Premium financed life insurance has emerged as a viable option for policyholders, offering a way to improve policy performance and potentially save on out-of-pocket expenses. In a challenging environment of falling interest rates, many life insurance companies struggle to meet the expectations of their policyholders, leading to reduced dividend rates and impaired policy performance. This article explores the concept of premium financing, its benefits, and potential risks, providing insights for policyholders considering this option.

For decades, falling interest rates have posed challenges for life insurance companies, making it difficult for them to achieve targeted investment returns on policy blocks. As a result, dividend rates have declined significantly, impacting policy performance. Whole life policyholders, for example, have witnessed a decline in dividend rates from a peak of 11.5% in 1989 to as low as 4.25% in recent years[^1][^2]. This decline in dividends puts policyholders in a dilemma, forcing them to make tough choices:

1. Pay more to sustain their policy benefits as planned.
2. Keep paying planned premiums and reduce the death benefit.
3. Allow the policy to lapse.

In some cases, even tax-free exchanges for new policies cannot compensate for the performance shortfall[^1].

o illustrate the potential benefits of premium financing, let’s consider the case of Jane, a policyholder disappointed with the performance of her policies. Jane, 55 years old, wanted to free up more cash flow for investment opportunities and reduce her annual premium expense of $68,980. Her three policies had a combined death benefit of $10,903,000 and a cash surrender value of $1,599,000. Without any action, Jane could expect the death benefit to remain around $10,800,000 at her life expectancy plus five years[^2].

Exploring Policy Exchange Options

One option for Jane was to roll or exchange her policies into a newer product design with a lower cost structure. Since her policies had no encumbrances and were beyond the surrender penalty period, she could use the $1,599,000 cash value to fund a new policy. After considering multiple choices, a protection indexed universal life (PIUL) policy seemed to offer the best outcome. However, the resulting death benefit of $7,794,000 meant sacrificing $3.02M in coverage. Given concerns over increasing estate tax exposure, Jane decided against this option[^2].

Premium financing presents an alternative solution for policyholders seeking to improve policy performance while maintaining flexibility in their cash flow. This option allows policyholders to obtain third-party financing to pay life insurance premiums, reducing initial and ongoing cash outflows. By utilizing premium financing, policyholders can keep their capital invested in higher-yielding assets without having to liquidate those assets to cover policy costs[^2].

Advantages of Premium Financing

Premium financing offers several advantages for policyholders like Jane:

1. Improved Death Benefit: By accessing premium financing, policyholders can potentially increase their death benefit, providing greater financial protection for their beneficiaries.
2. Enhanced Cash Value: Premium financing may also contribute to the growth of the policy’s cash value, increasing its overall value over time.
3. Increased Investment Opportunities: With premium financing, policyholders can redirect their cash flow towards higher-yielding investments, taking advantage of external investment opportunities.
4. Flexibility in Cash Flow: Premium financing allows policyholders to maintain flexibility in their cash flow, ensuring that they can meet other financial obligations while keeping their life insurance policies in force.

How Premium Financing Works

In a typical premium financing scenario, a policyholder secures third-party financing to cover life insurance premiums, minimizing their initial and ongoing out-of-pocket expenses. This approach enables policyholders to leverage their outside investment opportunities, projected to yield higher returns than their life insurance policies. By redirecting their annual cash flow towards these investments, policyholders can potentially achieve better overall financial outcomes[^2].

To understand the mechanics of premium financing, let’s revisit Jane’s case study. After favorable medical underwriting, Jane opted for an IUL policy with an initial death benefit of $18,010,390. The funding for the new policy involved two components: the carried-over $1,599,000 in cash value from her existing policies and an additional $997,947 financed by a bank specializing in premium financing[^2].

Jane projected that she would be able to repay the loan and accumulated interest using the policy’s cash values within 15 to 20 years. In the event of her passing before this time, the death benefit would first be used to repay the outstanding loan, with the remaining balance going to her beneficiaries. The new policy’s death benefit was designed to increase over time, projecting a net death benefit of $22,900,000 for Jane’s beneficiaries at age 89[^2].

While premium financing offers potential benefits, it is essential for policyholders to carefully consider the risks involved before proceeding with this option. These risks generally fall into three main categories:

Lending Risks

Lending risks primarily relate to the interest rates and terms associated with the loans. Changes in loan duration or repayment terms can impact the desirability of a premium financing loan. Policyholders should assess the stability of the lending institution and evaluate the potential impact of interest rate fluctuations on their premium financing arrangement. But there are many lenders out there, so you ever had an issue with one lender, another can be found quickly.  From the banks perspective, this is secure loans which contributes to their Tier 1 assets.  These loans to fund life insurance premiums are highly desirable to the lenders and the regulators that oversee them.

Personal Risks

Personal risks are closely tied to an individual’s net worth, liquidity, and posted collateral. Factors such as a significant decrease in net worth or inadequate collateral can make it challenging to secure future premium loans or result in the lender calling in the outstanding loan. Policyholders should carefully evaluate their financial position and collateral requirements before entering into a premium financing agreement.

Policy Risks

Policy risks involve changes to the performance of the life insurance policy itself. While a policy can perform better than expected, there is also the possibility of it failing to meet expectations in terms of its crediting rate or dividend payments. Insurance companies may adjust insurance costs to meet profitability targets, requiring policyholders to pay additional premiums to maintain the policy’s intended performance[^2].

Premium financed life insurance offers an avenue for policyholders to enhance their policy performance while maintaining flexibility in their cash flow. By leveraging third-party financing, policyholders can potentially increase their death benefit, grow their policy’s cash value, and take advantage of external investment opportunities. However, it is crucial for policyholders to carefully assess the risks associated with premium financing and consider their specific financial circumstances before committing to this option. Consulting with a licensed professional can provide valuable guidance tailored to individual situations, ensuring informed decision-making[^2].

Disclaimer: The information provided in this article is for informational purposes only and should not be considered investment, tax, or financial advice. Policyholders should consult with a licensed professional to receive advice specific to their situation. Contact us to get a custom quote and illustration at 508-429-0011. No cost or obligation to see how the numbers work out.  New rules restrict overly optimistic illustrations.

References:

[^1]: Top Whole Life: Northwestern Mutual 2018 Dividend
[^2]: Top Whole Life: Whole Life Insurance Dividend Rate History