Premium Financing Risks: 10 Reasons to Avoid Financing an IUL

Premium financing means borrowing the premium for a life insurance policy and securing that loan against the policy itself. Banks market it as a way to hold a large death benefit without moving capital out of higher-yielding assets. At seven-figure premium levels, with the right structure and a tested exit, it can do exactly that.

The strategy depends on one piece of arithmetic: the cost of borrowing has to stay below what the policy credits. Between 2021 and 2023 that arithmetic reversed for a large number of facilities written in the low-rate years, and policyholders who had never modelled a rate rise found themselves funding interest bills several times what they had planned for.

Below are the ten risks we see most often in the cases advisers bring to us, a client situation that shows what happens when the arithmetic turns, and the circumstances where financing still holds up. If you want the mechanics of how premium financing works rather than the risks, start with our guide to premium financing life insurance.

Who premium financing is actually for

Premium financing is arranged at seven-figure premium levels. Lenders expect a banking relationship, assets under management, and collateral beyond the policy itself. Below that threshold the conversation is usually academic: the set-up costs alone make the structure uneconomic, and most lenders will not write the facility.

If you are considering a policy below that level, the relevant comparison is not financed against unfinanced. It is how many years you spread the premium over. Our comparison of a multi-pay IUL against premium financing covers that decision directly.

Ten risks to weigh before financing an IUL

1. The interest rate is the whole strategy

Financing works while borrowing costs sit below the policy's crediting rate. Most facilities are variable, priced over SOFR plus a lender margin, and they reprice on renewal rather than staying fixed for the life of the policy. A facility written at 1.75% is not a facility that stays at 1.75%.

Model the structure at rates several points above where you sign. If it only works at today's rate, it does not work.

2. Set-up and ongoing costs are real

Legal fees, lender arrangement fees, structuring costs and annual custodian charges sit on top of the interest. On a facility that runs for decades these compound into a material figure that rarely appears in the illustration you are shown at outset.

3. Collateral ties up more capital than you expect

Lenders require assets under management or cash deposits in addition to the policy. The capital you were told you would keep free for other opportunities is frequently the same capital the bank asks you to pledge.

4. Margin calls arrive at the worst moment

If the policy's cash value falls behind the loan balance, the lender can call for additional collateral. Market conditions that reduce policy values are the same conditions that reduce the value of everything else you might post. Some facilities also allow the lender to recall the loan outright.

5. The lender holds rights over your own policy

Once the policy is assigned as collateral, the lender controls what you can do with it. Typically you cannot take a withdrawal, take a policy loan, change the death benefit, or surrender the policy without their agreement. A policy you cannot adjust is a policy that cannot adapt as your circumstances change.

6. Unpaid interest compounds

Where interest is rolled up rather than paid annually, the debt grows against a policy whose cash value may not be growing as fast. The gap widens quietly for years before it becomes visible.

7. Underperformance and lapse risk

An indexed universal life policy credits according to index performance subject to caps and participation rates. A sequence of flat years is entirely possible. If the loan balance overtakes the cash value and the shortfall cannot be met, the policy can lapse, and a lapsed policy leaves you with no cover after years of interest payments.

8. Your beneficiaries receive less than the headline

The outstanding loan is settled from the death benefit before anything reaches your family. A $37m policy with $8m of debt against it is a $29m policy for estate planning purposes, and the debt figure is the one that moves.

9. Tax exposure if it unwinds badly

If a financed policy lapses or is surrendered with a loan outstanding, the position can crystallise a taxable gain. The tax treatment depends on your jurisdiction and the policy's structure, and it is the part of the arrangement clients are least often shown at outset.

10. The insurer's credit rating is a risk you do not control

If the life company is downgraded by a major rating agency, the lender can demand additional collateral or call the loan, regardless of how your policy is performing or how reliably you have paid. You are exposed to a third party's balance sheet. Where a facility is involved, insurer selection stops being a matter of product features and becomes a matter of credit.

What it looks like when the arithmetic turns

A professional partner referred a client to us — we will call him Mohammed — after his financing costs had moved beyond what he could sustain.

The position. Mohammed took out a universal life policy through a Singapore private bank at 39, with a $37,000,000 death benefit for his wife and two children. The policy credited a fixed 3.75% a year. The bank financed the premium at an initial rate of 1.75%.

