Last year, my colleagues and I — who traditionally have focused on individual wealth management — devised a novel plan that uses leveraged life insurance to provide accessible capital to healthcare employers while providing a very meaningful cost-free benefit to its most valued professional personnel.
What is life insurance premium finance?
Life insurance premium finance provides financing, through the form of a relatively low interest loan, to a trust, which then uses the funds to pay life insurance premiums. Life insurance premium financing has traditionally been attractive to high net-worth individuals who would rather not liquidate well-performing assets to cover premium checks that can amount to several hundred thousand dollars or more a year. Life insurance premium financing has proven to be a welcome and beneficial solution for many of them. While this technique has been in existence for almost 20 years, it is not readily available at private banks, brokerage firms or even insurance carriers.
A novel idea
Last year we started to think about how life insurance premium finance could be used to assist hospitals and medical centers in raising funds for their pensions, endowments and other needs. We also wanted to create something that would help attract, reward and retain key physicians and executives, while enhancing the medical center’s balance sheet over time. After considerable negotiation with insurance companies and banks, we were successful in designing a plan that not only addresses these objectives, but also provides a permanent death benefit to key employees as well as “key man” protection to the employer.
Up until recently, group financed plans were not possible. That is no longer true. The maturation of the policies used (i.e. index universal life), new information technology, increased capacity and interest of banks and the carriers now allow hospitals and medical centers to adopt this proven strategy.
Late last year our partners concluded the first financed hospital transaction involving about 310 physicians and senior employees of a facility in Louisiana.
Leveraging employee benefits
A one-size fits all approach does not work in life insurance premium finance for wealthy individuals or medical centers. Each case is unique and depends on available resources of the institution and its stated goals and objectives. With that said, the following will attempt to broadly enlighten hospital and medical center presidents, trustees, CFOs and human resource personnel who should be considering this new approach. This article will also identify the essential ingredients needed to experience a successful premium-financed outcome.
The process and basic facts
- Engaging competent tax counsel from the beginning is always helpful. The CFO and Chief HR people need to work together.
- The hospital or medical group establishes a wholly-owned Irrevocable Life Insurance Trust. It is a bankruptcy remote vehicle.
- Employees earning at least $75,000 consent to having the Trust purchase index universal life insurance policies on their lives — typically for an amount equal to 2 to 10 times their salaries.
- Normally, guaranteed issue policies are used requiring no medical underwriting on the insureds.
- The plan can be discriminatory as to who is eligible to participate in it. ERISA rules do not apply.
- The Trust borrows funds from pre-selected banks to pay the premiums on the policies. Loans are typically priced at 1¾ to 3 percent over LIBOR. Actual interest rates will depend on the size of the transaction (bigger deals have lower funding costs) as well as credit rating of the life insurance carrier used in the transaction.
- No premiums are paid by the insureds or the employer.
- Interest on the loans is paid by the hospital or medical center through the Trust.
- Collateral for the loans is provided by: (1) the cash value of the policies that are assigned to the lender, and (2) to the extent the policy values are less than the amount of the loans, which is generally the case in the first few years, one or more securities accounts are pledged to the lender by the employer (or endowment) to cover this gap. When there is no longer a gap the collateral is released.
- The insurers that underwrite the policies are among the largest in the U.S. Indexed universal life policies are purchased because once cash is credited to the policies, the cash is guaranteed to remain in the account. It will not be reduced when the market declines.
- The policies’ cash values and face amounts continue to grow over time. Loans against the policies can be taken by the Trust for immediate cash needs, including the funding of non-qualified retirement income.
- When an insured passes away, a portion (usually up to 50 percent) of the death benefit goes to his or her beneficiary and the remainder to the employer (or endowment).
It is worth noting that each case is different and this outline is just one way of proceeding. An illustration of the cash flows, need for collateral, internal rates of return and other important details of a plan are generated based on an employer’s census data and reasonable assumptions. The number of insureds, amounts of the policies and their individual designs and performances will vary from one plan to another.
The risks
There are risks involved with life insurance premium finance. But that is true with any financial transaction. The risks, however, are manageable. If they were not, the major money center banks would not be so anxious to lend into this market at such relatively low rates.
The principal risk in premium finance is the need to monitor the interest rate levels relative to the overall performance of the policies. For this reason, it is important these policies are stress tested in advance and that the historical arbitrage between LIBOR and the index(s) being used is thoroughly understood.
What type of insurance is purchased?
As previously mentioned, the life insurance used in these arrangements is indexed universal life. With the low interest rates associated with these plans (normally around LIBOR plus 1 3/4 to 3 percent), a positive arbitrage can be anticipated over time between the borrowing rate and the performance within the index universal life policy.
Index universal life should not be confused with index funds. The index universal life that is normally purchased uses the S&P 500 Index to drive its performance. Many indexed universal life policies have both a cap and a floor on the crediting rate. The floors are typically zero to 3 percent, while current caps are in the 12 percent to 13 percent range. The crediting amount can never be lost or decrease irrespective of how the S&P 500 Index performs.
During the period 1930 to 2011, the S&P 500 Index averaged an annual return of 5.92 percent. If during that time the negative years were replaced with a zero percent return (as does index universal life), the average return would be 9.16 percent. The cost of the loans over this period approximated 6.35 percent (using LIBOR plus 1 ¾ percent) resulting in a positive spread of about 2.8 percent.
Politics
Often the biggest obstacle to structuring plans for hospitals is the involvement of too many people. A lack of financial perspicacity and/or decision-making authority can impede or even derail opportunities. A judicious and well-organized campaign by the employer’s CFO and chief HR officer can help circumvent many of these potential difficulties.
An innovative and cost-effective approach to raising funds for hospitals and medical centers, while providing some very attractive benefits to its physicians and senior employees merits serious consideration. Much of what has worked in the wealth management world can now be implemented to assist hospitals, medical centers and its most valued employees.
Kevin B. Murphy is managing director of Johnson & Murphy Wealth Advisors, LLC with offices in Bedminster, N.J., New York, N.Y. and Naples, Fla. He is President & CEO of Johnson & Murphy Insurance Services, LLC. He can be reached at Kevin@JMWAdvisors.com or 908-719-3025.
