Life Settlements and Premium Financing

What You Need to Know

Premium financing can maximize life policy performance in some situations.
But not, for many clients, in this environment.
One way out may be to sell the cash-value policy at the heart of the arrangement.

Life insurance premium financing involves using leverage or taking out a loan to pay premiums on a life insurance policy.

Like other loans such as those for a building, home, or car, the bank charges interest and the borrower(s) pay interest payments or installment payments to the bank.

Individuals will purchase, for example, a $10 million policy but don’t want to liquidate assets to be able to pay for the policy’s premiums, so they turn to a lender and finance the premiums.

Premium-Financed Life Insurance

There are a few reasons why individuals may want to finance premiums.

First, doing so may improve a policy’s performance by reducing or eliminating the policyholder’s annual out-of-pocket expense.

Premium financing can also increase the death benefit and/or cash value of the policy.

And sometimes it accomplishes all of the above.

It’s also a smart strategy for high-net-worth individuals looking to avoid costly tax implications for themselves or their policy beneficiaries.

It is, essentially, a creative way for these clients to minimize gift and estate taxes.

This is a popular strategy also because permanent cash value life insurance can have rapid tax-free growth within the policy and can even eventually pay off the premium finance loan, thus creating a large paid-up life insurance policy with millions in available funds inside the policy.

Premium-financed life insurance relies on the arbitrage between low borrowing rates and increased cash accumulation value within the policy.

Interest Rate Hikes

Like with any investment, there is risk.

Many financial advisors who wrote premium-financed policies — and the clients who bought such policies — are now being hit hard with interest rate hikes on their financed premiums.

Who could have ever predicted that there would be eight or more interest rate increases in a one-year time frame?

Most premium-financed loans are set at variable yearly rates because that allows for the lowest rate available, meaning many borrowers who have used this strategy are already paying much more in interest payments due to these rate hikes.

In addition, collateral requirements are increasing for these borrowers.

This along with a volatile stock market counteracts the arbitrage strategy of premium-financed life insurance policies.

The result?

Many premium-financed life insurance borrowers — unable to afford exorbitant premiums — are looking for an exit strategy.

A life settlement can be the solution.

Life Settlement Premium Finance Rescue

A life settlement is defined as the sale of an existing life insurance policy for more than its cash surrender value, but less than its net death benefit.

A life insurance policy is an owned financial asset and therefore can be sold to a licensed buyer, also known as a life settlement provider.

For millions of Americans who own a life insurance policy, letting it “lapse,” or surrendering the policy back to the life insurance carrier, means losing most or all of your investment in that asset.

Imagine paying into an asset for several years, only to be left with nothing of value when your policy lapses or is no longer worth keeping.

It sounds crazy, but it happens.

In fact, approximately 4.2% of all life insurance policies lapse each year, representing about 5.2% of the face value actually insured. Putting that into dollars for the senior population, some $200 billion in life insurance will lapse or be surrendered each year for those over 65.

A life settlement can be a much better option for policy owners.

While it’s possible you may have never heard of a life settlement, it is indeed a viable solution more and more policyholders are becoming aware of — and embracing.

In fact, given the favorable nature of the drivers of life settlement market growth, the average annual volume of new life settlements from 2022 to 2031 is projected to reach $5.2 billion.

While a life settlement can be a great option as an exit strategy for premium-financed life insurance, there are a few eligibility requirements to be aware of, the most important of which are:

Age and health: In general, to qualify for a life settlement, the policyholder should be 65 or older, though younger individuals may still qualify if there are significant health impairments affecting the insured(s).

Type of policy: The majority of life insurance policies sold are universal or term policies, though others may still qualify.

Premiums: The amount of premium payments required to keep the policy in force will play a role as to whether the policy can be sold or not.

Death benefit: Also known as the face value, policies with a death benefit of more than $100,000 are usually more likely to sell.

Premium-financed policies are commonly much larger.

Opting for a life settlement can greatly help senior policy owners during rising interest rates and record inflation, like now.

Life settlement providers can pay off the premium finance loans for the life insurance policyholder, who may even profit from this transaction.

Here is an example of a life settlement premium finance rescue:

An 85-year-old had a premium finance loan on a $12 million life policy for the past 11 years.
The cash surrender value in the policy was $6.1 million.
The premium finance loan was up to $7.7 million.
The interest payment increased from $194,000 last year to $522,000 this year after several interest rate hikes and an additional premium added to the loan caused an excessive increase.
The policy owner had $1.6 million in collateral at risk, which would be taken by the lender at surrender.
The life settlement option provided $7.8 million for the seller, which allowed the seller to retain their $1.6 million collateral and pay off the premium finance loan with some additional funds to spare.

Opting for a life settlement can reduce or even remove the collateral call that is being taken in a foreclosure on the loan — essentially saving the day for such policyholders and giving financial advisors another viable regulated and legal financial option for their clients.

Premium financing is a complex transaction, as can be life settlements.

That’s why it is so important to rely on a life settlement provider that has experience not only with life settlements, but also with the premium finance structure and the lenders in the industry.

Shane McGonnell is executive vice president of Abacus Life.

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