Premium Financing. Prepared for: Mr. & Mrs. Client July 6, 2015

Transcription

1 Premium Financing Prepared for: Mr. & Mrs. Client July 6, 2015 Mr. Agent Highland Capital Brokerage 3535 Grandview Parkway, Suite 600 Birmingham, AL

2 Premium Financing Many affluent clients understand the benefits that life insurance can provide. However, you may be concerned that a substantial income tax liability may result from liquidating low basis assets to pay premiums and/or that buying life insurance will require you to redirect assets from potentially lucrative investments. Like many wealthy clients, the premium costs for your desired level of life insurance protection may exceed your annual gift tax exclusion1 and remaining lifetime gift tax exemption amounts. In that case, acquiring more life insurance would likely result in a significant gift tax. What is Premium Financing? How Does It Work? Premium financing may be a cost-effective approach to acquire your needed death benefit while maintaining liquidity. Many clients use premium leveraging arrangements, such as premium financing to facilitate funding their life insurance premiums with little or no gift tax or cash flow impact. Premium financing is a strategy that can help you obtain a needed life insurance death benefit. Typically, premium financing is a fair market loan arrangement between a commercial lender and an irrevocable life insurance trust (ILIT) where the lender loans the premiums for a life insurance policy on your life to the ILIT. 1 In that case, the gift to the ILIT is equal to the amount of loan interest charged - not the entire policy premiums. As a result, you are able to acquire the death benefit needed with little or no gift tax impact. In addition, there is minimal or no impact on your current investment portfolio: You maintain control and use over assets that otherwise would have been liquidated to pay life premiums. With regard to the specific loan terms, the policy usually serves as the primary collateral for the loan. During the early years of a policy, cash surrender values are generally less than premiums paid. As a result, you are typically required to provide additional collateral. Loan interest can be paid annually or deferred for a period of time. Loan principal, including accrued interest, may be repaid from the life insurance proceeds or from other sources during your lifetime. Potentially, a return of premium rider can be used to repay the premium loan without diminishing the death benefit needed. 2) Additional Collateral, as Required Client 4) Gift of Interest to ILIT Commercial Lender 1) Premium Loan 4) Interest Payments Loan Repayment ILIT 3) Premium Payments 5) Death Benefit Life Insurance 6) Trustee Distributions exp. 7/16 ILIT Beneficiaries 1 Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including generation-skipping tax). Failure to do so could result in adverse tax treatment of trust proceeds.

3 Client Information Illustration Assumptions Client Name Mr. Client Mrs. Client Client Gender Male Female Client Age Client Underwriting Preferred Nonsmoker Preferred Nonsmoker Joint Life Expectancy 92 Premium Financing Option Assumptions Loan Details Loan Rate 3.00% Origination Fee 0.00% Legal Fee 0 Loan Interest Paid Yes Collateral Value of Cash Surrender Value % Line of Credit Fee 0.00% Life Insurance Details Carrier John Hancock Product Protection SUL 13 First Year Premium 223,470 First Year Death Benefit 10,223,470 Current Crediting Rate 5.05% Guaranteed Crediting Rate 2.00% Non-Financed Option Assumptions Life Insurance Details Carrier John Hancock Product Protection SUL 13 First Year Premium 184,868 First Year Death Benefit 10,000,000 Current Crediting Rate 5.05% Guaranteed Crediting Rate 2.00% Please see the glossary for additional information regarding terminology used in this presentation. 3 Premium Financing Mr. & Mrs. Client

4 Summary Comparison of Financing vs. Non-Financing Comparison of Internal Rates of Return 10% 9% 8% 7% 6% 8.6% 7.7% 8.2% 7.4% 7.7% 7.0% 7.3% 6.8% 7.0% 6.5% 6.7% 6.3% 6.4% 6.0% 6.1% 5.8% 5.9% 5.6% 5.5% 5.7% 5.3% 5.5% 5% 4% 3% 2% 1% 0% (LE) Non-Financed Policy Financed Policy Comparison of Cumulative Cost (in Millions) (LE) Non-Financed Policy Financed Policy 4 Premium Financing Mr. & Mrs. Client

5 Life Insurance Details Loan Details Loan Ledger Details Year Younger Cash Origination Loan Loan Loan Withdrawals Death Premiums Loan Loan Premium Surrender, LOC & Interest Interest Principal Age / Loans Benefit Borrowed Rate Balance Value Legal Fees Due Paid Paid # EOY BOY EOY BOY EOY BOY BOY BOY EOY BOY/EOY BOY BOY , ,223, , % 6,704 6, , , , ,446, , % 14,526 14, , , , ,670, , % 23,464 23, , , , ,893, , % 33,521 33, , , , ,117, , % 44,694 44, ,117, , , ,340, , % 56,985 56, ,340, ,470 1,186, ,564, , % 70,393 70, ,564, ,470 1,425, ,787, , % 84,919 84, ,787, ,470 1,675, ,011, , % 100, , ,011, ,470 1,938, ,234, , % 117, , ,234, ,996, ,234, % 0 0 (2,234,700) ,056, ,234, % ,117, ,234, % ,177, ,234, % ,237, ,234, % ,295, ,234, % ,370, ,234, % ,439, ,234, % ,500, ,234, % ,553, ,234, % ,639, ,234, % ,796, ,234, % ,959, ,234, % ,125, ,234, % ,296, ,234, % ,468, ,234, % ,641, ,234, % ,814, ,234, % ,983, ,234, % ,147, ,234, % Hypothetical example for illustrative purposes only. Individual results may vary. 5 Premium Financing Mr. & Mrs. Client

