The Hidden Risks of Premium Financed Life Insurance

Speaker 1 – 00:00
Premium finance, what is it? When does it make sense? When does it not make sense?
Speaker 2 – 00:04
We’ve kind of been around the industry a good bit and we’ve seen majority of advisors and insurance agents can’t
even explain how these work.
Speaker 1 – 00:11
We think this is one of the worst financial decisions you could ever make.
Speaker 2 – 00:15
On paper in theory yes, that could work. But there’s all of these just like hidden risks involved with this that we’re
going to unpack.
Speaker 1 – 00:22
The insurance company doesn’t care if you’re personally paying the money or a bank’s paying the money. The
agent isn’t to get a huge commission because the person recommending this should not be allowed to practice as
a financial advisor, let alone an insurance agent because this could harm the client. If you look at the fine print of
the policy, nothing’s guaranteed. The insurance company has control of what mortality and expense charges they
pay. Those aren’t disclosed.
Speaker 2 – 00:45
I have five tips if you are going to consider this, how to do this correctly.
Speaker 1 – 00:52
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There are certain financial strategies that are often pitched to high net worth clients that are positioned as
absolute no brainers. Premium Finance Life Insurance using Index Universal Life is pitched high net worth clients
all the time as a no downside, huge upside. We’re here to debunk this. We think this is one of the worst financial
decisions you could ever make. And these are, you know, relatively new and just based upon the math alone. We’ll
show you in today’s episode why you should avoid this at all cost. If you’re in one, you know, options to get out of it.
So Jameson, let’s get right after it. So give us an overview. You know there’s, I guess there’s two conversations
here. So I don’t think either strategy by itself is evil. Premium Finance, you know, on a high level can make sense for
certain people.
Speaker 1 – 01:44
So first let’s talk about what it is, when it makes sense, when it makes zero sense. And then let’s talk about Index
Universal Life. Index Universal Life is not evil by itself. Heavily sold, you know, zero down, you participate in SP 500.
But I’m gonna talk about that. If you underlook the hood of these things, you know why? You know even a boring
traditional whole life policy will, with the right company will crush these things over the long term. But you could
still do an IUL that works as long as you assume around a five to five and a half percent return assumption. But
combining that with the premium finance is just literally you have all these levers. One goes wrong and the thing
implodes. So let’s first break it down. Premium finance. What is it? When does it make sense?
Speaker 1 – 02:31
When does it not make sense?
Speaker 2 – 02:33
Yeah, these are like, so if were to publish like a, you know, the IRS publishes the dirty dozen list. If were to have our
own like, you know, dirty dozen financial tools, this would probably be on the list. Is just like premium financing.
And again there’s good premium financing. Yeah, yeah, it’s oversold but high level. Essentially what it is you’re
going to take a loan and there’s a difference between premium financing and private financing. You take a loan
from a bank, so bank structures a note and you use that loan to pay premiums on insurance. And so it’s generally
pitched and these loans are interest only loans. So like example, you could pay a premium for 500,000. You know,
the premium to the insurance could be $500,000 a year that the bank’s going to pay.
Speaker 2 – 03:21
And, and then you are just paying the interest on that note along the way. So like you said, there’s a lot of variables
and levers that we can talk about, but just structurally, number one, you have to have assets to back that loan. So a
lot of times it’s pitched as, here’s this vehicle to get insurance that doesn’t cost you anything out of pocket or cost
you just the interest which could be 20 or $30,000 a year out of pocket. So number one, you have to have, it’s just a
traditional loan. You have to have assets to back it. There’s be something as collateral. They’re just going to write
you a loan based on this policy. And it can make sense if you have to have a good exit strategy to pay that loan off.
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Speaker 2 – 04:05
So what I mean by that is it’ll be illustrated and pitched a lot as you could do nothing and never pay it back. And
then when you die, that death benefit pays off what’s left in the note and then your family gets the difference. So
like on paper, in theory, yes, that could work. But there’s all of these just like hidden risks involved with this that
we’re going to unpack. And I would say let’s talk about who this is pitched to and then who it is for and who it’s not
for. It’s generally pitched to people that they want insurance, but they, it’s usually a lot of business owners, they
don’t want to take the cash and park it into insurance. They want to take that cash and put it somewhere else.
That’s Going to get a higher return. Their business.
