By: Robert C. Intelisano CLU, CSA, LUTCF
How does it work?
Those who don’t understand the true benefits of life insurance premium financing worry this is a tool dependent on interest rates or policy performance. But even when interest rates have been high and markets have been shaky, financially savvy brokers have been closing deals by funding life insurance premiums.
Why? Because in order for high-net-worth individuals to continue to grow and protect their wealth, they need to take advantage of leverage and actively look for investment opportunities that yield returns greater than the cost of capital. In other words, many need life insurance to address inheritance, business and tax issues, but they’d prefer to keep the funds they would spend on life insurance premiums in investments that yield more profitable returns.
The economy, although sluggish, is moving again, and with rates hovering at all-time lows, premium financing life insurance makes more sense than ever.
The reason? Retained capital.
In this instance, retained capital is the amount of money a client can hold on to — and ultimately invest elsewhere — by paying interest on a loan that covers the cost of a premium versus paying the premium itself. Many high-net-worth clients report that they earn 10 percent to 15 percent or more on their money. If that’s the case, why take funds out of profitable investments in order to pay a premium?
But let’s be clear. Premium finance is not a gimmick. It is not free insurance. It never was and never will be. It is not a play on the potential arbitrage between policy crediting rates and interest rates. Your client will have to pay interest to a lender and will have to post collateral equal to the difference between the cash surrender value of the policy and the loan balance. It is simply a tool to help your client reduce the initial out-of-pocket expenses relating to the purchase of a life insurance policy and a way to keep their money working for them in their investments of choice.
To finance or not to finance?
To better understand what an asset premium financing can be, we have to look at the potential profit our clients would lose out on if they don’t use it. In other words, the lost opportunity cost. So, let’s take a look at the numbers and consider the lost opportunity cost of paying a $100,000 premium out of pocket.
If an individual truly earns 10 percent on the funds he would use for a premium payment, then he would lose the opportunity to grow his net worth by $10,000 if he were to pay the premium himself. Utilizing the benefits of premium financing, if the client finances the $100,000 premium at 5 percent interest, his out-of-pocket cost in year one is $5,000, and his retained capital is $95,000. That client could re-invest the $95,000 in a vehicle that returns 10 percent and end the year with $104,500 and a life insurance policy to protect those assets. Over time, this growth compounds. This is the power of premium finance!