Premium Financing

Premium financing is used primarily by high-net-worth individuals who want significant life insurance coverage but prefer not to liquidate assets or reduce investment positions to pay large annual premiums. By borrowing the premium from a specialty lender — often a bank or premium finance company — the policyholder keeps their capital deployed in other investments while the insurance policy is put in force.

The strategy hinges on the spread between the cost of borrowing and the rate at which the policy's cash value grows. If the policy is an Indexed Universal Life or whole life product crediting a rate higher than the loan interest rate, the net carry cost of the arrangement is positive for the policyholder. If borrowing costs rise or policy crediting rates decline, the spread compresses or reverses, which can require the policyholder to inject additional collateral or repay part of the loan.

Lenders typically require the policy's cash value to serve as the primary collateral. In many arrangements, the borrower also pledges additional assets — investment portfolios, real estate — as supplemental collateral to bridge the gap in the early years when cash value has not yet grown to equal the outstanding loan balance.

Premium financing is a sophisticated strategy with meaningful risks. Rising interest rates can make the loan more expensive than anticipated. Policy performance below illustrated rates can leave the policyholder exposed to collateral calls. Misrepresentations by insurance marketers about the certainty of policy performance have generated regulatory scrutiny and litigation in several states.

High-net-worth individuals considering premium financing should work with independent legal and tax counsel, thoroughly stress-test the cash flow projections at adverse interest rate and crediting rate scenarios, and understand their personal liability if the arrangement requires additional collateral or repayment.