Guest Post: Thomas Yaeger – Managing Director | Premium Finance Group, Pacific Western Bank

Life insurance financing is a way to pay for insurance premiums for the purchase or maintenance of a life insurance policy. The term may also be used to describe the monetization of excess cash value within an existing policy.

In a 1911 U.S. Supreme Court case, Grigsby v. Russell Justice Oliver Wendell Holmes confirmed in the court’s decision that life insurance is an asset and as such enjoys the same characteristics as more traditional investment property such as stocks, bonds, and real estate.

Similar to real estate purchasing, life insurance is long term. The difference between real-estate finance and premium financing is the asset being financed. Both real-estate financing and life insurance financing are about leverage: borrow money to increase the purchasing power for the buyer.

The returns on these two assets are also similar in nature. Real-estate returns can broadly be broken into cash flow or rent and asset appreciation. Life insurance has two primary components as well, cash value and death benefit. Cash value is the excess cash in a policy. Cash value growth is like rent. The buyer gives the insurance company excess money and they pay a return. Today’s policies pay an annual cash value return based on the excess cash in the policy which exceeds the amount needed to pay for the mortality and other costs.

The life insurance buyer has several “investment” options to choose from with a typical universal life policy. Generally these are tied to some performance index like the S&P Index or other easily trackable gage. These returns are not guaranteed. Typically the agent and the client establish a reasonable expectation of anywhere between 4.00% and 6.50% depending upon the options offered by the insurance carrier. Setting a realistic expectation is important when evaluating either a financed or a non finance insurance policy. Whole life policies pay a dividend each year based on the performance of the insurance company and its grouping of policy holders. These are not guaranteed either.

The Insurance Design

Selecting the right financing design (a fancy way to say structure) depends on which asset characteristic the buyer it trying to optimize, cash value or death benefit.

Buying to maximize death benefit may mean stretching out the number of premiums so that the cash out flow is small compared with the death benefit. This would maximize the leverage; more purchasing power for the least out flow. This is an approach older buyers may want to consider.

Alternatively maximizing cash build up may mean shortening the number of payments while increasing the size of each payment. This is a common practice for younger buyers. The concept is to over fund the policy with borrowed funds to increase the policy cash value. The result is an increase in the amount of excess cash value exposed to the returns that the insurance company will pay the policy holder. With today’s bank loan rates, many premium finance candidates consider this approach as a way to augment leverage through interest rate arbitrage.

As mentioned earlier, buying insurance is long term. As such, temporary interest rate arbitrage is not a good long term strategy. The long term advantage of premium financing is leverage. Buying more with less. This can be cash value or death benefit or a combination of the two.

Typical Loan Structure

Most banks have a minimum loan amount. Pacific Western Bank’s minimum loan is $250,000 in annual premiums. A typical loan is five to ten years. Most lenders will renew at the end of the term. If not, the obvious ten year choice is better. The premium finance industry is primarily comprised of banks and other short term lenders. They make their lending decision based on the cash value of the life insurance policy and the credit worthiness of the buyer. To the extent the cash value of the life insurance policy is less that the premium, the client must post collateral for the difference. The main reason that prospective premium finance cases don’t close is because of the lack of collateral.

The type of collateral required for a premium finance transaction will have the same features as insurance cash value: AA counterparty, known guaranteed value, both short and long term, very liquid, and almost cash like. This narrows the selection to cash and or near cash assets like heavily discounted marketable securities. A common question is can a client post real-estate. Unfortunately the answer is no because of the liquidity issues. The other main feature of life insurance, the death benefit is of minor interest to the lender.

In lieu of collateral the buyer may pay part of the premium themselves. Depending on the policy ownership this may be a way to manage the loan amount and make it easier to pay off the loan later.

Premium Finance Risks

The two main risks to any premium finance loan are collateral and interest rates. The concept of borrowing to over fund a policy to juice the returns also exposes the buyer to potential collateral calls should the policy not perform. When considering a premium finance transaction prospective borrowers need to evaluate the best and worst case scenarios. Compare a reasonable projected policy performance with the minimum performance to bracket the risks. This will give the buyer a perspective on what is at stake.

The other risk as with any loan is interest cost. Unlike the last thirty years, interest rates are expected to increase in the future. Stressing the loan rate during evaluation is a sound practice.

Managing the Risk

Working with a professional agent, corporate trustee. or adviser with premium finance experience is the best way to evaluate a premium finance transaction. There are many ways to build flexibility into the loan that are beyond the scope of this brief. Some of these include the use of loan features such as caps, collars, fixed rates vs. variable rates, interest capitalization, equity vs 100% financing, etc.

On the asset side of the equation the insurance companies offer many options that can enhance a premium finance transactions. These include single vs multiple life policies, cash enhancement riders, investment options, minimum guarantees, flexible premiums, and crediting enhancements.

Conclusion

Premium financing can be a way to pay for insurance premiums. The leverage afforded allows a buyer to purchase more sooner. Premium finance is not without risk. Understanding the risks is important. Premium finance is not a reason to buy insurance; it is only a methodology. If a buyer cannot budget sufficient resources for the acquisition of insurance without financing they won’t be able to do so with financing either.

Thomas Yaeger, Managing Director | Premium Finance Group
Pacific Western Bank | pacwest.com

A veteran of the premium finance business, Tom Yaeger joined the Bank as Director of the Premium Finance group, where he is building upon the national reach and strengths of Pacific Western Bank to provide funding alternatives for insurance asset initiatives.

Prior to joining Pacific Western Bank, Mr. Yaeger was a life agent specializing in funding alternatives for corporate and high net worth clients. Mr. Yaeger was with AIG’s premium financing businesses for 23 years, including head of the Life Financing business. During his career he started and led numerous lending initiatives for AIG and, most recently, lead AIG’s initiative with marketing and distribution affiliate for premium financing.

Prior to AIG, Mr. Yaeger was a commercial lender with First City National Bank of Houston.