Lately, people have asked for our opinion on life insurance premium financing (hereinafter premium financing) as part of an estate plan for foreigners with assets in the United States. Our immediate, safe, and conservative response has always been, “It depends on the particular circumstances of each case, given that premium financing is not for everyone.”
This strategy of purchasing life insurance was created by the insurance companies themselves to sell major coverages to be used as a source for the payment of estate taxes, given that the value of properties and businesses around the world has been trending upward by leaps and bounds, and hence taxes as well. Likewise, the owners of these properties and businesses have a high life expectancy that keeps getting higher due to their access to modern medicine, healthy diets, and other contributing factors. In general, our clients are living longer and their properties and businesses are worth more each passing day, so they either have to pay more taxes or replace the assets that those taxes consume.
However, when we refer to selling or buying major insurance coverages, it is necessary to precisely identify the amounts we are referring to. The minimum amounts that most of the insurance companies believe is necessary to issue a financed policy are varied, but the consensus within the industry puts those minimum amounts at $100,000 of the annual premium or $10 million of coverage. Of course, there are exceptions to the general consensus which are based primarily on the age and the medical health of the insured. Nevertheless, our personal opinion is that premium financing is not a recommended strategy for coverages below $25-$30 million or for annual premiums below $250,000 to $500,000. Especially, because this type of strategy or program is designed for high coverages whose owners have the vast majority of their investments in illiquid form, but if necessary, they have the ease to liquidate as much of them as necessary to safeguard the insurance program. Otherwise, in addition to the inherent risks of the strategy, the personal financial situation of the client has to be accounted for in detail. His liquidity, the particularities of his business, and his lifestyle would have to be considered, as well as how they would impact the funds and the collateral used to guarantee the financing.
In order for the insurance companies to be able to offer these types of strategies or programs, it is necessary that they associate with banking institutions that have the disposition and experience of working with foreign clients and the capability of financing annual premiums because these operations necessarily imply a commercial transaction and a profit for the crediting bank, as well as an additional expense to the cost of the policy for the client. In addition to having disposition, it is necessary that the repayment of the loan be guaranteed with assets located in the United States. Occasionally, these guarantees are only partial to the amount of the loan, and on other occasions, for the original amount of the loan plus interest. Nevertheless, the most frequent problem for the client is not having enough guarantees in the United States.
Of utmost importance, and where the majority of the risk resides in these types of strategies, is the real and actual performance of the policy, which necessarily has to be over and above the interest of the financing and the cost of insurance so that at the maturity of the loan, the policy has accumulated enough cash-value to pay it off and allow the insurance policy to subsist without the need of additional premiums until the death of the insured, and the sought-out objective is achieved. Otherwise, the owner of the policy would either have to continue making annual premium payments or surrender and terminate the policy. Hence, the loan terms and conditions are of great importance because many banks require annual payments during the life of the loan—generally from 12 to 14 years—and very few, if any, allow the interest to accumulate and make one balloon payment at its maturity. Therefore, if the performance of the policy is not excellent or is weak, and the bank also requires annual principal and interest payments, the probabilities of success shall not be very good. Most client dissatisfaction comes when variable policies—badly referred to as investment policies—do not perform according to the projected, illustrated, or promised rates are used.
The above shines a light on the importance of evaluating the type of policy to be used and comparing it to other policies and financing programs from other companies, because not all insurance companies have the same financial stability, and not all policies are created equally. As a result, the decision will be a delicate game of financial juggling upon which premium financing will depend. In most circumstances, the insurance companies use Equity-Indexed Universal Life policies which are a hybrid of policies that pay a variable earning subject to the highs and lows of the stock market and a participation rate but with a minimum cap of 0% to 1%, depending on the policy, to avoid losses when the stock market indexes go down or lose value.