In order to educate clients on the inherent risks of a premium financing program, it is important to “stress test” any plan proposals. Stress-testing may involve any of the following:
- Illustrating the plan using reasonable increasing future cost of borrowing
- Illustrating the policy with a lower than current crediting rate, we suggest using 85% of the current rate
- Illustrating the combined effect of 1 and 2
The best way to demonstrate the importance of stress testing your premium financing cases can be illustrated by using a real example. Highland was asked to opine on a financed supplemental retirement income design, using a leveraged indexed universal life product. The client, a male aged 40, was to borrow $200,000 a year for ten years, accruing 100% of the loan interest, and repay the third-party loan at the end of year 15. He would then take an income of $434,105 per year for 25 years, beginning year 26 via participating policy loans.
Quick math on the proposed plan design:
✓ $2,000,000 of premium borrowed
✓ $528,000 out of pocket interest payments by the client, amounts over $40,000 accrued
✓ $10,852,625 of tax-free income
✓ $3,157,092 of tax-free death benefit
What could go wrong?