6 Life Insurance Details Loan Details Loan Ledger Details Year Younger Cash Origination Loan Loan Loan Withdrawals Death Premiums Loan Loan Premium Surrender, LOC & Interest Interest Principal Age / Loans Benefit Borrowed Rate Balance Value Legal Fees Due Paid Paid # EOY BOY EOY BOY EOY BOY BOY BOY EOY BOY/EOY BOY BOY ,303, ,234, % (LE) 0 4,452, ,234, % ,594, ,234, % ,729, ,234, % ,856, ,234, % ,974, ,234, % ,083, ,234, % ,185, ,234, % ,278, ,234, % ,364, ,234, % Hypothetical example for illustrative purposes only. Individual results may vary. 6 Premium Financing Mr. & Mrs. Client

7 Year Younger Age Loan Balance Impact on Collateral Collateral Value of Cash Surrender Value Additional Annual Collateral Needed/Released Impact on Collateral and Cashflow Cumulative Collateral Requirements Impact on Cash Flow Loan Interest Paid Cumulative Loan Interest Paid # EOY EOY EOY EOY EOY EOY EOY , , ,470 (6,704) (6,704) , ,884 59, ,056 (14,526) (21,230) , ,130 39, ,280 (23,464) (44,694) , ,370 30, ,510 (33,521) (78,215) ,117, ,038 20, ,312 (44,694) (122,909) ,340, ,878 7, ,942 (56,985) (179,893) ,564,290 1,186,772 (3,424) 377,518 (70,393) (250,286) ,787,760 1,425,158 (14,916) 362,602 (84,919) (335,205) ,011,230 1,675,513 (26,886) 335,717 (100,562) (435,767) ,234,700 1,938,218 (39,235) 296,482 (117,322) (553,088) ,996,946 (296,482) 0 0 (553,088) ,056, (553,088) ,117, (553,088) ,177, (553,088) ,237, (553,088) ,295, (553,088) ,370, (553,088) ,439, (553,088) ,500, (553,088) ,553, (553,088) ,639, (553,088) ,796, (553,088) ,959, (553,088) ,125, (553,088) ,296, (553,088) ,468, (553,088) ,641, (553,088) ,814, (553,088) ,983, (553,088) ,147, (553,088) Hypothetical example for illustrative purposes only. Individual results may vary. 7 Premium Financing Mr. & Mrs. Client

8 Year Younger Age Loan Balance Impact on Collateral Collateral Value of Cash Surrender Value Additional Annual Collateral Needed/Released Impact on Collateral and Cashflow Cumulative Collateral Requirements Impact on Cash Flow Loan Interest Paid Cumulative Loan Interest Paid # EOY EOY EOY EOY EOY EOY EOY ,303, (553,088) (LE) 0 4,452, (553,088) ,594, (553,088) ,729, (553,088) ,856, (553,088) ,974, (553,088) ,083, (553,088) ,185, (553,088) ,278, (553,088) ,364, (553,088) Hypothetical example for illustrative purposes only. Individual results may vary. 8 Premium Financing Mr. & Mrs. Client

9 Comparison of Internal Rates of Return on Financing vs. Non-Financing Financed Policy Non-Financed Policy Year Younger Annual Cumulative Financing Internal Rate Death Benefit Annual Cumulative Financing Financing Internal Rate of Age (Net of Loan) Premium Outlay Premium Outlay Death Benefit of Return Outlay Outlay Return (IRR) (IRR) # EOY EOY EOY EOY EOY BOY BOY EOY EOY ,704 6,704 10,000, % 184, ,868 10,000, % ,526 21,230 10,000, % 184, ,736 10,000, % ,464 44,694 10,000, % 184, ,604 10,000, % ,521 78,215 10,000, % 184, ,472 10,000, % , ,909 10,000, % 184, ,340 10,000, % , ,893 10,000, % 184,868 1,109,208 10,000, % , ,286 10,000, % 184,868 1,294,076 10,000, % , ,205 10,000, % 184,868 1,478,944 10,000, % , ,767 10,000, % 184,868 1,663,812 10,000, % , ,088 10,000, % 184,868 1,848,680 10,000, % ,234,700 2,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % Hypothetical example for illustrative purposes only. Individual results may vary. 9 Premium Financing Mr. & Mrs. Client