Speaker 2 – 04:53
Yeah, if the business is producing, you know, 20% return per year, they’re like, well, why would I take this $500,000
and put it into insurance? Well, let’s take it from the bank and do that. Redeploy the cash elsewhere. The only way
this makes sense, in my opinion, is if you’re. If you have, like, no liquidity event is guaranteed, but if you have some
sort of liquidity event that you can use to pay that note off, because it gets illustrated. Number one, like I said, the
death benefit pays it off. Or number two, you take some of the cash value out and then pay that loan off, and then
the rest gets used to keep growing the policy.
Speaker 1 – 05:27
You know, these are really pitched heavily because insurance agents will earn a commission, generally between 50
to 100% of the. Of the payment going on the life insurance policy. So the insurance company doesn’t care if you’re
personally paying the money or a bank’s paying the money. The agent is going to get a huge commission
regardless. So we have an example right here of the client getting pitch. It’s basically pitching, okay, put in 425
grand a year into this policy for 10 years. So right off the bat, this agent would earn 200 to $400,000 commission
right off the bat. And so obviously there’s like, you know, he’s pitching. This is like, this is the greatest thing ever,
selling the client. You just have to pay the interest.
Speaker 1 – 06:05
And some of these, you can pay the interest and then pay double the next year, because as the loan grows. But this
one’s pitching, like, let the interest, let the loan just compound. So, like, literally 20 years into this thing, the loan
balance here is going to be $8 million. And so anything goes wrong, this client’s on the hook for $8 million.
Hypothetically, they could get his kids a death benefit, which may not even be there if the policy doesn’t perform.
So also, this agent can earn a 200 to $400,000 commission. However, he’s telling the client you have to pay 30
grand a year for the next 10 years, and then this thing’s all going to work out. There’s a couple issues with this. First
of all, no bank offers this on a fixed rate. So the interest rate is variable.
Speaker 2 – 06:43
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So for plus, actually, I have it right here. It’s usually SOFR plus. Yeah. 150 to 300 base.
Speaker 1 – 06:49
Yeah. So if you look at this thing and the interest rates can fluctuate dramatically. This is assuming 5.7 this agent
actually assumes the interest rate long term goes down to four and a half. It may happen, it may not. That’s just
like that alone.
Speaker 2 – 07:01
You don’t want to be in the ball game on relying on, yeah, this. Predicting interest rates.
Speaker 1 – 07:05
The person recommending this should not be allowed to practice as a financial advisor, let alone an insurance
agent, because this could harm the client millions.
Speaker 2 – 07:13
Let’s talk about the structure of this guy’s balance sheet too. It’s. He needs death. He needs a death benefit, which
you.
Speaker 1 – 07:20
Can go get in a term policy and pay a couple hundred dollars a month for. Cause it’s, you know, he’s highly levered
in.
Speaker 2 – 07:26
He’s. Yeah, he’s very high net worth. All in real estate in his.
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Speaker 1 – 07:31
Yes.
Speaker 2 – 07:31
And so he. Why, why would he add more leverage, more of a loan onto his balance sheet that is already not liquid
enough and you know, you could argue over leveraged.
Speaker 1 – 07:46
So real quick, simple is like, hey, dude, you put in 30 grand a year for 10 years and your kids are each going to get
like, you know, 3 or 4 million bucks. In the end, if 10 different things work out, interest rates drop, the policy
perform. So first of all, we have no idea if interest rates are a bank. The bank could have a margin call along the
way. So the 30,000 a year is just crazy for 10 years. Now the other aspect of this is he’s pitching an index universal
life policy.
Speaker 2 – 08:16
I was just saying let’s unpack that margin thing real quick because that’s important. Again, you have to have
collateral to give the bank. I’m not a banker. We could look this up. It’s some percentage of, I don’t know, something
you’re going to have a few hundred thousand dollars to give as collateral. Why do people who normally use as
collateral, probably a brokerage account. And so what determines the growth or the value of the brokerage
account? Stocks. So if stocks go down, interest rates go up, which could happen in any type of severe economic
situation. You don’t have enough. So the loan balance is going up, the cost of the loan is going up because now the
interest rate, which is variable, is going up.
