Assessing the Risks of Premium Financing

Assessing the Risks of Premium Financing

If there’s one thing successful investors and business people understand, it’s the multiplicative power of leverage.

For a client interested in life insurance, premium financing can harness the power of leverage to potentially reduce costs and conserve capital for more attractive investments. There can also be significant gift and estate tax benefits.

Premium financing can also be part of a compensation package. For example, college football coach Jim Harbaugh got a great deal from the University of Michigan. The University loaned him $2 million a year, interest free, for seven years to pay life insurance premiums. As long as the policy remains in force, Harbaugh will have access to millions in tax-free cash during retirement, and the loan will be repaid when he dies.  At his death, the University will get back its $14 million and his beneficiaries will receive the remaining payout.

Premium financing can be an option for anyone who needs a lot of insurance coverage for business or estate-planning purposes, who doesn’t want to spend current cash flow on insurance premiums, is insurable at standard rates and meets a lender’s underwriting guidelines. The ideal candidate has a net worth of $10 million or more.  

In premium financing, the insured borrows money from a bank or other lender to pay life insurance premiums. Usually, this comes in the form of a long-term loan with a variable interest rate linked to the London Interbank Offered Rate (LIBOR). The insured furnishes collateral – usually the policy’s cash surrender value – with any shortfall covered by additional collateral.

The biggest benefit in premium financing is the acquisition of life insurance at a minimal out-of-pocket cost. The policyholder can invest the money that would have been spent on premiums, potentially receiving higher returns. There can also be significant estate and gift tax benefits. With the correct structure, death taxes can be avoided on the insurance payout.

For more information, please read:
Benefits and Risks of Premium Finance | Wealth Management

Related:
Michigan Adds Extraordinary Value To Coach Harbaugh’s Contract Using Insurance

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