Premium Financing: What You Need To Know

To the general public the idea of borrowing money to pay for an insurance premium seems like an outrageous idea.  However, the need for premium financing is huge, but these aren’t your average insurance policies.

The idea of premium financing or premium funding is simple – typically a third party will loan the consumer funds to cover the premium for insurance they want to buy.  These loans are most easily compared to a variable rate loan with a set term.

You may be having some of the same thoughts I did when I first heard about this idea…”why the heck would anyone do this?!”

Before I get into an example let me point out that this strategy is one that is typically used by high net worth individuals that don’t want to liquidate current assets but still understand the need for coverage. They may also be dealing with large estates, businesses, or taxes.

So here’s a quick example: 

Meet Phil and Jill.  They’ve been married for 30 years, Phil is 60 and and Jill is 54 and their net worth is $50 million.  They look into getting a $5 million dollar life insurance policy only to find out that that the annual premium would come in around $223,000.  That’s a good chunk of change each year.

Enter Premium Financing.  Instead of paying $223,000 each year for the next 30 years until the policy is paid up they could borrow $1.7 million at 4.5% from a premium finance company.  This lump sum of money would allow them to pay for the life insurance in full today, known as a single premium insurance policy, have $6.7 million in coverage,  and pay $76,500 in interest each year to the premium finance company that lent them the money.

When Phil passes on, he will leave $6.7 million to his wife Jill. Jill can use $1.7 million to pay off the loan to the premium financing company and she will be left with the same $5 million death benefit. The benefit? They paid a fraction of the cost. They saved $146,500 a year in insurance premium… not bad.

 What to Look For

As with any financial strategy it’s vital that you work with a reputable company and representative.  As you do your due diligence make sure you find out the terms and conditions of the loan.  Often times the loan will have to be refinanced or renewed before the death of the insured – make sure you know if and when this will happen and what effect it could have on the overal outcome.  Ideally you would want a loan with a term that stretches well beyond your life expectancy.

Take interest rates into consideration.  Most premium finance loans are variable, which could be a good thing while rates are low, but if rates are expected to go up dramatically it could pose a problem to the strategy.

A good rule of thumb is to run from anyone who claims that premium financing is a way to obtain “free” insurance.

Is It For You?

Premium financing is a option for high net worth individuals that, for estate planning or business purposes, need substantial life insurance coverage.  The decision for most is whether or not they want to use current cash flow or liquidate assets to pay for the premiums.  If current cash flow and assets are better used elsewhere then premium financing could be a viable option.

Bring on your comments….what did you first think when you learned about premium financing?

Photo credit: flickr – SAN_DRINO

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Nick D.

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