Premium Financed Life Insurance: The Risk Far Exceeds the Reward

• August 27, 2025
• Uncategorized

Premium financed life insurance transactions have become more popular in recent years.  From 2008-2020, the United States operated in an artificially low interest rate environment, allowing people to borrow money at historically low rates.  Insurance agents have responded to this phenomenon by selling “large,” previously unaffordable Indexed Universal Life Insurance (IUL) or Whole Life Insurance policies to retail customers and borrowing the premium from third-party financial institutions.  In theory, agents advise their clients that the performance of the underlying IUL or Whole Life Insurance policy will outpace the interest rate of the loan.  In reality, these transactions rarely work as designed, resulting in sometimes catastrophic collateral calls that carry the potential to wipe-out retirement savings.

This article explores many of the characteristics of premium financed life insurance transactions, including common pitfalls.  The Wolper Law Firm represents investors around the country who have lost money in complex investment and insurance strategies, including premium financed life insurance policies.  If you have been sold a life insurance policy coupled with a premium financing arrangement, and the characteristics and risks of the strategy were not fully disclosed, please contact the Wolper Law Firm at (754)-551-7388 or by email at mwolper@wolperlawfirm.com for a free, confidential consultation to discuss your legal options.

1. Life Insurance Premium Financing

When individuals or businesses purchase substantial amounts of life insurance, premium financing may be chosen as the source of premium payments. Premium financing involves borrowing money to pay life insurance premiums rather than paying those premiums out of pocket. Premium-financed life insurance combines regulated bank lending with regulated insurance products to meet a planning need.

Premium financing involves obtaining a third-party loan to pay premiums. Like any other loan, the lender typically charges interest at floating short-term rates influenced by the credit markets, the borrower’s creditworthiness, and the duration of a rate guarantee. The borrower, often the insured, may pay only interest in regular installments or make larger payments that cover both interest and principal until the debt is paid off or the insured passes away. In some loan setups, the borrower makes no payments for a certain period, and the interest is added to the loan balance (i.e., interest is accrued). This is also known as “rolled-up” or “capitalized” interest, which causes interest costs to grow as the loan balance increases. Capitalizing the accrued interest results in a rapid rise in the total debt, potentially raising the security requirements the borrower must post and increasing the risk involved. Eventually, the loan must be repaid, either because the term ends or because rising borrowing costs lead the borrower to end the financing agreement.

Premium financing can be paid off by the borrower using cash from the policy’s death benefit at the (usually premature) time of the borrower’s death, or it can be effectively retired and exchanged for a policy loan from the insurance company, with the policy serving as collateral. During underwriting, many insurance companies require that loan interest be paid out of pocket rather than accrued. Since the insurance company cannot enforce this “rule” after the policy is in effect, it typically conducts due diligence on premium finance intermediaries, maintains lists of reviewed firms and their program parameters, and notes where these align (or not) with insurance company guidelines for premium financing.

Premium financing strategies can benefit High Net Worth (HNW) individuals who prefer not to liquidate assets to cover their life insurance premiums. Borrowing from a bank to pay premiums leverages the HNW individual’s assets instead of using cash out-of-pocket.

Leverage, in turn, depends on the borrower’s perspective. In some cases, “retained capital” is the focus. Instead of tying up high-earning capital, some HNW individuals or businesses believe that maintaining the growth of assets—such as investments, businesses, or real estate—is more valuable than the carrying costs of a third-party loan. In other cases, the borrower may assume that the bank’s (non-tax-deductible) interest expense will be lower than the policy’s net crediting rates, creating a positive spread or so-called “arbitrage.” While these beliefs do not always prove to be accurate, they are common and accepted reasons for HNW individuals’ decision-making in this context.

2. Elements of Premium Financing

• Life insurance products must be approved by the Department of Insurance in the state(s) where they will be sold. Once approved, these products cannot be modified or altered without the approval of the relevant state regulator. Life insurance policies are contracts between the issuing insurance company and the policy owner. Neither the life insurance agent nor their customers can influence the contractual terms of the policy.

