Say you have a wealthy client who is looking for ways to fund a high-value insurance policy. They have the money, but they're staring at a volatile market in which they've already lost plenty in the financial and real estate markets. The client's goal: to remain liquid while increasing their portfolio with safer, more stable investments. And they're looking to you, their life insurance agent, to make that happen.
Enter premium financing. The misunderstood, oft-maligned financial tool is one way that prospective policyholders can obtain high levels of insurance coverage without draining their financial reserves to pay for the first year's premium. Policyholders borrow the premium money and pay it back in installments, either in the first year or over the life of the policy.
For those looking to avoid asset liquidation, premium financing promises to be a useful tool. But the option must be used responsibly, according to Andre Blaze, director of marketing and training at Succession Capital Alliance, a leading premium finance firm in Newport Beach, CA. While Blaze's company does profit from premium financing for life insurance, the focus, he said, is on responsible use of the funding option.
For Blaze, the problem too often is an eager agent hoping to sell a high-net-worth policy.
"This is something I've been battling for the last five years," he said. "If a client starts working with an insurance agent, the first thing the agent will do is suggest premium financing before recognizing his job as an insurance agent to uncover the need. If the client is capable of paying the premium and you come in with a cheaper way, that's a problem later on [such as when the interest rate on the loan outpaces the premium]. Everyone will look for exit strategies because it was sold incorrectly."
Perhaps that's why the life insurance agent population has not jumped into premium financing with both feet. It's complex -- loans of this nature have their own set of tax implications and loan rules far apart from most traditional loan types. Since the concept's application in the mid-1990s, experts like Blaze have done their part in educating agents and keeping the excitement in check.
For the right reasons
Is premium financing viable? Experts say yes -- under the right circumstances.
"It's not sensitive to today's economy," says Blaze. "If you have money invested, you're getting a future value to that. The only thing the client is doing right now is repositioning it, but they're recognizing that that dollar will grow."
It's also viable if all possible scenarios are considered thoroughly. Steven Weisbart, vice president and chief economist for the Insurance Information Institute in Washington, D.C., said he believes that traditional insurance assumptions often fall short of explaining the potential gains and losses of any insurance policy, whether it's funded or not.
As for premium financing, there's inherently nothing wrong with it -- as long as the policy applicant and the agent both understand what they're getting into and how the process would work in an adverse environment.
"There's nothing wrong with its use by people acting in an informed way that's tailored to their own risk preferences and circumstances," Weisbart said.
The problem, he said, comes when premium financing is applied on a broad basis; he said he believes that life insurance funding creates the impression that coverage is cheaper. Blaze agreed.
"Traditional premium financing is not as sexy as 'free.' It is important to recognize that how it is illustrated may not be the way it will perform," Blaze said. "Any deviation may represent a liability to the client and the producer if not illustrated and sold using realistic assumptions."
Premium financing applied
When it comes to the popularity of premium financing, all signs point to due caution on the part of the industry. It's difficult to find agents who are regularly using premium financing, particularly because the funding is targeted to such a specific audience -- those with a high net worth and life insurance policies with benefits in the millions. Those using premium financing are doing so in situations of estate planning, buy-sell arrangements, or even key man coverage for businesses.
C.J. Bowker, an independent insurance specialist in Boston, has used premium financing just three times in his career -- and he said that it was only in those three cases that he's found premium financing to be a fit.
"It's just a niche strategy. It's not going to fit the average person by any means," Bowker said. "The majority of what it fits is large estates, highly appreciated assets, businesses, or someone who's done a lot of real estate investing."
As a matter of illustration, Bowker detailed one premium financing deal: an estate planning situation in which the older policy -- a universal life policy -- was underperforming. Because the policy was sizable, Bowker and his team determined that the policy needed to be saved. They considered the premium financing approach because the estate owners wanted to maintain liquidity in a tough market.
There was property involved, as well as a family business -- illiquid assets. In the end, said Bowker, the numbers worked out and the financing ended up benefiting the clients and allowed them to obtain more insurance coverage.
Market influences
Despite premium financing's potential application, its use has been affected by outside influences. In recent years, lending has become tight, and the losses experienced in the financial markets can affect the liquidity of many clients' assets. For that reason, Weisbart suggested that agents and policyholders avoid or reconsider premium financing -- because life insurers have remained solvent throughout the financial crisis, Weisbart said, they remain the best source for secure, available credit.
"The lesson of the last two years is you need whole life insurance or universal life insurance where if you want to borrow money, they can't say 'no,' " he said. "If you finance the premium, you foreclose that possibility."
No matter what, said Weisbart, agents need skepticism and collective brain power, along with a strong familiarity with the product and its tax implications.
"This is best sold in a team environment where, to some degree, the team can help educate (the client)," he said. "Premium financing is a tool -- a screwdriver, a hammer. You first have to know what the construction is."
Lori Widmer is a Philadelphia-area freelance writer and editor who specializes in insurance and risk management topics. She can be reached at lwbean@verizon.net.
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