Episode #49: The Hidden Dangers of Premium Finance and How to Address Them

Episode #49: The Hidden Dangers of Premium Finance and How to Address Them

Premium financing has been a very lucrative path for agents to gain a significant amount of business from just a few cases. However, when dealing with huge amounts of death benefit and premium payments, the situation could be quite fragile. There are typically multiple parties involved in the decision-making process and it could be difficult to manage another voice chiming in that could sway the client elsewhere.

In this episode of Money Script Monday, Sal addresses the five dangers an agent had to overcome to win a $650,000 premium finance case.


 

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Video transcription

Hi, my name is Sal Mendoza, and welcome back to Money Script Monday.

Today, we're going to be talking about the hidden dangers of premium finance and how to address them.

What is Premium Finance?

But before we get started, what is premium finance?

Premium finance at the end of the day, is a funding mythology, kind of like, let's say that you are driving around and, your car was getting kind of old.

All of a sudden you're in the market for a new car, and you saw a beautiful BMW.

So, you went to the lot, you talk to the car salesman, and all of a sudden you find out that price tag is $50,000.

Well, at the end of the day, you have two ways of paying for that.

You can go ahead and liquidate some assets and pay $50,000 upfront, or maybe what you can do is go to your local credit union and pay that over the next six years.

And because you have a great FICO score and all the other factors that a bank is looking for, maybe you're paying a point and a quarter or a point and a half.

This way, you're not liquidating your assets and your assets are getting 9%,10%, 11%, 12% out in the market.

That's the same thing as premium finance.

The reason I decided to do the dangers of premium finance is, not too long ago, I was working on a very substantial case.

When I say substantial we're talking about a death benefit, 30 million plus, and very large premiums going into the policy.

Now, I was working with the vendor that we work with, who's been fantastic, and we had model it six, seven different times for the CPA and for the attorney because, at the end of the day, they have to write off.

If they don't agree, there's a chance you're not going to get this policy in force.

So, finally, we're getting to that stage, we were about to get that yes when all of a sudden, I get a call and it was a panicked call and it was from the agent and he said, "We have a problem."

And I said, "What is the problem?" He said, "Another agent is aware of this case and he wants to participate, and the client has said yes."

So, he was panicking. I was not panicking. The reason that I wasn't panicking is that I've been in premium finance now for a while.

I know the vendors out there, I know the carriers out there and, of course, the unknown was who the agent was, right?

So once I found out who the agent was I did some background on him.

And I knew who the carriers were in the space, and who the premium finance model was.

Once I knew who that was, and he gave me that information, I was not concerned anymore.

I knew that that premium finance model was very flawed from the inception because of the dangers and the risk that this particular company took in order to win the business.

Once we formulated a plan and we got the client, the CPA, and the attorney and we explained, we actually ended up winning the case, putting it in force.

The commission to that agent was over $650,000.

So let's move on a little bit.

Qualifications

We always want to talk about the qualifications of a client that is looking into a premium finance.

qualifications for premium finance

High-net worth

The first thing is going to be your net worth.

We have different kinds of models, but the model that I'm going to be specifically addressing today is the model that the net worth has to be at least $5 million.

Now, if that particular insurer is making $600,000, $700,000, we can drop that down to a 4 million net worth.

Let's say he's a doctor and he's been in school for a long time. Maybe it's only his fourth year and he's just ramping up the practice, we can get away with that kind of stuff.

Leverage

The second is leverage.

Usually, when you're working in that particular arena, that person needs to understand that we're going to be using OPM, other people's money.

In this particular case, we're going to be using money from a bank.

So, the client has to be aware that if we're going to be borrowing money from the bank, you're going to have to put up some collateral.

That's usually the way it works.

Annual review

Annual reviews are mandatory in premium finance.

This is not a transactional sale where you sell someone a 30-year term and you can say, "We'll see you in 30 years."

This is more like every year we need to sit down with the client, we need to go over the performance of the product and also find out if we're going to have to put up some more collateral.

