Premium Financing - Ultimate Leverage
Premium financing is available for some types of permanent life insurance - especially indexed universal life (IUL). Premium financing appeals to those wanting to keep their capital at work to the greatest extent possible within their businesses or other investments. Many banks that offer these types of loans usually want loan sizes of $500,000 and above, for borrowers of $5 million or more of net worth, but a few banks and credit unions may allow lower limits. They also may be willing to consider aggregate borrowing on multiple lives in a business or family environment, so long as a single borrower is established. Under certain circumstances a margin brokerage account may provide an attractive source of loans for premium financing.
Such loan programs typically extend for as long as 15 or more years' premiums, so the aggregate loans tend to increase over time. The bank is eventually paid off at the death of the insured(s) or at a point down the road when the bank loans can be converted to policy loans through the loan provisions of the underlying policy(ies).
At this time, some banks are offering terms under 3% interest for $1 million or more aggregate lending, with future rates tied to a certain spread above a benchmark, such as LIBOR. In today's interest environment, such rates are less than the cost of borrowing directly from the policies themselves. Rates for participating loans from IUL policies usually range from 4% to 6%. This would serve to further enhance the potential leverage that may be possible for index strategies hoping to achieve 7% to 10% effective returns over time.
The financed policy sometimes is structured to include an Early Cash Value Rider (ECV), available from some carriers, that often will produce net cash values of more than 95% of first-year premium. This cash value serves as partial collateral to the bank for its loan. However, long-term policy performance will suffer to some extent from being charged for the use of these riders. Any excess loan above the collateral provided by the policy itself ("overhang") is secured by the policy owner by pledging additional collateral that must be viewed by the lender as roughly equivalent to cash. This collateral may take the form of bank deposits or CD's, receivables, securities (usually at 50 cents on the dollar), and sometimes real estate. The borrower may alternatively post a Letter of Credit for the overhang. Overhang usually grows at first and peaks out between the 3rd and 5th year, and recedes to zero by the 6th to 10th year, depending on policy performance.
Most banks require personal liability on premium finance loans, but since these loans are essentially risk-free to the lenders, they may not report such transactions to the credit agencies. Thus, the borrower that also borrows for other reasons, such as a real estate developer, need not necessarily include premium financing transactions in his financial reporting. Of course, each case may vary, and one should consult his account or attorney in making a final decision on that subject.
Banks usually require that the policy owner also contribute some cash to the program. In some cases, an amount roughly equal to the loan interest, or even as small as the cost of alternative term insurance will suffice. Imagine getting permanent life insurance, with all of its inherent advantages in the long run, for the same outlay as term insurance!
Premium financing has the potential for a win-win deal. The bank has essentially a no-risk loan. The policy owner can take advantage of today's low interest environment to obtain relatively safe leverage that may produce enormous results.
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