What is universal life insurance premium financing and why has it become such an attractive solution for wealthy clients? It offers a perfect arbitrage, with benefits for intermediaries too.
Universal life insurance is a product that has recently found its way into the Swiss private banking scene and suddenly become a preferred liquidity planning tool for wealthy clients around the globe.
Yet this product is not entirely new, having been popular in Asia since the beginning of the new millennium, and even emerging in the United States in the late 1970s. Back then, it was a response to the need for a flexible life risk product.
What differentiates universal life from any retail life insurance product is its flexibility which means that it can be tailored to the specific needs of ultra-high-net-worth investors. However, the features that really catch the eye of wealthy clients are the attractive investment characteristics and liquidity value.
Perfect loan collateral
From an investment perspective, insurers pay the current interest rate but also guarantee a minimum rate. And from a liquidity standpoint, they will pay out the cash value at any time.
Indeed, taken together, these features make universal life products the perfect collateral for a bank loan. Insurance companies’ robust balance sheets, together with the access to liquidity at any time and guaranteed interest, give comfort to banks. Consequently, they are happy to take universal life policies as collateral.
In fact, universal life policies are often regarded to be as secure as cash, with banks often lending up to 90% of a policy’s cash value.
For example, typically a man in his fifties would pay a premium of approximatively USD 3.5 million to secure life cover of USD 10 million. Assuming that the policy’s cash value would be USD 3 million on its first day, the client could receive a loan from the bank of USD 2.7 million. That means the client would only need to pay USD 800,000 to arrange the life cover. But in most cases the full USD 3.5 million premium is financed by the bank, as it uses the client’s investment portfolio as security for the additional USD 800,000, meaning the client does not need to outlay any cash.
A win-win solution
The terms of the loan are negotiated between the client and the bank. They are typically those of the bank’s Lombard loan offering.
Today something like eight out of 10 new universal life policies are financed. The benefits for clients are threefold: they don’t use cash or liquidate investments to pay premiums, they can maximise the premium to life cover ratio, and they realise an attractive arbitrage between the cost of the loan and the higher insurance interest return.
What is the value for the bank or intermediary offering the policy? The fact that investments are not sold, there is no cash outflow, the Lombard loan is cross sold – and the policy acts as a bridge to the client’s next generation.