10 Comparison of Internal Rates of Return on Financing vs. Non-Financing Financed Policy Non-Financed Policy Year Younger Annual Cumulative Financing Internal Rate Death Benefit Annual Cumulative Financing Financing Internal Rate of Age (Net of Loan) Premium Outlay Premium Outlay Death Benefit of Return Outlay Outlay Return (IRR) (IRR) # EOY EOY EOY EOY EOY BOY BOY EOY EOY ,787,788 12,234, % 0 1,848,680 10,000, % (LE) 0 2,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % ,787,788 12,234, % 0 1,848,680 10,000, % Hypothetical example for illustrative purposes only. Individual results may vary. 10 Premium Financing Mr. & Mrs. Client

11 Glossary of Terms Collateral In premium financing, collateral is the borrower s assignment of assets to a lender for repayment of the loan. At the end of the loan term the assets are not required to be used to repay the loan (other assets can be used), but in the case of default, the lender can use the assets pledged to satisfy the outstanding debt. The cash surrender value of the life insurance policy is typically the primary source of collateral. Other collateral sources for premium financing include letters of credit, cash, marketable securities (stocks and bonds), or other liquid instruments. Collateral Value When the borrower pledges collateral for the loan, the lender may assign different values to the assets based on their ability to easily liquidate the asset in the case of default. For example, if the borrower pledges $1 of cash, the lender would give 100% collateral value for that asset. If the borrower pledges $1 of stock, the lender may only give 50% collateral value depending on the lender s perceived ability to easily liquidate that stock. Loan Rate The lender may offer a variable or fixed loan interest rate: Loan Principal Loan Principal is the total amount of premiums borrowed. LIBOR A variable loan rate has two components, an underlying rate benchmark (typically LIBOR or Prime) and an interest rate spread. The spread varies by lender and benchmark used, and can range anywhere from basis points. The lender may also impose a floor on the loan rate; for example, assume the variable rate is Prime + 50 basis points. If Prime is 3.25%, the total loan rate would be 3.75%. However, if the lender s interest rate floor is 4.00%, then the total loan rate would never fall below 4.00% for the duration of the loan. A fixed loan rate can either be set at the discretion of the lender or through a SWAP contract. In a SWAP contract, the borrower swaps a variable rate for a fixed rate. The SWAP contract, ultimately the total fixed rate, consists of three elements: the break-even swap rate, net interest income, and a credit spread. The break-even swap rate is a market rate determined at loan inception. The net interest income is a spread added to the breakeven swap rate and set by the lender; it is basically the income to the lender. The credit spread is similar to the interest rate spread in a variable rate and is also added to the swap rate to determine the total fixed rate. The fixed rate does not change for the duration of the loan. An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year. 11 Premium Financing Mr. & Mrs. Client

12 PRIME Net Death Benefit Origination Fee Legal Fee A fee that can be charged by the lender to prepare the loan documents and/or review them. Loan Principal Loan Principal is the total amount of premiums borrowed. Financing Internal Rate of Return Internal Rate of Return Glossary of Terms The U.S. Prime Rate is a commonly used, short-term interest rate in the banking system of the United States, used as an index or foundation rate for pricing various short- and medium-term loan products. The Prime Rate will move up or down in lock step with changes to the on the fed funds rate, which is set by the Federal Reserve Board. The Prime Rate is listed in the Eastern print edition of the Wall Street Journal (WSJ). Prior to mid-december 2008, the WSJ Prime Rate was determined by polling thirty (30) of America's largest banks. When twenty-three (23) of those 30 banks had changed their prime lending rate, The WSJ would respond by updating its published Prime Rate. On December 17, 2008, the Wall Street Journal recognized that fewer, but larger banks controlled most assets and changed the methodology for the prime rate that is published. The Journal's rate today now reflects the base rate posted by at least 70% of the top ten banks by assets. The gross death benefit paid by the life insurance less the outstanding loan balance. A fee that can be charged by the lender or loan facilitator to originate or structure the loan. The fees can vary, but are usually charged as a percentage of either the first year premium or of the entire amount of principal to be borrowed over the term of the loan. The interest rate returned by comparing the cumulative cash outlay paid in any given year by the client (including part or all of the loan interest and any additional fees or principal) to the net death benefit. The interest rate returned by comparing the cumulative premiums in any given year to the gross death benefit illustrated in the life insurance policy. Premium Financing is complex and involves many risks, such as the possibility of policy lapse, loss of collateral, interest rate and market uncertainty, and failure to re-qualify with the lender to keep the financing in place and maintain the desired level of insurance protection. Financing is subject to the lender s collateral and financial underwriting requirements. Financing lenders typically require additional collateral during the early years of a policy in the form of cash, cash equivalents, marketable securities, a personal guaranty or a letter of credit from a bank approved by the lender. Interests in closely held businesses and real estate are not generally acceptable collateral. In certain situations, additional out-of-pocket contributions may be required to retire the debt and/or maintain the desired level of insurance protection. A well planned exit strategy should be in place prior to accepting any financing arrangements. 12 Premium Financing Mr. & Mrs. Client

13 Historical Prime and LIBOR Rates Historical Prime Rates and Average Since January 01, % 10% 8% 6% 4% Average Prime 2% 0% Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: Historical LIBOR Rates and Average Since January 01, % 9% 8% 7% 6% 5% 4% 3% Average LIBOR 2% 1% 0% Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: 13 Premium Financing Mr. & Mrs. Client