Premium Financed Life Insurance – Trying to Fix The Derailed Train
AgencyONE is often approached by advisors who want to discuss premium financing. The conversations usually fall into two separate categories – the financing transaction has not yet happened OR it is already in place. When the transaction has not yet happened, this is an “easy” conversation. These advisors typically want to present financing options to their client OR their client has approached them with a financing transaction that was presented by a competitor that seems “too good to be true” and they would like AgencyONE to review the proposal. When the financing is already in place and AgencyONE is approached, typically there are issues for the client and/or the advisor! The client is unhappy, the advisor is “concerned”, and/or the advisor is trying to “fix” a problem for a potential client or a valued referral source. But what could have gone wrong? Well – a LOT!
On September 11, 2020, I wrote Premium Financing Life Insurance – What Can Go Wrong? At that time, the US Prime Rate was 3.25% and the one-year LIBOR rate was just south of .40%. The S&P Index had returned 28.88% in 2019 and ended up delivering 16.26% by the end of 2020 and another 26.89% in 2021.
It is no surprise that the Premium Finance market was booming during that time. Cheap money was available, and the equity markets were on a tear. Index Universal Life, the product of choice for many promoters of financing premiums, dominated life insurance product sales in 2019 with a record year at $2.3BB in premium, up 14.6% from the prior year, according to Wink Intel. I would venture to guess that premium financing helped fuel some of that growth.
Premium Finance loans in 2020 were being extended to clients, typically, at one year LIBOR plus a spread of around 150-200 basis points. Insurance buyers looking to finance premiums could borrow premiums at 1.9% to 2.4% and leave their money in the bull market, furthering their gains by paying a low-interest rate on borrowed funds that would benefit from gains in an IUL Index, creating positive arbitrage. Not a bad plan, but as I said in my previous article – what could go wrong?
Fast forward to today and last year: the S&P 500 was down over 19% in 2022, the prime rate is now at 8.5%, and one-year LIBOR which no longer exists, was at around 5.85% as last reported in June of 2023. People who had entered premium finance arrangements got hit with a few things at once:
- Many of the maturing index segments (options) in their IUL policies earned ZERO return, due to negative market index returns in the indices they were tied to. While they did not have negative returns in the index segment itself, because of the way IUL works, many did, in fact, see their cash value decline because of contract expenses (cost of insurance, administrative expenses, loads, etc.) and because they had selected index options that promised higher returns but had an additional charge for performance enhancements which was deducted from the cash value, even with a ZERO return.
- Because in a premium financing arrangement, the cash value of the policy is used as partial collateral, with the balance of the collateral being posted by the owner of the policy in cash or other marketable securities (money markets or other short-term securities), declines in policy values because of #1 above created collateral calls by the lending institution. Many policy owners had to produce more cash or securities to shore up their collateral position.
- Finally, as loans were renewed, the interest expense to the customers almost tripled from 1.9%-2.4% to over 7%. Imagine entering a $1,000,000 loan at the end of 2020 which required $20,000 (or thereabout) in interest payments, increasing to over $70,000 in 2023, assuming no further premiums were borrowed. Most premium finance transactions are multiple loans for premiums over multiple years, adding to the loan balance due to the financing institution.
I am not, for one second, suggesting that premium finance arrangements will not work or should be terminated, but at a minimum, they should be reviewed periodically to make sure that the long-term objectives of the policy owner, be it a business, an individual or a trust, are still being met. A few years of negative star alignment should not impact the long-term nature of some of the planning that was accomplished through the creation of trusts, the purchase of insurance and the financing of the premiums. However, some policy owners are no longer able to continue these transactions or choose to not continue them.
The market is replete with problematic premium financing transactions. AgencyONE is frequently called upon by advisors to discuss cases where collateral calls, well into the six and seven figures, were/are required. Most recently, we reviewed a transaction where the insured\policy owner, who had been paying around $20,000 per month in interest expense, saw that number more than double to over $50,000 per month. These sorts of situations require review.
If you have a client who has called you to discuss a life insurance premium financing transaction that is no longer financially attractive or feasible for the insured/owner to keep in place, or if you are concerned about your client’s life insurance portfolio, there may be a solution. But the time to act is NOW because the current financial climate does not appear to be getting any more favorable for individuals who are looking to finance life insurance premiums with OPM.
Planning strategies can be implemented to alleviate the burden of these transactions while still meeting some of the long-term planning objectives of the original transaction structure, and AgencyONE can help.
Our knowledge, experience, and analytics capabilities, in addition to our advanced planning expertise, can provide a multitude of solutions to your clients. When life insurance premium financing transactions are already in place, these services are provided on a fee-for-service consultative basis.
Please call the AgencyONE Marketing Department at 301.803.7500 for
more information or to discuss a case.