Risks vs Rewards

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The rewards of premium financing are quite clear. By not having to pay premiums with your own cash, you are free to use that cash elsewhere. There are also great estate tax implications because instead of gifting large premiums to the trust, the trust is being loaned the premium dollars.

Not all programs are created equal. The risks of certain premium finance structures can outweigh the rewards. These certain programs are often better for the agent and carrier than they are for the client. Below are some of the risks that you should be aware of when reviewing premium financing programs.

Interest Rate Risk - If the loan interest rates increase more than projected, the clients could be required to pay more money into the program and/or provide more collateral than originally anticipated. If they don’t have sufficient funds and/or collateral to make up this shortfall, the entire loan could be called – forcing them to repay the loan before they planned to do so.

Collateral Risk - If the value of the client’s collateral falls below the level required by the lender to satisfy the loan, the client could be called upon to provide additional collateral.

Earnings Risk - If the policy’s cash surrender value does not perform as projected, the client may be required to provide more collateral than originally anticipated. If the policy’s death benefit does not, or cannot, grow sufficiently to keep pace with the outstanding loan, then the client is at risk of either not getting as much coverage as expected, after the loan is paid off, or, worse yet, getting no insurance coverage at all and having to come up with additional funds to repay the balance of the loan.

Policy Design Risk - The cost of an increasing death benefit, a feature often used in premium finance, can have an enormous effect on the policy’s premium requirements particularly in the later years. With premium financing programs, higher premiums means larger loans since a larger loan is needed to pay the policy’s higher premium. However, a larger loan means even higher death benefits are needed which in turn means higher premiums. This circular dependency can require significantly more insurance to satisfy the ultimate loan.

Lack of Guarantees - There is no guarantee the policy will keep pace with the outstanding loan balance. Since the loan is repaid from the insurance proceeds first, before the client gets their share, if the loan is larger than projected, the additional amount would be paid from the death benefit originally intended to be available for the client. Therefore, the client could be left without sufficient coverage.

Loan Underwriting Risk - Loans can be made for a fixed term of years, but cannot be made in perpetuity. Premium financing programs assume the loan continuously gets renewed at the end of each term until the client’s death or when the client can pay the balance through a liquidation event. Since each loan renewal is subject to the lender’s underwriting guidelines, the lender’s appetite for continuing to fund insurance premiums and the client’s financial situation, there is no guarantee the lender will renew the client’s loan nor that any lender will offer a new loan to continue the program.