 

• IUL policies are almost exclusively the type of insurance product used with premium financing. Variable Universal policies are generally not approved by lending institutions due to banking and securities regulations and the possibility of unacceptable swings in sub-accounts. Traditional universal life has not had sufficient cash value returns to support the arbitrage on which most plans were based. And, until recently, Whole Life policies were considered too “expensive” and had insufficient expected returns for the desired arbitrage.

 

• All IUL policies are quite similar in structure and functioning. While it is nearly impossible to predict even short-term growth of accumulation value—and thus more accurately estimate collateral needs and loan repayment—agents, including those who act as intermediaries, depend on illustrating and communicating their expectations of these values to customers. Accumulation values and premiums are not guaranteed.

 

• Elements of financing and “premium” amounts – policy funding relies on non-guaranteed assumptions about future policy performance. The “premium” and related financing terms will be based on projected illustrated values. Because of the nature of the policy’s underlying credits and debits – which depend on the actual performance of the Index or Indices chosen by the policy owner and the carrier-determined Cap and Participation Rates – the actual policy values will differ from the policy illustration.

 

• The choice between accruing or paying interest lies with the borrower, but most insurance companies will not issue policies if all loan interest is meant to be accrued. As noted, accruing or capitalizing interest can significantly increase both the risk to the borrower and the collateral requirements. An initial decision should be made about whether to pay some or all of the interest due on premium financing. A loan model might suggest accruing all interest, but doing so can greatly hamper the success of the financing program.

 

• Loan assumptions – Modeling borrowing costs is speculative because only the lender can set lending rates, and these rates typically fluctuate annually based on broad economic factors. Confidence in these assumptions quickly diminishes over time.

 

• Gap Collateral is the difference between the surrender value of the policy being financed and the loan balance, usually recalculated annually or more often. Since policy account values do not initially match premiums paid (and then borrowed) in the early years of the policy, lenders require collateral from the borrower beyond just the policy itself. Common collateral assets include acceptable assets like real estate and Letters of Credit. Lenders need collateral to “balance the books” between themselves and the borrower, reducing the lender’s financial risk.

 

• The premium payment period for funding a life insurance policy primarily depends on plan design considerations. Premiums and the duration for which they are paid are based on non-guaranteed assumptions. Over time, premiums might need to be adjusted to keep the policy active and ensure it provides a future death benefit. Generally, a shorter payment period results in a larger annual loan but a lower total loan needed to fully fund the policies; however, there is no universal rule for this calculation.

 

• Loan exit strategies are a crucial part of the considerations when setting policy premiums, and many insurance companies require an exit plan as part of their financial underwriting of the prospective policy. All premium financing from a third-party commercial lender must eventually be repaid. Repayment to the lender is often shown as coming from the policy’s cash value at some point in the future, but repaying the policy values is essentially paying off the original loan with a new loan – this time from the life insurance company.

 

• Marketing arbitrage—Since the 2010s, messages from some intermediaries have shifted toward financing arrangements based on an illustrated (but not guaranteed) persistent and stable “positive arbitrage” between policy interest crediting linked to market indices and the cost of the loan. This concept proved to be short-lived, reflecting a limited period of historically low borrowing rates and high crediting rates for IUL policies.

 

• Constant rate illustrations – Insurance carriers understand that IUL policy illustrations assume consistent lifetime returns, even though these assumptions do not reflect real-world conditions. Consequently, insurer premium financing guidelines have been established, and many carriers have even set limits on the proportion of new premium-financed life insurance business they will accept as part of their total sales.

3. Realities for the Premium Borrower to Consider

The premium borrower must consider numerous realities. The principal areas of risk often mentioned in insurance premium financing include interest rates, policy crediting rates, loan exit, requalification, and refinancing risks.

• Interest rate risk – Although the U.S. experienced a period of historically low interest rates since the 2008 Great Recession, borrowing rates that affect premium financing costs have predictably recently risen sharply. This higher cost of borrowing necessitates more out-of-pocket interest payments or, if interest is capitalized, increases the size of the outstanding loan. This challenges the assumptions many borrowers may have made and complicates the objectives of the arrangement made at inception. The future impact of interest rate changes remains an uncertain risk.

