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Premium Financing
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WHAT IS PREMIUM HOW DOES PREMIUM
FINANCING? FINANCING WORK?
Premium financing allows individuals With premium financing, the potential
who have a life insurance need to defer insured applies for premium financing
using their liquid assets to fund a life after he/she has been underwritten for a
insurance policy. In a premium financing life insurance policy. Once the lender
arrangement, you (or your trust or approves the insured for a loan, it will
corporation) can take out a loan from a finance the annual premiums on the life
third party lender to pay the premiums insurance policy and the policyowner
on a life insurance policy. Premium (usually a trust) will only have to pay
financing can significantly reduce out-of- interest annually. The life insurance
pocket costs as well as gift tax costs on policy and other liquid assets are used
large life insurance policies. for collateral against the loan. The loan
may be repaid in a lump sum, in
CANDIDATES FOR PREMIUM
installments over time, or at the death of
FINANCING the insured.
The candidates for premium financing
WHAT ARE THE REQUIREMENTS
are usually individuals who are age 60
or older, whose net worth is FOR A PREMIUM FINANCING
approximately $5 million or more, and LOAN?
who would need a life insurance policy Each bank or lending institution has
with a minimum annual premium of different requirements for premium
$100,000 or more. These individuals financing. Some banks, such A.I. Credit,
may be business owners, or may have Wells Fargo and Mellon Bank have
the majority of their assets tied up in real established premium financing
estate or other investments. The programs. Provada has an an
financing allows you to leverage a new arrangement with a premium finance
life insurance policy by paying only lending broker who can bring multiple
interest and maintaining your other sources for consideration. In addition,
investments. If you fit this profile, then you may also consider using a local
you may want to consider life insurance bank with which you have an
premium financing. established relationship. Although each
lender’s terms vary for premium
financing, a loan must typically meet the
following requirements:
1. The insured must be underwritten for
a new life insurance policy and qualify
financially for premium financing.
2. The borrower will pay interest
annually at the beginning of the year,
although some arrangement allow for
interest to be paid at the end of the year
or accrued for a specified period.
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Basic Strategy Diagram
During Life
Engagement into Loan Agreement
Collateral as
Negotiate
Needed
Loan
Terms
Policy as
Pays Premiums
Collateral
At Death
Trust Receives Tax Free
Death Benefit Proceeds
Life Insurance Policy
Loan Repayment
Life Insurance Trust
Financing Institution
(owner of policy)
Collateral Released
After Loan Repayment
Net Proceeds to Heirs
3. The loan interest rate is reset every 5. The lender takes a collateral
year, depending on the terms of the loan assignment in the cash surrender value
(some lenders may offer fixed rates for a and death benefit of the financed policy.
period of time). 6. The client signs a personal guaranty
4. The loan is collateralized by the on the loan.
insurance policy and will also require a
secondary form of collateral.
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WHAT IS SELF-FINANCING? WHAT TYPE OF COLLATERAL
You may also want to consider the “Self- CAN BE USED?
Financing” approach where you or your In addition to the life insurance policy,
trust or partnership loans all or part of the lender usually needs a secondary
the annual premium to an irrevocable form of collateral to secure the premium
life insurance trust (ILIT) and the ILIT financing. Assets that can be used for
only has to pay the annual interest cost.2 collateral typically include cash and
For self-financing, you would act as the cash equivalents, marketable securities,
bank and would use available cash to a letter of credit, existing life insurance
advance annual premium loans. This policies, and certificates of deposit (CD).
approach avoids the financial Marketable securities such as stocks
underwriting and collateral requirements and variable life insurance policies are
of using a third party lender. As with usually discounted 50% to account for
traditional premium financing, self- fluctuations in the market value. Most
financing can significantly reduce gift tax lenders will not take real estate as
on large premiums since the premium collateral for premium financing, but real
loan is not considered a gift and only the estate or privately held stock may be
annual interest cost needs to be gifted used to secure a Letter of Credit.
to the ILIT.
USES OF PREMIUM FINANCING
HOW IS THE INTEREST
Although premium financing is often
RATEDETERMINED ON A LOAN? used for estate planning purposes, it
Each lender will calculate interest in can also be used in other situations
different ways. Most lenders will such as 1035 exchanges to new
calculate interest based upon the one- policies, non-qualified deferred
year London Interbank Offered Rates compensation, buy-sell agreements and
(LIBOR) or the PRIME rate and a fixed key person life insurance.
spread.3 Although some lenders will
offer fixed interest rates for five or ten-
year periods, many will offer lower
interest rates that are adjustable
annually, based on LIBOR or PRIME.
For the self-financing approach, the
interest rate on the loan should be set at
or above the current Applicable Federal
Rate (AFR).4
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This material is for informational purposes only. Although many of the topics presented may also involve
tax, legal, accounting, or other issues, neither Provada Insurance Services, Inc., nor any of its agents,
and employees are in the business of offering such advice. Individuals interested in these topics should
consult with their own professional advisors to examine tax, legal, accounting, or financial planning
aspects of these topics.
1
Trusts should be drafted by an attorney familiar with such matters in order to take into account income,
gift and estate tax laws (including generation-skipping tax). Failure to do so could result in adverse tax
treatment of trust proceeds.
2
Upon death, the loan from the insured to the ILIT will become an asset of the taxable estate, and the
principal balance at death will be subject to estate tax.
3
It is important to note that the LIBOR rate is not fixed and may be different from the initial rate used in
the illustrations. The monthly LIBOR rate from January 1992 through January 2002 ranged from a low of
2.31% (October 2001) to a high of 7.75% (December 1994), with an average rate of 5.46%.
4
The IRS publishes the Applicable Federal Rate on a monthly basis.
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