Premium Financing Rescue Strategies

Premium Financing is a leveraging technique primarily used by high-net-worth individuals needing substantial life insurance coverage but would like to acquire coverage without giving up the current use of assets invested in their business or portfolio. While effective in the right circumstances, it is crucial for clients to understand all the variables involved and how potential changes can affect these arrangements.

A clear plan for loan repayment is essential when entering into a premium finance agreement. While there is a possibility that death may occur before the planned repayment, it should not be the intended exit strategy. If an exit strategy is poorly planned, it may become necessary to implement a premium finance rescue strategy.

Private Financing: The policy owner can utilize a new fair market loan to pay off existing bank loans. The lender may be the client, a family member, or an associated entity, such as a business or family limited partnership (FLP). The new loan can be provided as a lump sum to settle the existing loan, followed by scheduled installments to cover ongoing premiums. The annual loan interest is determined by the current Applicable Federal Rate (AFR). This loan may be structured to allow interest payments at regular intervals or to defer interest, adding it to the loan balance. When annual loans are made to the trust for premium payments, each loan will carry a different interest rate. In suitable situations, the lender might consider gifting the loan interest by utilizing annual gift tax exclusions to forgive that interest. The higher lifetime exemption from gift tax could also help eliminate or reduce the loan balance. Upon the client's death, the loan balance and any accrued interest can be settled from the insurance policy proceeds. If the client acts as the lender, heirs will receive both the life insurance policy and the repaid loan balance. However, it is important to note that the loan repayment will be included in the estate and may be subject to estate tax.

Life Settlement: Exploring the concept of third-party sales of life insurance policies can reveal valuable insights. In this scenario, a life insurance policy is sold for an amount greater than its cash surrender value but less than its net death benefit. A life settlement company evaluates the policy and brings it to market for investors to bid on. Upon sale, the policyholder and beneficiary are transferred to the investor in exchange for the offered amount. The investor then assumes responsibility for paying the premiums throughout the policy's duration and ultimately collects the death benefit. The proceeds from this sale can be utilized to pay off any existing loan balance. If the loan amount exceeds the proceeds, the difference must be covered out of pocket. When considering a life settlement, it's essential to be aware of the eligibility requirements, which include age (65 or older with significant health impairments), type of policy, minimum required premium, and death benefit amount. It's important to note that a policy sold through a life settlement will still count towards the total line of insurance available for future needs. Additionally, any gains from a life settlement will trigger a taxable event, and the insured must grant ongoing access to their medical records.

Policy Loan: Withdrawing cash value to cost basis and then borrowing against the policy as a policy loan can be a strategic financial move. This policy loan will accrue interest at the loan rate within the policy, which is often significantly lower than the lender's loan rate. By using the funds that were previously allocated to the lender, you can repay the policy loan and rebuild cash value. This approach has the advantage of freeing the policy from a lender, eliminating collateralization, and avoiding refinancing risks associated with fluctuating interest rates. It's important to note that this strategy depends on the policy's performance and the availability of cash value within the policy. Requesting an inforce illustration is crucial to assess the potential impact of this approach. When utilizing policy cash values to repay the loan, ensure that you only borrow to the extent that the net cash value is sufficient to maintain the policy until maturity. If the available cash value falls short of covering the lender's loan, the difference can be addressed out of pocket.

1035 Exchange: IRS code 1035 enables tax-free exchanges of specific insurance products. When evaluating an existing life insurance policy against a new one, the performance is assessed to determine potential benefits for the client. If the new policy is deemed acceptable, an application is submitted. Upon approval, insurance carriers collaborate to transfer the surrender cash value from the existing coverage to the new policy. The primary objective of the new policy is to establish better parameters tailored to the client’s needs. It's important to note that new underwriting must be completed, and the insured must medically qualify for the new policy before exchanging their old one. Additionally, new surrender and contestability periods commence with the new policy. If a collateral assignment is being carried over, it must be released from the old policy and re-established on the new one, requiring the lender's agreement for the exchange.

Mirrored Loans: When repaying a loan through a policy loan, any applicable out-of-pocket costs must also be considered. Following this, a 1035 exchange to a new policy can be executed. In this scenario, the surrender cash value along with the policy loan will be transferred to the new policy. The new policy will be structured with a loan that mirrors the policy loan from the previous policy. Interest on the policy loan will accrue at the specified loan rate within the policy and can be paid annually alongside the policy premium or deferred to accumulate. It's important to note that any outstanding loan balance or accrued interest will reduce the death benefit. Both the ceding carrier must consent to the transfer of the loan, and the accepting carrier must agree to receive the loan and apply it to the new policy. There may be restrictions on the amount of the transferable loan, so it's crucial to consult with both insurance carriers before initiating this process. Due to a significant loan, the new policy may result in a lower death benefit compared to the old policy. Therefore, considering an additional new policy might be necessary to bridge any coverage gaps. The previously discussed 1035 exchange considerations should also be thoroughly evaluated.

We welcome any questions or opportunities to assist you or your clients in achieving identified goals. We take pride in serving a select number of families, businesses, and charitable institutions each year, and we look forward to hearing from you.