Life Insurance

Premium Financing

1 of 5
WHAT IS PREMIUM
FINANCING?
Premium financing allows individuals
who have a life insurance need to defer
using their liquid assets to fund a life
insurance policy. In a premium financing
arrangement, you (or your trust or
corporation) can take out a loan from a
third party lender to pay the premiums
on a life insurance policy. Premium
financing can significantly reduce out-of-
pocket costs as well as gift tax costs on
large life insurance policies.
CANDIDATES FOR PREMIUM
FINANCING
The candidates for premium financing
are usually individuals who are age 60
or older, whose net worth is
approximately $5 million or more, and
who would need a life insurance policy
with a minimum annual premium of
$100,000 or more. These individuals
may be business owners, or may have
the majority of their assets tied up in real
estate or other investments. The
financing allows you to leverage a new
life insurance policy by paying only
interest and maintaining your other
investments. If you fit this profile, then
you may want to consider life insurance
premium financing.
2 of 5
HOW DOES PREMIUM
FINANCING WORK?
With premium financing, the potential
insured applies for premium financing
after he/she has been underwritten for a
life insurance policy. Once the lender
approves the insured for a loan, it will
finance the annual premiums on the life
insurance policy and the policyowner
(usually a trust) will only have to pay
interest annually. The life insurance
policy and other liquid assets are used
for collateral against the loan. The loan
may be repaid in a lump sum, in
installments over time, or at the death of
the insured.
WHAT ARE THE REQUIREMENTS
FOR A PREMIUM FINANCING
LOAN?
Each bank or lending institution has
different requirements for premium
financing. Some banks, such A.I. Credit,
Wells Fargo and Mellon Bank have
established premium financing
programs. Provada has an an
arrangement with a premium finance
lending broker who can bring multiple
sources for consideration. In addition,
you may also consider using a local
bank with which you have an
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.
 Basic Strategy Diagram
During Life
Engagement into Loan Agreement

Collateral as
Negotiate
Needed
Loan
Terms

Client & Advisors Collateral Source

Financing Institution Insured, Parents, Children,
Trust(s), Family Partnerships,
Premiums &
Family LLC, Corporation
Loan Interest

Policy as
Pays Premiums
Collateral

Life Insurance Trust Life Insurance Company

(owner of policy)

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
year, depending on the terms of the loan
(some lenders may offer fixed rates for a
period of time).
4. The loan is collateralized by the
insurance policy and will also require a
secondary form of collateral.
5. The lender takes a collateral
assignment in the cash surrender value
and death benefit of the financed policy.
6. The client signs a personal guaranty
on the loan.

3 of 5
WHAT IS SELF-FINANCING?
You may also want to consider the “Self-
Financing” approach where you or your
trust or partnership loans all or part of
the annual premium to an irrevocable
life insurance trust (ILIT) and the ILIT
only has to pay the annual interest cost.2
For self-financing, you would act as the
bank and would use available cash to
advance annual premium loans. This
approach avoids the financial
underwriting and collateral requirements
of using a third party lender. As with
traditional premium financing, self-
financing can significantly reduce gift tax
on large premiums since the premium
loan is not considered a gift and only the
annual interest cost needs to be gifted
to the ILIT.
HOW IS THE INTEREST
RATEDETERMINED ON A LOAN?
Each lender will calculate interest in
different ways. Most lenders will
calculate interest based upon the one-
year London Interbank Offered Rates
(LIBOR) or the PRIME rate and a fixed
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
4 of 5
WHAT TYPE OF COLLATERAL
CAN BE USED?
In addition to the life insurance policy,
the lender usually needs a secondary
form of collateral to secure the premium
financing. Assets that can be used for
collateral typically include cash and
cash equivalents, marketable securities,
a letter of credit, existing life insurance
policies, and certificates of deposit (CD).
Marketable securities such as stocks
and variable life insurance policies are
usually discounted 50% to account for
fluctuations in the market value. Most
lenders will not take real estate as
collateral for premium financing, but real
estate or privately held stock may be
used to secure a Letter of Credit.
USES OF PREMIUM FINANCING
Although premium financing is often
used for estate planning purposes, it
can also be used in other situations
such as 1035 exchanges to new
policies, non-qualified deferred
compensation, buy-sell agreements and
key person life insurance.
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.

Provada Insurance Services, Inc.

201 Mission St., Suite 1940, San Francisco, California 94105
877-PROVADA (776-8232)
www.provada.com info@provada.com
CDI #0E20490

© 2006. Provada Insurance Services, Inc. All rights reserved.

5 of 5