Liquidity

If there is more collateral, we have to be able to have that liquidity immediately.

This is not something that is, "Hey, where am I going to borrow this money?" This money has to be attainable today if not tomorrow

Downside risk

Like anything else in the world of premium finance, look at it like in Florida.

In Florida, there is a stage-five hurricane that hits every once in a while. And when it does, we don't know where it's going to hit and when it's going to hit.

It's the same thing in premium finance, but it's called the economy. The economy, every so often, there's going to be a major pullback.

This particular premium finance has to be built with walls that are at least four feet deep.

When we build these, we risk model over, and over, and over so that it can take a beating from a stage-five hurricane.

Ability to pay

Lastly, which I believe is one of the most important things for the client, is remember the mechanism that I told you about the BMW?

He has the money that he can liquidate and pay it off or he doesn't want to liquidate his money.

He's going to go to a bank and borrow that money.

In premium finance, you want to have a client that has the ability that if the worst scenario came, he could still pull the money out of his assets and pay the premium and keep that policy in force.

Okay, let's continue to move on.

Premium Finance Dangers

Now, we're going to get into the dangers of premium finance, and the first is what we call the exit strategy.

1. Exit Strategy

premium finance exit strategy danger

The exit strategy is very, very important. There is a lot of different premium finance models out in the market today, but only a very few of them, have been tested.

The ones that are tested the best, are from a risk modeling perspective, are the ones that get out of the commercial bank as soon as possible.

In other words, they're going to pay the bank off in year 10, or year 11, or year 12 depending on the performance.

If everything works out, we want out within 10 years. We don't want like some of these models that the exit strategy is death.

There is so much risk involved in that.

2. Communicate

premium finance communicate danger

Communicating to the client about not rolling up interest is not only important from a verbal perspective, but we want to be sure that we actually get it in writing.

We don't want to be rolling up interest, we don't want to be any kind of associated with any kind of free insurance.

We want the client, to participate in that. In fact, we want to make sure that they're not only paying for it, but we actually want them to pay a little bit of principle.

In other words, we want them to pay all of the interest and just a little bit of the principle.

If we do that, we're able to bring some of the collateral that they're going to need down significantly, down to sometimes even 40%, 45%.

3. Levelized

premium finance levelized danger

The other thing we want to do is when we're building a premium finance model out, every year we're going to have to go back and we're going to have to ask for the interest payments.

The way we're modeling today is that instead of going every year and saying, "Hey, year one is $72,000, year two is going to be $87,000 and so on."

What we do is we take all that interest, we take a little bit of principle in this special math equation that we created, and then we simply divide it over 10.

Let's say it's $100,000.

It's $100,000 every year for the next 10 years before we exit the strategy.

Of course, if a stage-five hurricane hit this thing, it may require a little bit more, but it would have to be a very big stage-five hurricane.

4. Structure

premium finance structure danger

There's a lot of premium finance model companies out there.

And if you work with the correct one, we ensure that we've stress tested it going all the way back to the depression.

So, you want a company that can model that far back and still be safe.

5. Lenders

premium finance lenders danger

And finally, on the dangers is the lender.

You know, there's a lot of lenders in this space... 35, 42...I haven't counted all of them.

That's all they do, they specialize in letting clients borrow premiums for life insurance products.

But not all of them are created equal.

And the ones that we're looking for, of course, are the ones that have been around for a long time, 50, 75, 100 plus years.

Those that are publicly traded, and those that won't call the loan at any time.

So those are some of the dangers of premium finance. If you have any questions, feel free to contact us by phone at 1-888-LIFEPRO and we can walk you through our premium finance strategies. My name is Sal and thank you very much.

About Sal Mendoza

Sal Mendoza is the Vice President of Field Support at LifePro. He coaches hundreds of financial professionals on how to build effective financial strategies that achieve their clients' long term goals and helps them stay educated on the latest industry trends.

Disclaimer

This information is meant for educational purposes only.

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