Premium financing

How it's meant to work

A lender pays the premiums on a large policy. The policy and often additional collateral secure the loan. The intention is that the policy's growth and the eventual death benefit exceed the accumulated loan and interest, so the arrangement produces coverage that would otherwise be unaffordable to fund from cash flow.

It's used where someone has substantial estate liquidity needs and prefers not to liquidate assets or use gift tax exemption to fund premiums.

Where it goes wrong

• Interest rates rise, so the loan grows faster than assumed
• The policy credits less than illustrated, so cash value grows more slowly than the loan
• The lender calls for additional collateral, which the borrower must post or unwind the arrangement
• The loan cannot be refinanced when it matures
• Unwinding requires surrendering the policy, which can trigger a taxable gain and leave no coverage

The pattern in the failures

The common thread is arrangements sold on illustrations that assumed favourable rates and favourable crediting simultaneously, to people who did not have the liquidity to post additional collateral when both assumptions moved the wrong way.

Ask to see the arrangement modelled with unfavourable rate and crediting assumptions together, not separately. If nobody will produce that, that is the answer.

Questions before proceeding

• What collateral is required now, and what could be required later?
• What happens if I cannot post additional collateral?
• What is the exit strategy, and what does exiting cost at year five, ten and fifteen?
• What are the tax consequences of unwinding?
• How is everyone in this transaction compensated, including the person recommending it?
• Who has reviewed this on my side who is not being paid by the transaction?

Who it's genuinely for

Someone with a substantial and verified estate liquidity need, significant liquid assets available as collateral, an independent tax adviser and attorney, and the capacity to absorb the arrangement failing.

If any of those is missing, the honest answer is a smaller policy funded conventionally. A smaller policy you own outright beats a larger one that can be unwound by an interest rate.