Speaker 2 – 09:06
So for you to service the loan now, Instead of paying 30, maybe you’re paying 60 a year, your loan balance is
snowballing and your asset that it’s backing is going down. So that’s just like a nightmare scenario. Bank’s gonna
do a margin call and the bank doesn’t care. The bank wants their money to support that loan because they’re, you
Know it’s a bad deal on their end so that so many things can go wrong. And then the next issue is the underlying
type of insurance, which is very important as well.
Speaker 1 – 09:38
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Yeah. So if we unpack how index Universal Life Policy works. So index Universal Life policy is usually tied to an
index. Like, let’s just pick S&P 500. So with this company particular, you have a couple of different options. You can
pick a floor of 1, a ceiling of 9.25, a floor of 0, a ceiling of 10.25. However, if you look at the fine print of the policy,
nothing’s guaranteed. The insurance company has control of what mortality and expense charges they pay. There’s
like minimum maximum charges. Those aren’t disclosed. Those go up a percent a year. The whole thing can
implode by the returns themselves. This agent is pitching a 6% return on index Universal Life Policy, assuming It’s
S&P 500. If you look up the S&P 500 return since the Great Depression, 1926, so now we’re over 10% a year, goes
to 11%.
Speaker 1 – 10:22
If you reinvest dividends, you look at this contract, there’s two things that have happened. One, you don’t get
dividends. Dividends are usually are historically about 30% of the return. So now we’re at 7. If you look at, you
know, the market last year, the SB 500 did about 18%. If you’re in this policy and we did the 0 to 10.25, you would
have been capped at 10.25. You’d have missed on 8% of your returns. A lot of years, the market’s doing 20, 25,
you’re only getting half of that. So if you look at analysis in this structure where you’re getting 0 to 10.25 without
dividends and with it being capped now, the good news is you’re missing the bad years. The bad news is you’re
missing a lot of the good part of the good years.
Speaker 1 – 11:04
Your net return is going to be somewhere between five to five and a half percent, depending on what your floor rate
is. What the. And if you look at the expenses of the policy that erode that, you’re really looking at forward at, you
know, potentially 3 to 4%. So him showing a 6% return based upon the last hundred years is impossible. I mean, it
just would not occur. It has never occurred. Now, why does the insurance industry allow you to illustrate something
that’s not possible? Why is the insurance company not investing in the s and P500 when it’s backed up. They’re
investing in derivatives. It’s a highly complicated thing. They’re guaranteed to make money in this. And if anything
goes wrong, you’re stuck with this loan bill. You’re stuck with a policy shifting the.
Speaker 2 – 11:45
Risk onto the client instead of.
Speaker 1 – 11:48
There’s no guarantees here. So the whole thing, both sides in this scenario, I wouldn’t do either. In this client
situation, we wouldn’t do a premium finance and we would never do an index universal life illustrating 6%. Now
where you could do, where this could make sense on a premium finance is if you have a business owner that’s
going to sell their business in five or ten years. They’re young. Let’s say a business is worth 50 million bucks. They
have a big estate tax problem. So, you know, 30 million of that between the husband and wife would be tax exempt
if they die right now, but 20 million would not. So it’d be 40% of that would be a tax bill of $8 million. Okay, maybe
this client’s 50 years old. They’re going to sell their business in the next five years.
Speaker 1 – 12:30
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They need $8 million death benefit. All their cash flow is going to get reinvested the business to get ready for the
sale. Well, premium finance are young, they’re healthy. Could make sense, fund the premiums, use a traditional
whole life. Maybe the interest on this, on the loan is 1% higher than the return of the whole life policy. But after the
business is sold, there’s a couple million dollar loan balance. Out of the 50 million net of taxes, maybe you get 35
because part of the S Corp, part of its capital gains, you pay off two or three million dollars of the loan. Now you
have that tax liability permanently taken care of for the rest of your life.
Speaker 1 – 13:05
But I, this is basically, he suggested the premium finance just do it for 10 years and let it, let the assumptions ride
for the next 50 years.
Speaker 2 – 13:13
Yeah, the illustration was not paying the loan back. It was. And this guy’s in his, he’s in his early 40s.
Speaker 1 – 13:19
Yeah.
Speaker 2 – 13:19
And it’s like you’re going to just,
Speaker 1 – 13:20
You’re going to 40 or 50 years of what ifs. Yeah, yeah. Of, of assumptions that are probably will implode or are
guaranteed to implode under these illustrations now. So that would be where premium finance would make sense.