 

• Policy crediting risk – Unlike the assumptions made in the policy sales illustration, policy cash values may not grow as quickly as the loan interest and will likely differ from the illustration. This means the borrower may need to provide increasingly larger collateral. Can the policy consistently perform above the cost of borrowing?

 

• Loan Maintenance Risk: Most premium financing plans are designed to fund the policy during the first 10-20 years and to pay off the bank loan as soon as possible after funding is complete. The longer an external loan remains active, the greater the chance that rate risks will cause adverse effects, potentially affecting the borrower’s financial situation and initial expectations. It is also uncertain whether policy values can sustainably support third-party loans over the long term.

 

• Requalification risk – The borrower may face unexpected changes to their wealth and income, which could make it harder to pay their loan or reduce their creditworthiness compared to the past. This may affect future loan terms. They might also be unable to handle unexpected collateral demands or planned out-of-pocket expenses needed to manage the loan. Often, multiple factors can come together that prevent a borrower from continuing to pay the planned premiums.

 

• Refinance risk – The lender may change its risk appetite for this specific lending category and decide to stop funding future premiums.  This change in institutional attitude was observed in many premium financing plans during the financial crisis. It is important to reiterate that premium financing involves taking short-term loans to cover a long-term liability. Refinancing a premium loan can involve a considerable coordinated effort and additional unplanned costs, especially if working with new lenders and premium finance intermediaries who need to be paid for their services. Where the need to refinance is driven by deteriorating plan economics or the threat of default on the existing loan, there may be no interested lenders to be found.

Additional Risks

Beyond these obvious financial risks, other risks are not always quantified or qualified in the decision-making process before implementation, but are just as critical to understand.  Often, they are identified only after adverse circumstances are experienced.

• Design risk – The individual risks that are easy to identify and manage on their own can become more complex to handle or visualize when combined. Is the policy designed for protection or retirement income? Does the borrower plan to pay all interest costs out-of-pocket, or will they capitalize some or all interest costs? Will they pay some of the premiums and gradually pay down the loan principal, or do they plan to redeem the loan in one lump sum at a future date – or only at death?

Designs that eliminate or reduce out-of-pocket contributions to the loan or policy premiums are the most leveraged and least resilient. Minimum out-of-pocket expectations depend on the continuous success of favorable loan and policy performance, requiring higher net worth and collateral. The seller and the buyer often view designs with no or minimal out-of-pocket costs as “free insurance,” which inevitably leads to the lowest chances of success.

• Dollar Sequence of Return Risk – IUL is subject to crediting volatility and carrier discretion over numerous non-guaranteed crediting parameters and policy charges. Few of IUL’s elements of cost and benefit are guaranteed (e.g., cap rates and/or participation rates, offered indices, and cost of insurance rates), and changes are inevitable. Yet, risk can be quantified with the right tools.

Efforts to measure the risk of non-guaranteed crediting often involve using a volatile returns data set and applying it to the policy accumulation process. The goal is not to “put your thumb on the scale” regarding the sequence of returns but to provide objective forecasts based on long-term expectations that are not overly affected by short-term biases.

In my experience, a more objective process that is less prone to manipulation is one that randomly generates returns based on a statistical distribution characterized by its mean and standard deviation. This distribution is derived from a long history of actual performance of the underlying reference financial instrument (e.g., S&P 500 in the case of IUL). This approach to statistical analysis – based on Stochastic Analysis and often called Monte Carlo Analysis – is widely accepted in the wealth management industry and is very relevant here to life insurance.

• Behavioral risks are often unanticipated issues underlying the consideration of premium financing. Most agents don’t consider the necessity of performing independent statistical analysis on the combination of financing and life insurance since they have placed their trust in the premium finance specialists who were selected after demonstrating their preeminence as experts in financed life insurance programs. More importantly, there is a need to ask the right questions of the right people. Unfortunately, in most cases, the agent relies solely upon the premium finance specialist when structuring these transactions.

Clients almost always defer to their expectation of expertise on the part of the agent and the premium finance specialist. Clients cannot be expected to have expertise in financing today’s complex, current assumption life insurance policies.

