Greenwich Financial

When Does Premium Financing Make Sense?

In many cases, premium financing does not make sense:
- Insured person has adequate cash flow to pay premiums.
- Insured person does not face difficult choices concerning allocation of discretionary cash flow.
- Insured person lacks alternative uses of capital with much higher rates of return than can be expected to accumulate within a life insurance policy.

Ideal case for premium financing combines these elements:
- Insured person of any age.
- High net worth.
- Long-term need for permanent insurance.
- Short-term or transitional constraints on use of discretionary cash flow

Another possibly valid scenario has these elements:
- Age at least 60 years old.
- High net worth.
- Collateral available to fund a low interest cost, secured loan.
- Financing lined up for the remaining lifetime of the insured person.

Risks of premium financing:
- Accumulation of interest cuts into economic value of death benefit.
- Liquidity may not be available at time of expected loan repayment.
- As always, tax matters deserve special discussion with your accountant or tax advisor.

Market considerations and trends
- “Non-recourse premium financing” is defined as financing in which the borrower makes no personal guarantee and posts no collateral (other than the insurance policy being financed) as backing for the Note; instead, the lender looks to the policy value alone as collateral.
- Non-recourse financing minimizes the financial risk of the borrower, but the interest rate charged will be substantially higher than if the borrower gives a personal guarantee. This is because the lender may face greater risk without such personal backing. If the borrower is willing to give a recourse note, and/or post financial collateral to back a loan, there is much greater flexibility in choice of insurance companies to make application to
- We see interest and continued activity in non-recourse premium financing. But most insurance companies have taken a stand against it, and it is increasingly difficult to obtain.
- “Collateralized financing” of life insurance premiums requires that the policy owner post financial collateral to support the gap at any time between policy cash value and loan amount due at that time.
  - Some lenders may accept a so-called “control agreement” over a securities account. Under such an agreement, administered by a securities firm, the borrower is normally free to trade securities but cannot withdraw them.
    - Collateral will suffer a “haircut” depending on its perceived safety. New York Stock Exchange listed stocks may be accepted at 50% of value for collateral purposes, while US Treasury Notes may be accepted at 90% and Treasury Bills at 95%. Stocks, to be acceptable collateral, must be marginable.
    - If the securities account subject to the control agreement suffers serious market losses, the borrower may be asked to add assets to that account; if the borrower fails to do so, the loan will be subject to acceleration by the lender.
  - Other lenders may ask the borrower to post an irrevocable letter of credit (LOC) from a commercial bank. Normally, the commercial bank should have a solid rating on its long-term debt outstanding from a nationally recognized rating agency.
  - Some lenders may accept other collateral, such as a lien on residential or commercial real estate, in lieu of marketable securities or an LOC.
- Premium financing backed by the personal guarantee of the insured and/or financial collateral remains an orthodox means of funding life insurance that is accepted by all major carriers, provided that the financing is not being using as a means to a future sale of the underlying policy to investors—so called “Investor Owned Life Insurance” (IOLI) or (more pejoratively) “Strange Owned Life Insurance” (STOLI).
  - On most life insurance applications, the applicant (and often, separately, the life insurance agent) will be asked to disclose any financing being contemplated.
    - As with all other parts of the life insurance application, the applicant should answer such questions candidly and specifically. If a policy application is answered untruthfully as to a material element, it is subject to “rescission”—meaning return of life insurance premiums and denial of death benefit.
    - Short-term financing, with the purpose of making a profitable life settlement, or other types of speculation using life insurance, including life insurance/annuity arbitrage, are frowned upon by the major carriers. The insurance company may, and likely will, disapprove of an application with such a purpose.

Regulatory considerations:
- In many states, providers of premium financing on life insurance must be licensed.
- In some states, providers of premium financing on life insurance may also be subject to certain provisions of statutes regarding viatical and/or life settlements.
- Because of regulatory considerations, we are not able to discuss financing alternatives except with “accredited investors,” as defined under Rule 501 of Regulation D of the federal securities law. For an individual to be an accredited investor, that person must have net worth of at least $1 million or annual income of at least $200,000 (or joint income with a spouse exceeding $300,000). See http://www.sec.gov/answers/accred.htm. Such accredited investors must sign a statement affirming their status as such, of which we can provide a sample.

Eligibility
- Non-recourse premium financing is typically limited to seniors (ages 70 and above).
- Recourse and collateralized lending is not limited by age, but rather by adequacy of financial backing.
- Borrowers must demonstrate wealth/income, as discussed above under “Regulatory Considerations.”
- Prospective borrowers must be informed of their rights under HIPAA, the federal health care privacy statute, and sign releases under that Act.