What changed. By the time we met him he was ten years older, had moved to Dubai to start a business, and was paying the bank $277,000 a year in interest alone, close to $200,000 a year more than when the facility was written. Nothing about the policy had failed. The rate had moved, and the rate was the strategy.

What we recommended. Capital for Life reviewed the policy and the facility with Mohammed and his adviser, and proposed four steps:

1. Approach a different insurer for an indexed universal life policy, with returns linked to a blend of the Nasdaq 100 and the S&P 500 rather than a fixed credit.
2. Complete underwriting quickly, since a decade of age materially affects the premium.
3. Build an affordability schedule for a multi-pay structure with no bank facility behind it.
4. Reset the death benefit to $20,000,000, matching the cover he actually needed rather than the cover he had been able to borrow for.

The outcome. Mohammed took the new policy, surrendered the old one and repaid the bank. That removed $277,000 of annual interest, which made the multi-pay premiums affordable, and left him with a policy he controls outright.

The point of the case is not that the original advice was wrong when it was given. At 1.75% against a 3.75% credit, the arithmetic worked. The point is that the arithmetic was never stress-tested, and the death benefit had been sized by what the bank would lend rather than by what the family needed.

More client situations are set out in our case studies.

When premium financing still holds up

We arrange premium financing where it is the right answer. It usually is when all of the following are true:

• The premium is genuinely at seven-figure level and the client has the balance sheet to post collateral without straining liquidity.
• There is a specific reason the capital cannot be moved — an illiquid holding, a business that cannot be drawn on, a tax event triggered by liquidation.
• The structure has been modelled at rates several points above the rate on offer, and it still works.
• There is a written exit: how the loan is repaid, by whom, and on what trigger.
• The insurer is selected for credit strength as well as product terms.

Where any of those is missing, a multi-pay structure usually produces a better outcome for less risk. For the financing facilities we arrange directly, see Premium Finance and Loans.

Five questions to ask before you sign

1. At what interest rate does this structure stop working, and how far is that from today's rate?
2. On what triggers can you call for more collateral, and what counts as acceptable collateral?
3. What happens to the facility if the insurer is downgraded?
4. What are the total set-up and annual costs, expressed in cash rather than basis points?
5. What is the exit, and who is responsible for funding it?

If the answers are not in writing, the structure has not been tested.

Frequently asked questions

What is premium financing for life insurance?

Premium financing means borrowing the premium for a life insurance policy from a third-party lender and securing the loan against the policy. You service the interest rather than funding the premium from your own capital. It is arranged at seven-figure premium levels and typically requires a private banking relationship.

What are the main risks of premium financing?

Interest rate movement is the largest, because the strategy depends on borrowing costs staying below the policy's crediting rate. Beyond that: collateral calls, loss of control over the policy while it is assigned, policy underperformance and lapse, a death benefit reduced by the outstanding loan, and exposure to a downgrade of the insurer.

Which policies can be premium financed?

Permanent policies with a cash value the lender can take as collateral — indexed universal life, universal life and whole of life. Term assurance cannot be premium financed, because there is no cash value to secure the loan against.

Can I refinance an existing premium finance facility?

Often, yes. Refinancing can secure a lower rate or a longer term, and it is worth reviewing where a facility written in the low-rate years has repriced. Check the existing facility for early repayment charges first. In some cases replacing the underlying policy is the better route, as in the case above.

What happens if I stop paying the interest?

The lender can call the loan and, because the policy is assigned to them, realise it to settle the debt. That can mean the policy is surrendered and the cover ends. Where the shortfall exceeds the cash value, the liability does not simply disappear, and a surrender with a loan outstanding can crystallise a taxable gain.

Speak to a specialist

Capital for Life arranges both premium financed and multi-pay structures for (U)HNW clients and their advisers. If you hold a financed policy that has repriced, or you are being shown a financing proposal, we will review the arithmetic with you before you commit.

Disclaimer

This article is authored by Carlton Crabbe, Chief Executive Officer of Capital for Life, a specialist indexed universal life insurance broker. The information provided is for educational purposes only and should not be taken as financial or investment advice. Readers are advised to consult a qualified adviser before making decisions about life insurance or financing arrangements.