But we wouldn’t recommend using an index universal life policy because the index universal life policies in general
look really good. They’re easy to sell. It’s like, oh, you get the market return 04 when you unpack the contract,
they’re horrible. And a whole life policy of the right company is going to crush the performance long term with zero
risk. All the risk is on the insurance company, not the individual. So that’s where a premium finance company
structure could make sense. If you maybe the policy can pay back the loan, but you should also be able to pay
back the loan on your balance sheet.
Speaker 1 – 14:06
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If you cannot, you should steer clear of this thing. No question. There’s no discussion here. This is a black or white
conversation.
Speaker 2 – 14:12
Here I have five tips on how to if you are going to consider this, how to do this correctly. Number one, use the right
type of policy. Don’t use the iul. Use it whole life. Number two, use conservative return assumptions. So exactly
what you just said. Number three, have a clear exit strategy. So yeah, I have a way to pay it off. Four, have proper
collateral planning. Again, you need to have something that’s going to be able to support that loan. And number
five, make sure your team of advisors are aligned. Because exactly how you started this conversation. You’ll have
an insurance agent trying to get a commission. Hopefully you have someone that knows what they’re doing on
your team that can then say this is a bad idea.
Speaker 2 – 14:51
But you need to make sure you know your tax person, your estate planner, your advisor, everybody understands this
and knows what they’re doing.
Speaker 1 – 15:00
Yeah. And if you have one of these already a premium finance use an iul. We’re genuinely feel, you know, bad but
let’s talk about how to unwind it before it gets because every year you keep it’s, it’s a compounding problem in the
wrong direction and you’re. It just gives me an issue. These Iuls aren’t going to keep up if you separate from a in
finance. If you want an IUL policy not the worst thing in the world because some of the companies that don’t offer
guarantees they will, they’ll accept you with health problems more than a whole life. You know, a company with a
whole life would accept you. So sometimes it’s the only option on the table. So if you’re going to get an iul, not a
bad thing by itself. Don’t premium finance it.
Speaker 1 – 15:40
Make sure you can pay for it out of pocket. Use a 5% return assumption max and make sure that death benefit is
going to last till 110,120 assuming a 5% return, then it’s okay by itself. But I would use it if you’re Having trouble
getting accepted other places in a more guarantee life insurance is where you want to have guarantee. That’s not
where you want to take your risk and you don’t mix the two in our opinion. That can be a whole podcast episode
itself. So high level, you know it’s a strategy by itself can make sense for very few people. We’re talking out of the 1
percenters, people that are going to sell their business.
Speaker 2 – 16:15
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I’ve seen one scenario where it could make sense.
Speaker 1 – 16:18
And out of this year, out of how many cases?
Speaker 2 – 16:20
I mean I’m saying I’ve been doing this for what I mean seven year, eight years now, like one time I’ve seen that it
could make sense. Yeah yeah.
Speaker 1 – 16:27
If you have a real cash one high bet just why take the risk of a loan Just fund the life insurance cash flow. This
would really be in that sniper shot scenario where you’re don’t have the liquidity need a bunch of life insurance. If
you estate tax problems. So get it, sell the business, pay the loan off there. And again you do have the option of
land life insurance but with the weight life insurance policies are net of fees performing compared to what loan
rates are. The spread is working against you right now.
Speaker 2 – 16:51
I would say just like the meta lesson here too is like this.
Speaker 1 – 16:55
Seems too good to be true. It is.
Speaker 2 – 16:57
Yeah. Well, yeah that I was just to say like complication and complexity is not the answer. If you’re, if you’ve, you
probably already have a complex balance sheet, don’t make it more complex and like don’t invest in something that
you don’t understand or can’t understand. And I’ve, you know we’ve seen, we’ve kind of been around the industry a
good bit and we’ve seen majority of advisors and insurance agents can’t even explain how these work in detail and
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they’re trying to sell them to you. So if the person selling it can’t explain it, you can’t understand it, you should never
buy it or invest in it.
Speaker 1 – 17:31
Well, if you have any questions, if you’ve been pitch one and you want an alternative or if you need to unwind one or
if you’re in that, you know one of a hundred scenarios where you think this makes sense. We’re happy to answer
any questions you have. Thanks for tuning in, we’ll catch you next week.