Risks of Rising Interest Rates in 2022 for Life Insurance Financing

Over the last decade, premium financing life insurance policies have become increasingly popular.

Cheap bank loans, new lenders and life insurance brokers have fuelled this explosion in debt.

And high net worth clients have taken full advantage.

At one point, 83% of international life insurance policy sales were premium-financed, according to a study by Capital for Life. That study was done back in 2018.

Booming equity markets have given financed index universal life leveraged returns well into double-digit growth year after year.

Meanwhile, whole of life policyholders have benefited from arbitrage — that’s the amount their policy has earned (credited) vs the cost of their loan.

But the end of cheap borrowing is near. Interest rates are expected to rise.

So what’s causing interest rates to rise now?

One word. Inflation.

Labour shortages, rising wages and supply chain blockages are all causing prices to rise.

To counter inflation, interest rates need to rise.

The financial markets reaction…so far.

“Market expectations grow for early Fed rate hike as inflation rises” — Standard & Poor’s

“Federal Reserve moves up forecast for interest rate hikes” — CBS News

What is Life Insurance Premium Financing?

Life insurance premium financing involves getting a bank to lend you the majority of the policy’s premium. The bank takes your policy as collateral until you pay off the loan.

How Interest Rate Rises Will Affect Your Premium Finance Loan

Your borrowing will cost more. But how much more depends upon your lender, current interest rate and loan terms.

Premium Finance Loan Quick Checklist

1. What is my current interest rate?

2. Am I on a variable or fixed loan rate?

3. What are the terms of my loan?

Once you have these basic details, you’re in a position to find out how a rate rise will affect you.

It’s worth mentioning that, it’s also important to review your life insurance policy. If you need help with this, contact the insurance broker or financial adviser who sold you the policy.

Borrowing Rates

Most premium finance lending is in US$ accounts. Loans are priced against short term US Libor rates — typically 1-month and 3-month rates.

It means the variable part of your rate changes monthly or quarterly. In a rising interest rate world, you can expect to pay more for your loan each time this rate resets.

On top of this, your bank or third party lender will charge a margin. This margin is typically fixed but is reviewable by the bank.

Effect of Interest Rate Rise [Table]

Do you know how much more your loan will cost you? Here’s a quick ready reckoner table showing you how much you’d have to pay if you borrowed $1,000,000

Borrowing Increase

0.15% — $1,500 + margin

0.35% — $3,500 + margin

0.50% — $5,000 + margin

0.75% — $7,500 + margin

1.00% — $10,000 + margin

2.00% = $20,000 + margin

Now, let’s look at what you can do to protect yourself against rising interest rates

6 Strategies to Protect Your Life Policy from Rising Interest Rates

1. Best Lending Deal

If your current lending deal is coming to an end, look at your options. Even if you have some time left on your current rate, do some research now so you are prepared.

For more information, read our guide on the different types of premium financing loans for life insurance available.

But even if you’ve got some time left on your current deal, you may be better off with a rate switch.

There may be some fees to pay, but the savings could be worth it.

2. Fixed-Rate Loans

If you’re worried about rising rates, most lenders will allow you to fix your interest rate.

Urgent action is needed.

Speak to your existing lender and see if they will give you a longer-term fixed rate.

12 months is the most common fixed rate for life insurance premium financing.

If you want to keep your loan for years to come, you should ask the lender if you can have a 2,3,4 or even 5-year fix.

Do this now. Don’t wait.

3. Refinance Your Life Insurance Loan

Just like your home loan, you can always shop around for a better finance deal. And consider getting a fixed rate now.

4. Lombard Lending for Life Insurance

Lombard lending to buy a life policy is usually a cheaper alternative compared to traditional life insurance premium financing.

Banks are always on the lookout for high net worth clients.

If you have a portfolio of assets and take those to the bank, even better.

Ask the bank to lend you money against your investment portfolio. Rates are normally cheaper than borrowing against your policy.

You should be able to negotiate a good deal.

But make sure you know the terms of the loan before you sign up for a new account. Banks have a tendency to increase your loan rate after the first year.

5. Pay off Your Debt

Cash is NOT King.

Consider using spare cash to pay down your debt. After all, rising inflation will erode the value of your cash. Banks aren’t currently paying interest on cash deposits and it’s unlikely they will for at least a few rate rises.

Instead, put your cash to good use by paying down your outstanding loan before rates start to rise.

Over-paying your loan can be a smart strategy. You’ll end up paying less interest this way.

6. Portfolio Profits to Pay Off Debt

The last decade has not just brought historically low interest rates.

Investment portfolios have benefited from rising stock markets.

Think about taking some of those profits now, whilst equity markets are still high.

Use the profits to pay down, or even pay off, your life insurance policy loan.

7. Use High Yield Assets to Pay Interest Costs

If you want to stay invested, consider switching some of your portfolio to higher yielding bonds.

Use the higher coupons to pay for interest rate rises on your loan.

How to Prepare for Rising Interest Rates

The Good, the Bad and the Ugly

The Good.

Rising interest rates are actually good for life insurance companies. Insurers are heavily invested in bonds and cash. When interest rates rise, these assets tend to do well.

But interest rates can’t rise too quickly, otherwise bonds could get caught

The Bad.

It all depends upon Uncle Sam. If US interest rates start rising soon, life insurance premium financing rates will rise too.

It’s because all loans are linked to the US Libor interest rate.

And after decades of ultra-low rates, it’s started to move.

The Ugly.

Things could get ugly if rates rise too quickly. Borrowers who are used to low financing payments, will need to find more cash to pay their loan interest.

What Happens if I Can’t Meet the Interest Payments?

collateral may be required, and the loan will need to be repaid. If you are unable to continue making payments, you will be forced to default, and the collateral you put up may be forfeited. Because the collateral may include the policy itself, it is also possible that non-payment will lead to the cancellation of the insurance policy, although a similar risk occurs when paying the insurance carrier directly, as well.

Risks of a Loan Recall

“Please repay your loan within the next 90 days.”

What would you do if your lender asked you to repay your loan?

It’s not the sort of correspondence you want to get.

But lenders usually reserve the right to cancel your loan facility.

Or they can ask you pay down your loan. In lenders words, reduce your loan to value (LTV).

Here’s one bank’s small print for life insurance policy loans:

“the Bank reserves the right to increase, reduce or cancel the facility or any part of it at any time by notice to the borrower. However, if it occurs an event or a series of events which in the bank’s opinion that might have a material and adverse effect on the financial condition of the borrower, the facility may be modified, reduced or cancelled by the bank without prior notice.”

So, always have a Plan B. Be prepared for a bank to:

Reduce.

Recall.

Increase…..your life insurance loan.

Conclusion

Have a financial plan for rising interest rates. Consider what you would do if your lender recalled your premium financing loan.

Take action if you want a fixed-rate loan. The best-fixed rates are already being withdrawn as lenders prepare themselves for a new era of interest rates.

Work with your financial advisor or life insurance broker to consider your options.

Most importantly, act now.

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