By Michael Krasnerman
Life insurance became a commodity long before premium financing on existing policies evolved. An enormous stock of about $12 trillion of face value of an illiquid investment held by millions of people will become financeable.
Premium financing on existing policies is in the infancy stages. Life insurance advisors, estate planners, attorneys and accountants should become informed about this new option so they can educate their clients.
Seniors borrow against such assets as homes, boats, jewelry, stocks and bonds to meet their changing financial needs. The advisor might ask, “Why wouldn’t seniors borrow money to pay their premiums?” The answer is simple: They would.
A major transformation of the new premium financing business that uses the life insurance policy as the only collateral will bring growth and money-making opportunities for life insurance professionals in the next few years.
Take into account the number of policyowners whose coverage has lapsed, and you begin to understand the need for premium financing.
Daniel Gottlieb and Kent Smetters pointed out in their 2014 study of “Lapse-Based Insurance” that from 1991 to 2010, almost $24 trillion in life insurance policies had lapsed, compared with $29.7 trillion in new policies written during that same time period. In addition, 88 percent of universal life policies in force between 1991 and 2010 failed to end with death claims.
To illustrate further, a recent blog from the Life Insurance Settlement Association titled “Lapsed Life Insurance Policies An Astounding Number” found $112 billion in policy lapses and surrenders occur among policyholders who are more than 65 years old. In addition, about $57 billion in coverage – or 250,000 of those policies – could have been sold on the secondary market.
To make matters more pressing, as various business media recently reported, a number of life insurance companies are increasing the cost of insurance. This inevitably will lead to even more clients scrambling for solutions.
Let’s look at what options are available for professionals serving these clients. Assuming there is no cash value in the policy, the options that can be presented to clients are:
• Continue paying premiums. The policyowner can continue paying as is, which keeps the policy in force. Unfortunately, the cost of insurance may continue to increase, ultimately forcing them to realize a much greater loss after paying more premiums into the policy.
• Surrender the policy. The policyowner can surrender their policy, but they get nothing in return and forfeit the reason they purchased the policy in the first place. Furthermore, it also may hinder them from purchasing additional insurance.
• Selling the policy. The policyowner can sell their policy to investors. These investors value a policy based on the life expectancy of the insured. When your client sells their policy, the offer may be low, or there may be no offer at all. The reason is that they are selling the policy at a very deep discount off its face value because of intermediary fees and the rate of return investors are seeking in today’s market. This can be as high as 20 percent annually. Also, if your client is young or is relatively healthy for their age, selling their policy may not be suitable because of their long life expectancy.
• Financing premiums. The policyowner can borrow future premiums to keep the policy in force. This type of financing is different from traditional financing because its purpose is to alleviate the burden of premiums on policies that already have been in force for a number of years. The only collateral is the policy itself, and the lender does not go after the policyowner’s personal assets in the case of default. This can be a very viable option for policyowners who would like to ease the increasing financial burden of owning a life insurance policy.
Here is an example of how premium financing on in-force policies works.
The insured owned a $1.75 million term policy that was 10 years old. The insured wanted to convert it to permanent universal life, but needed only $500,000 for their estate. They could either:
A. Surrender the $1.25 million of unneeded coverage to the carrier for $0 or
B. Attempt to sell to a life settlement company the $1.25 million of coverage they do not need.
The problem is that the insured would immediately lose the premiums that were paid. Furthermore, the insured had a life expectancy of 15-18 years and no life settlement provider would buy the policy. Faced with two options that would both result in negative results, the policyowner thought he had no choice but to surrender the extra coverage.
That was until an estate planner showed the premium financing option to the policyowner. This option enabled the policyowner not only to convert $500,000 of the term to universal life but to finance it as well. The policyowner also was able to finance the premiums for 36 months on the $1.25 million term conversion.
Now the insured now has two policies - one that is theirs and another that is financed. At the end of 36 months, the insured either can repay the loan or walk away and leave the policy to the lender without any recourse. If the insured’s life expectancy changes, he will be in a position to sell and profit from the financed life policy.
By taking action, a potentially negative situation can be turned into a positive one that is a win-win for everyone.
Michael Krasnerman is the CEO of AllFinancial Group. He may be contacted at [email protected].
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