Premium Financed Life Insurance
Even sophisticated individuals who are familiar with leveraged transactions need to be cautious about borrowing to pay life insurance premiums. Because the premium financing may last for a long period of time (for example, until the insured dies) the lender will want to renegotiate the terms of the loan periodically. Interest rates and collateral requirements can change dramatically over an extended period of time.
Premium financed life insurance can provide advantages in specific situations. However, there are important downside risks that must be understood by any one considering a premium financing transaction. These risks include but are not limited to:
-- Rising interest rates make borrowing more expensive.
-- Even a small increase in the interest rate charged on renewed premium financing can substantially reduce the anticipated net benefit.
-- The lender will require collateral to cover any shortfall between the amount of the outstanding loan principal and the policy cash value.
-- The interest paid to finance premiums is not deductible.
-- The lender has the ability to increase interest rates in the future as cumulative short term loans are rolled over.
-- There is no guarantee that the lender will renew the loan as each short term financing period expires.
-- If the lender decides not to make future loans as each short term period expires, the policy may lapse.
-- The longer the insured lives, the greater the amount of cumulative loan principal and interest. This will reduce and even possibly eliminate any remaining net death benefit for the beneficiaries.
-- Leverage can be "good" or "bad". If the life insurance policy does not perform as originally projected or interest rates rise over time, the ultimate result may be unfavorable.
-- It is possible that the net death benefit could end up being less than the accrued loan. If this happens, the beneficiaries will not receive any of the death benefit from the policy.
-- The loan must be repaid. This repayment will come from the policy death benefit or out of pocket by the borrower from the personal collateral placed at risk.
-- If the client's income or net worth declines, the lender may not to extend the loan. Or the lender may decide it needs more collateral as a condition of extending the loan.