Financing of Life Insurance Premiums

Funding the insurance policy

As discussed in the corporate or personal ownership section, the insurance policy can be owned by a company or personally. The premiums can be paid through personal income sources or assets, or if the policy is owned by a company, through its annual cash flow, dividend income or through a transfer of cash reserves into the policy. Another premium financing alternative that has become prevalent over the past few years is the use of leverage by way of bank financing, which can only be used with a permanent cash value type of policy.

A term-to-100 type of policy with annual premiums payable for life is an annual expense. If the policy is cancelled in the future, the cost associated with the policy will be the accumulated premiums paid to that date. This type of policy cannot be bank financed.

A whole Life policy that has a cash value will be an asset, whether it be owned personally or within a company. Should the policy be cancelled in the future, the net cost of the policy is the total premium paid less the cash surrender value.

In the vast majority of cases, the premiums are financed from annual income, dividends or transfer of assets into the policy.

The “asset transfer” method of funding the premiums takes advantage of the tax-exempt investment opportunities within an over-funded Universal Life or Whole Life policy. In this “asset transfer” approach, tax-exposed investment assets are transferred into the tax-exempt investment pool of the policy, such that the tax-sheltered income eventually pays the cost of the insurance. If the policy is owned corporately, all or a substantial portion of the death benefit will be credited to the Capital Dividend Account, thereby allowing the funds, that were previously "tax trapped" inside the company, to be withdrawn tax free. 

Leveraged financing

There are also a variety of leveraged premium funding models that utilize bank loans to fund the premiums that are dependant, to a great extent, on the ability to use some element of interest deductibility arising from the resulting loan. One example of this type of arrangement was the “10/8” or “9/7” arrangements. In 2013, this leveraged life insurance arrangement was eliminated by way of a federal budget measure.

Any type of leveraged life insurance arrangement requires thorough investigation by the proposed insured, as well as an opinion from the proposed insured’s legal and accounting advisor as to its suitability. As a general rule, leveraged life insurance arrangements that assume a loan for the lifetime of the policy, should be approached with great caution, as many assumptions used to model the arrangement will change over time.

Whole Life and Universal Life policies that have a high early cash value can also be pledged to a bank that is providing financing. There may be a need to obtain through bank loans all or a portion of the initial premium amount. A future liquidity event may be anticipated which will pay down the loan balance. In the interim, the cash value of the policy will provide all or substantially all the necessary collateral for the loan.