their available capital for other, vital purposes. High premiums could stifle a business’s cash flow or prevent business leaders from pursuing lucrative investments in the moment. Having to choose between long-term insurance coverage and pressing, short-term needs can feel like an unsolvable conundrum for businesses and executives.
In such an instance, premium financing can be an invaluable tool.
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Premium financing is a loan that allows businesses and high-net-worth individuals (HNWIs) to acquire life insurance while also maintaining financial flexibility and leveraging their assets.
Rather than using large amounts of cash to pay off life-insurance premiums on a monthly or annual basis, individuals or businesses who use premium financing can borrow that money (with interest) from a third-party lender. The lender then pays the insurance premiums in return for payments to be made at a later date –– often in part from the surplus cash value of the insurance policy. If the insured passes away before the debt is satisfied, the balance is typically paid off with insurance proceeds.
In this way, businesses and business leaders can protect their future without hamstringing their current efforts.
Here we’ll explain everything professionals need to know about premium financing: how it works, how to get it, and what risks and benefits it entails.
Challenges of Meeting High Premiums
A life insurance policy is –– in many ways –– the ultimate long-term strategy. After all, in a basic life insurance policy, the beneficiary only receives a payout after the insured individual’s death. Thankfully, that day may not come until many years into the future.
In the meantime, though, businesses and individuals who hold life insurance policies have to pay premiums to maintain their coverage.
The issue that many businesses and HNWIs have in regard to life insurance is that their premium payments may be extremely high.
Remember, while the “average” life insurance premium may only cost a little over a hundred dollars per month, businesses and business owners with multi-million dollar policies will have to pay much more for their coverage –– thousands or even tens of thousands per month.
In order to meet these premium payments, some businesses or business leaders may have to liquidate their holdings –– i.e. sell stock, real estate, etc. or divert current operating cash flow . However, this is hardly ideal and can actually prove detrimental to a business or business owner. If a significant portion of available capital has to go toward monthly premium payments, there will obviously be less of it to use on other expenses and investments.
How Premium Financing Works
As we’ve established above, premium financing is a loan that businesses and business leaders can use to cover their insurance premiums. In a very basic premium financing setup, the policyholder pays the third-party lender an interest rate to cover their premium costs as per the conditions of the loan. Eventually, the policy holder can use the surplus cash value that their policy accumulates to pay back the principal of the loan. Typically, policy holders can begin to use the cash value accumulated by the policy in order to pay off some of the interest on the loan through staggered payments or use other available cash flow from outside the policy to cover the interest payments.
To put it as simply as possible: premium financing lets you defer premium payments in exchange for the ability to retain cash and other valuable assets right now.
Benefits of Premium Financing
The benefits of premium financing revolve around one very strong concept: opportunity. By taking out a loan to cover insurance premiums, businesses and business leaders are able to secure high-quality insurance without disrupting their current cash-flow status. This means that they’ll be able to invest their available capital on ventures that will, ideally, produce much higher returns than the cash value of an insurance policy. In most instances, premium financing allows individuals or businesses to borrow money at a rate close to Libor.
Here’s how premium financing works in practice: Say a business owner takes out a $5 million life insurance policy and pays for it for the next 15 years. As their policy outlines, the annual premium cost is $164,000. With a premium financing arrangement, the business owner only has to make an interest payment on that $164,000. Their actual out-of-pocket costs may only be a few thousand dollars. That means that they’ll have roughly $160,000 available to spend, which they can then use to bolster their business, invest in new ventures, or land new clients. By investing that $160,000, a business could potentially generate much more revenue in return. For reference, a 12% return on a 160,000 investment is $19,200.
As long as policy holders are able to invest in projects that produce a return that’s higher than the cost of their interest rate, they’ll be able to bank extra savings thanks to premium financing. For many successful entrepreneurs, doing that isn’t a problem.
Perhaps the best part about premium financing is that it allows business owners to accumulate higher returns on their preserved capital every single year. So businesses can consistently generate revenue and income that they otherwise would’ve missed out on, without sacrificing their insurance coverage.
