Factors Involved in the Loan
The amount of the financing is normally equal to the amount of premium needed to fully fund a given policy. The loan may be fully disbursed to meet a single premium design or drawn in installments where premiums are paid annually. Some fees and the cost of purchasing certain risk reduction tools may be financed as well. The loan proceeds (premiums) are paid by the Lender directly to the Insurer as due.
The Lenders require that the loan be fully collateralized. To achieve this, the Lender is assigned a security interest in the death benefit and the cash surrender value (CSV) of the policy. To the degree that the CSV does not cover the anticipated principal due plus (perhaps) capitalized interest, additional collateral will be required by the Lender. This additional collateral is usually provided in the form of a letter of credit, cash, or other insurance policies. The amount of additional collateral will change each year and is driven by the schedule of disbursements and the cost of borrowing versus the crediting rates. Nonetheless, the amount of additional collateral is generally a small percentage of the loan balance.
Funding may be done in US dollars or other currencies based largely on the cost of borrowing. For the sophisticated client, the loan may be converted into any favorable index. Currency risk may exist for the account of the Insured absent a strategy to reduce or eliminate this risk.
Interest charged on the loan is generally comprised of a base rate tied to a benchmark rate such as LIBOR. The borrower has the ability to hedge against rising interest rates by using a 3 or 5 year SWAP rate. Added to the base rate is a bank spread which is typically fixed for the life of the loan. Bank spreads are kept low and vary depending on factors such as the size of the loan and whether interest is capitalized or not. Several programs allow for interest to be capitalized.
The average loan maturity is about 7 years but can be negotiated case by case. The requirements for interest capitalization and number of disbursements vary.
One time Origination or Arrangement Fees are common and may be financed in some cases. Fee amounts vary depending upon the lender.
