Did you know that if you're old and wealthy, you can get additional life insurance coverage for free or at fairly low cost? Termed as non-recourse premium financing, this is currently one of the hottest products in the life insurance marketplace.
Non-recourse premium financing has become a popular concept with high net worth individuals who need the extra life coverage for estate planning. How it works is premium financing firms extend a loan to older, affluent people to go out in the market and buy a large insurance on their life.
The life insurance policy bought by the borrower is the full and only collateral in this type of lending.
The loan is for a term of two to two-and-a-half years during which the borrower makes no payments on it. If the borrower passes on during the loan period, then his estate needs to repay the loan along with the fees and accrued interest. What's left of the estate is transferred to the borrower's legal beneficiaries or heirs.
However, if the borrower survives the term of the policy, he can take recourse to any one of the following:
- Transfer the policy to the lender.
- Sell the policy in the aftermarket and use the earnings thereof to repay the loan.
- Retain the policy and pay off the loan along with the fees and accumulated interest.
Non-recourse premium financing is available to all U.S. citizens who are over 70 years of age and bona fide accredited investors. The policy has to be purchased from a U.S.
based insurance company and must have a face amount between $1,000,000 and $10,000,000. The loan amount extended to the borrower cannot be less than $100,000.
So, how does the borrower benefit from taking a loan to buy additional life insurance
? Well, the biggest advantage of non-recourse premium financing is that it allows the borrower to buy a large insurance policy without having to make any expense out of his pocket. Traditionally, such as exercise would have meant that he uses either his savings or liquidates part of his estate to cover the cost of additional life insurance.
But just like anything else, this concept has as many critics as it has takers. The biggest criticism hurled at non-recourse premium financing is from purists who argue it dilutes the very purpose of life insurance by allowing third parties to treat it as an investment vehicle.
According to them, the reason for buying life insurance is to protect the financial stability of your family if and when you are no longer around to take care of them and it should not be left open to investor speculation.
Another major criticism of this type of financing is that a total stranger may stand to gain huge benefits from the policy holder's death. This is especially true if the insured borrower decided to transfer the policy to the lender or sell it in the secondary market, which would mean that a third party totally unrelated to him would own the policy and collect all the death benefits when he dies.
Even insurance carriers are up in arms against this kind of transaction between financing companies and policy holders. They fear that if non-recourse premium financing is allowed to flourish, it would lead to an increase in the cost of life insurance making the premiums unaffordable for ordinary citizens.
Life insurance companies' work on the premise that a significant number of policies lapse before the insured dies, which means their payouts are lesser making it possible for them to offer low premiums to policy holders. However, if investors were to buy a policy, it's likely they will continue paying premiums until the insured dies so they can collect the benefits.
An increase in the number of payouts by insurance companies will impact their profitability and lead to higher premium rates.
The jury may still be out on the moral and financial implications of non-recourse premium financing, but a California federal judge giving it his approval in a case last year may calm some of the dissenting voices.