Often in estate tax planning for business owners and HNWIs it is critical to reduce their taxable estate. An irrevocable life insurance trust, for example, allows proceeds to be distributed to beneficiaries without tax liability.This sort of trust work combined with permanent life insurance is a powerful tool to significantly reduce estate taxes. Premium financing can help facilitate getting these types of life insurance policies in place without diverting significant cash flow today.
Lastly, premium financing allows businesses and HNWIs the ability to plan for their futures with a quality life insurance policy in place. Securing life insurance can enable business leaders to create forward-thinking strategies, draw up detailed future budgets, and develop a plan for retirement and business succession. Never underestimate the peace of mind that life insurance can bring to you and your family.
Applying for Premium Financing
Premium financing is not available to everyone. In general, third-party lenders reserve premium financing for insurance policies that exceed $1 million. (At minimum. Most premium financing programs exceed that figure.) That’s in part because, in order to successfully apply for premium financing, businesses or business owners are required to put up significant collateral to secure the loan. Commonly used collateral in premium finance cases include things like real estate or advanced manufacturing equipment. Collateral protects the third-party lender if the policy holder were to default on their payments.
Structuring a Life Insurance Policy
No two life insurance policies are structured in the exact same way. Clients with different needs may make payments at different rates and times. They also may accrue cash-value at different rates –– depending on the nature of their insurance policy.
Note that a premium is a payment that is split three ways: one portion goes to the death benefit, another portion goes directly to the insurance company to cover their costs and profits, and a third goes toward the cash value of the insurance policy.
The cash value of an insurance policy is essentially the amount of money the policy owner would receive if they were to decide to cancel (surrender) their policy.
Cash value can be important in terms of premium financing because cash-value earnings on a life insurance policy may be used (at least in part) to pay back the loan.
There are several different ways that insurance companies structure cash-value growth. A few popular types of permanent life insurance that promote cash-value accrual are:
- Whole Life Insurance Policy –– grows cash value at a predetermined rate set by the insurance company.
- Universal Life Insurance Policy –– accumulates cash value based on current interest rates.
- Variable Life Insurance Policy –– invests cash-value funds in sub-accounts on the market. They operate like mutual funds.
Which type of insurance policy works best depends on many factors and is something that must be determined on a case-by-case basis. The same logic applies to paying off the premium financing loan interest. Some individuals may have to wait several years before they begin to put payments out of their surplus cash value toward their loan.
Further Premium Financing Considerations
Premium financing can provide business leaders with a solution to their life insurance needs. However, despite the many benefits of premium financing, it is not a completely risk-free investment. Nor is it –– as some people wrongly believe –– a form of “free insurance.”
Some factors that could contribute to trouble for policy holders on a premium financing policy include:
- Rise in Interest Rates. A significant increase in interest rates could nullify some of the gains associated with premium financing.
- Inability to Qualify. Premium financed insurance policies require regular maintenance and adjustment. This also means that the policy holder’s collateral is reviewed and re-evaluated every time the loan is renewed. The bad news here is that if the value of the policy holder’s collateral has dropped, they may be forced to put up more collateral to qualify for the loan.
- Earnings Underperformance. Should the cash value of an insurance policy underperform in terms of accrual, the loan balance may exceed the policy holder’s collateral.
- Level Death Benefit. At the end of a life insurance policy, an insurance company either pays out the cash value (upon surrender) or the death benefit to the beneficiary. These constitute the insurance proceeds. With premium financing though, a portion of these proceeds may go to the third-party lender if the debt has not been paid off yet. With a level death benefit, the death benefit does not increase over time. Individuals with premium financing therefore need to invest in a policy that includes an increasing death benefit –– most often paid out through insurance dividends and adjusted premium payments.
Because each life insurance policy contains many variables, it’s critical for business leaders who are interested in premium financing to partner with a firm that they can trust to secure the best possible policy and rates to meet their financial goals.
Premium Financing with Helm Financial
Premium financing is complex and nuanced. Each life insurance policy is unique, and there are different risks and rewards that need to be weighed on an individual basis. At Helm Financial, we work closely with our clients to determine their long-term financial goals, their vision for the future, and what they can do to make that vision a reality. We have the expert knowledge and the skills needed to ensure that your life insurance policy delivers the protection and savings that you or your business requires. Plus, we have years of experience partnering with insurance companies –– so we know how to structure policies that produce positive returns for our clients.