• Incoherent Information – Even when presented with integrity, data can become noise and lead clients to make false assumptions and draw incorrect conclusions. Lenders require collateral to “balance the books” between the lender and borrower, eliminating the lender’s financial exposure. While the policy’s cash surrender value forms the primary collateral for the loan, additional collateral must be pledged as security. Also known as “gap” collateral, it is the difference between the cash surrender value of the policy being financed and the current loan balance plus loan interest for the current year and is typically re-computed annually. Assignment of acceptable assets, such as cash, income-producing real estate, existing life insurance policies, securities, and letters of credit, are typical collateral resources. It is important to note the lender will value collateral at some discounted percentage for assets other than cash.

4. Premium Finance Intermediaries/Specialists

Those specializing in premium finance are typically life insurance general agencies that actively market and promote the sale of life insurance through commercial financing. Some specialize exclusively in this activity, while others engage in these arrangements in addition to other forms of life insurance planning and policy sales. The intermediary maintains selling agreements with insurance companies, earning overrides and often a percentage of the selling agent’s commissions. Some intermediaries earn revenue from referrals of these cases to lenders and may derive some of their income from the loan spread and/or loan origination fees. Insurer due diligence of these firms is defensive in that they know financed policies are more persistent if an experienced intermediary is involved.

Many insurance agents rely on premium finance intermediaries to assist with case design because these intermediaries are regarded as experts. The largest premium finance firms provide ongoing support to maintain life insurance premium finance cases through yearly service, even when wealthy clients finance premiums through their private banking relationships. These intermediaries “shop” cases with large banks and other lenders specializing in this type of financing, but they will admit that some clients can negotiate better terms through their existing private banker relationships.

Most carriers require their agents to work with a premium finance intermediary and usually keep a list of approved entities. Some carriers specify the intermediary’s name on the application alongside the primary agent for part of the commission. Others audit the intermediary after a policy is issued to ensure they are involved during renewal years for policy servicing and premium funding, with enough renewal commissions to cover the servicing effort.

Some carriers allow the primary agent to keep all commissions, known as a “No Split” arrangement. In this setup, the agent collaborates with a “behind the scenes” specialist who earns revenue from sources like general agency override commissions, loan spreads, and/or loan origination fees.

5. Indexed Universal Life (IUL) Insurance Policies

Practically all types of Universal Life policies combine term life insurance with a tax-advantaged accumulation account. It is expected that the account value will grow over time, and the insurer’s “net amount at risk” portion of the policy will decrease as the accumulation account increases so that the total of the accumulation account and “net amount at risk” equals the policy’s death benefit. Insurance charges and other expenses are deducted from the accumulation account (usually called the cash value), and the account is credited with premium payments and annual interest credits. An IUL policy tracks an external stock market index (such as the S&P 500®), most often over a 365-day period. If the index increases during that period, the rise—subject to a current “capped” maximum return and a current participation rate—will be credited to the accumulation account. If the index declines, the policy will “credit” a guaranteed amount, usually 0%, for the 365-day period’s performance.

The term insurance charges assessed against the accumulation account every month are for the “net amount at risk” (the difference between the death benefit that would be payable – and the current account value). These term insurance charges are referred to as Cost of Insurance (COI) rates and will increase each year based on the age(s) of the insured(s).

One unique aspect of most universal life policies (including IUL) is that there is no premium specified in the policy beyond a first-year minimum payment. The policy owner may pay any amount – or no amount – as often or as infrequently as the policy owner chooses. Because there is no guaranteed premium, the objective to sustain the policy until death–whenever death may occur–places the obligation on the policy owner to make sure the accumulation account at all times has a positive balance. Without a sufficient accumulation of account value, the policy will lapse.

Policy illustrations used to calculate a planned “premium” are simply non-guaranteed, calculated guesses or suggestions of what would be advisable to maintain the policy until the death of the insured. Unlike Whole Life policies, the insurance company does not guarantee the sufficiency of the calculated premium.

