Over the past decade, a common method to fund permanent life insurance was to finance the premiums and to take advantage of the difference between the lending interest rate and the dividend or crediting rate on a policy. From a design perspective, this strategy was presented as a way to lower the costs of obtaining a large amount of life insurance while preserving cash flow. Those who kept cash deployed elsewhere or those with liquidity challenges were drawn to premium financing.
Today, many policyholders who financed the premiums to purchase their life insurance policies find themselves facing skyrocketing lending interest rates, collateral that is worth less or insufficient, and policy performance that lags due to how insurance companies invest in premiums. In effect, some of these policyholders may be “upside down” in their financing arrangements and not realize it. At C3 Financial Partners, we help advisors with clients who have entered into premium financing arrangements provide clarity as to understanding how individual plans are working, confidence that the current strategy is meeting clients’ goals, and coordination in providing and implementing options for possible improvement.
If you and/or your clients don’t understand their premium finance structure, you are not alone. During the sales process, clients were typically shown illustrations that either had stable lending interest rates and rates of policy performance or these figures varied slightly to demonstrate a level of volatility. In reality, while lending interest rates remained historically low, over the past twenty years life insurance companies have reduced policy dividend and crediting rates due to financial pressures from a falling Federal Funds interest rate. This has dramatically reduced the likelihood that a premium financing arrangement might perform as designed.
Today, the Federal Funds rate has risen from nearly 0% at the beginning of 2022 to over 4%. Lending interest rates for premium financing have shot up from around 2% to over 6% while policy dividend and crediting rates have barely budged. Rates will likely continue rising in 2023 and do not appear to be going down anytime soon. The investment portfolios backing a life insurance company’s policies traditionally lag behind general interest rate increases since so much of these portfolios were invested at lower yields and it will take a sustained period of higher yields before insurers should be able to push up the amount it can contribute to a policy’s cash value growth. These market conditions could mean that the arbitrage a client expects for their premium financing arrangement to be successful is not currently present.
A cause for additional concern with interest rate risk inherent with premium financing is the way premium loans are structured. Some clients who depend upon renewable loans annually are surprised to find how drastically lending interest rates have risen year-over-year. Other clients may have locked in a low lending interest rate for up to five years or more and have not considered what rates will be when they need to renew their loan in the years ahead. Surprise could turn to shock at seeing what it will cost to maintain a financing arrangement.
Adding insult to injury, collateral posted for a premium loan in addition to the policy’s cash value may have declined in value, not be enough considering policy performance, or both. Collateral shortfalls can be especially problematic when clients who own businesses and real estate have liquidity challenges and may find themselves in the undesirable position of having to either liquidate or pledge property.
Lending interest rates and policy dividend and crediting rates are not the only components of premium financing about which an advisor should remain diligent. There are several contractual rights a life insurance company maintains in a policy. Insurers often have the right to raise fees and insurance costs from current levels all way to the guaranteed figures stated in the policy. For example, with index universal life (IUL) policies, the carrier can raise and lower yield ceilings on the cash value index options and this can sometimes limit a policy’s performance even when the index account does very well.
The planning team at C3 Financial Partners knows how all the parts of a premium financing transactions work – the loan, the policy, and the insurance company – and can provide clarity to advisors and their clients about their existing arrangements.
At the heart of any premium financing arrangement is the need for life insurance. Life insurance could be a part of a family’s wealth transfer plan or used to provide continuity among the owners of a business. Recognizing that the purchase of life insurance was the priority and the decision regarding how to pay for the policy was secondary is important in having confidence that the premium financing arrangement is meeting your client’s planning goals and objectives. Separating the two parts for individual analysis could be of tremendous help.
If the life insurance need still exists and having life insurance fits the planning for your client, a C3 Financial Partners Policy Review Process can assess the suitability and performance of the life insurance policy. It may be that making minor changes to the policy improves both the policy’s performance as well as the performance of the overall premium financing plan.
It could be that the policy is performing either as expected or close enough that, by itself, still works for your client. This leaves the financing aspect to be analyzed. In addition to studying the impact of current and expected lending interest rates, the amount, nature, and position of any collateral should be reviewed. A demand for additional collateral or the risk of having collateral seized certainly is not ideal and taking steps as soon as possible to assess these risks and take action to prevent them is critical.
By reviewing the financial strength of the insurance company, the competitiveness of the policy, and the financing arrangement, C3 Financial Partners can give you confidence that your client’s goals and objectives are being met and, if not, what options are available.
In the current environment, advisors are finding some of their clients unhappy with the decision to finance life insurance policy premiums. Other clients may be unaware that a problem exists or could be on the horizon. C3 Financial Partners can help by coordinating industry-leading resources to review both the life insurance policy and the premium financing arrangement. Then, our team can provide options to consider which may improve conditions. Our advisor community can depend upon us to be with them at every step in implementing any changes.
At C3 Financial Partners, we look forward to helping our clients and their advisors gain clarity in their goals and objectives, confidence that they are making the right decisions, and coordination with other advisors.