A factor working against any universal life policy is that the crediting rate used in a policy illustration is deployed as a constant in all policy illustration years. This is an inaccurate assumption about how the yearly crediting rate is determined and applied to the policy cash values each year on the policy anniversary. Yet, the policy illustration is the primary means by which agents typically describe “how the policy will work” and the results that can be expected.

When cash values are generated, they are available to withdraw or borrow. While the availability of cash value is an important benefit of IUL policies, the real purpose of cash value is to progressively reduce the net amount at risk of a policy so that the insurance charges will not exceed the cash value of the policy as the insured(s) age and the yearly cost of insurance begins to become prohibitively expensive.

Although payments are flexible, IUL policies are complex. The basis on which credits are determined and applied requires computer software provided by the insurance company and run by the insurance agent. Despite the many disclaimers, policy illustrations do not reasonably allow consumers to appreciate how such life insurance policies work with any degree of certainty. And because of the generally volatile nature of the chosen stock market index or indices and the degree of control the issuing insurance company retains over its in-force policies (i.e., by setting current cap rates, participation rates, and policy expenses subject to minimal guaranteed thresholds), it is not credibly possible to compare IUL policy illustrations to determine which one “is best.” A reliable comparison could only be made retrospectively after tracking many years of actual performance in policy credits and debits as herein described.

6. Standards of Care in the sale and service of life insurance products

Unlike securities, life insurance products are regulated by individual states.  An increasing number of individuals involved in financial services and insurance sales may be obligated to high standards of care with their customers based on their professional affiliations, federal law, or state of residence.

The commonly agreed-upon elements of a high duty of care include:

1. Placing the client’s best interest ahead of your own.
2. Acting with prudence, that is, with the skill, care, diligence, and good judgment of a professional.
3. Not misleading clients; providing conspicuous, full, and fair disclosure of all important facts.
4. Avoiding conflicts of interest, and
5. Fully disclosing and fairly managing, in the client’s favor, any unavoidable conflicts.

Insurance regulations alone do not require skill, care, diligence or even good judgment for agents to sell their products.  However, notwithstanding nominal insurance regulations, financial professionals may also be subject to these obligations of care by presenting themselves to their clients, business colleagues, and/or their community in a manner that establishes their expertise and creates an expectation of that expertise.

This obligation may accrue in several ways:

• When the individual routinely describes their specialization and services in a way that claims specialized knowledge and long years of experience that only s/he – or a small number – possess; and/or
• The descriptions they use with their email signatures, self-promotion on social media such as LinkedIn, their individual or corporate websites, and media or press articles that point to the individual’s specific areas of expertise.

Finally, various states have gone above and beyond the nominal obligations of care, and Florida is one of those states.

In Florida, where I practice, Rule 69B-215.210, Florida Administrative Code (F.A.C.), established in 1974 the ethical standards for life insurance agents in Florida, declaring the business of life insurance to be a “public trust” and requiring agents to act in the best interests of their clients. The rule sets expectations such as:

• Working in the best interests of the insuring public.
• Accurately and completely presenting all facts essential to a client’s decision.
• Acting with fidelity, honesty, and full disclosure.
• Placing the policyholder’s interests first.

 

These standards embody elements commonly associated with a fiduciary duty—such as loyalty, honesty, full disclosure, and good faith.  In fact, several courts in Florida have adjudicated that insurance agents and brokers have a fiduciary duty to the insured. To the extent an agent has failed to adequately illustrate the characteristics and risks of a premium financed life insurance strategy or the recommendation itself is improper given the age, objectives, needs and risk tolerance of the insured, there may be a breach of duty.

The Wolper Law Firm, P.A. Offers Free Consultations

The Wolper Law Firm represents investors nationwide in securities litigation and arbitration on a contingency fee basis.  Matt Wolper, the Managing Principal of the Wolper Law Firm, is a trial lawyer who has handled more than 1,000 securities cases during his career involving a wide range of products, strategies and securities. Prior to representing investors, he was a partner with a national law firm, where he represented some of the largest banks and brokerage firms in the world in securities matters. We can be reached at 754.551.7388 or by email at mwolper@wolperlawfirm.com.