Finance Insurance With Other People’s Money (OPM)

Succession Capital

Using other people’s money (OPM) with the intent to realize a financial gain is a financial concept that has been practiced by real estate developers, investors, business owners, and entrepreneurs for centuries. Most recently, this concept is being utilized to purchase life insurance, and has raised the eyebrows of insurance promoters and financial professionals alike. But, does this concept offer economic substance or is it just another sales tool to sell life insurance?[1]

Life insurance is an important part of any high net worth individual’s financial picture. Since adequate life insurance usually requires significant premium payments, the premium financing strategy can be an effective solution for clients who do not want to liquidate assets to fund their life insurance premiums.

Premium financing is a method of funding the purchase of life insurance for those individuals who have significant net worth and the insurable need, but do not have or want to use liquid capital to pay the premium on a life insurance policy.  By borrowing the money to pay the life insurance premiums with a loan, the insured individual frees up capital that can be used more efficiently.  The use of premium financing may lower out-of-pocket costs and potential gift taxes.

Most lender’s in this space base the current loan interest rate on the one-year London Interbank Offering Rate (LIBOR), adding a profit margin spread of 175 to 250 basis points. Essentially, lending rates are determined on a case-by-case basis taking into consideration the loan amount and the lenders’ risk exposure. Loan interest rates can be fixed on an annual basis, but may vary from year to year, based on fluctuations in LIBOR or changes in the borrower’s financial conditions, which must be updated annually. There was once a yen version that eventually went disastrous when markets changed and if an exit strategy was not built into the plan it could have cost the insured significantly.

There additional fees, such as loan origination fees (commonly 0.5 to 1.25%) of the expected total loan balance), associated with the loan that can offset any savings related to a low interest rate? Often times these fees must be paid up front while some lenders allow them to be financed with the policy premiums. In addition, is the interest variable or fixed, and if variable, how often does it reset? Typically, in most arrangements the interest is a variable rate, with a portion of the interest determined by an index resetting each year, but the spread on top of the index may be fixed for the life of the loan. The 12-month LIBOR is a common index as well as the prime rate. If there is a fixed interest rate, it is important to determine how long it will be fixed. In many instances the fixed rate is only for a certain time period such as five or 10 years. A cap will set on how high the loan interest rate can go during the loan term. So while the loan interest might be variable, there is a cap that will limit how high the interest rate can grow, such as 8%. When the loan interest has both a cap and a floor it is said to have a “collar.” The lender limits how high the loan rate can go, and the borrower agrees that the rate may never go a below a certain amount even if the index with the spread is below that rate. A cap by itself is more expensive than a collar, and the expense is usually expressed in a loan origination fee or in the amount of spread placed in the offer. Caps and collars are generally offered only in fairly sizable loan arrangements, generally in excess of $1 million.

The best candidates for premium-financed life insurance typically have a minimum net worth of $5 million.  Collateral for the loan usually consists of personal assets and can be reduced by the cash value in the policy being financed.

Plan highlights include:

· Target market: at least $5 million estate and a minimum of $100,000 annual life insurance premium

· Frees up business or personal investment capital for more efficient usage.

· Leverages available assets to provide needed insurance coverage with minimal out-of-pocket expenses.

· Potential to reduce gift taxes.

· Loan rate typically tied to a published rate like LIBOR, plus a spread.

· Required collateral can be offset by cash values growing tax-deferred in the policy.

· Can provide substantially greater internal rate of return on the life insurance policy death benefit over non-financed payment methods.

The power of premium financing lies within the same simple concepts related to the leveraging of permanent life insurance for estate liquidity and wealth transfer planning. The key is to evaluate premium financing not as a stand-alone transaction, but as an alternative to the traditional funding of life insurance using the same capital base.

The single greatest misconception is that the client must have an arbitrage opportunity for the financed transaction to provide a benefit over traditional funding. The power of premium financing is based on the leveraging effect created by combining the financing piece with a properly designed life insurance policy so one of the Secret Pillars predominates over the other.[2]

I have been involved in cases where it made sense to not drain cash flow and use leverage to accomplish payments of the life premiums. If the structure is designed properly it can have an exit strategy built in. There is one planning technique for families that have done no estate planning but are uninsurable and have healthy children. This planning tool is too technical to discuss here but if you’re reading this and know someone with over $10,000,000 of net worth without an estate plan and they have an illness, you can have them give my office a call.

Asset Protection Concerns for Hedge Fund Managers

We are currently in an economy where people are running scared and are uncertain. I also think there is a jaded perception where we never give thanks or gratitude for what we have and our fear and panic is all about loss of greed which is not useful. This type of environment leads people to always be dissatisfied with services and investments and many will go to the 12 person lotto (jury) via a lawsuit before you know it.

If anyone thinks I’m speculating just go to the web link at the end to review some of the ridiculous lawsuits and you’ll know we have become a country of whiners who expect to get paid from someone else based on our mistakes. Every month I go here because unlike much of the legal profession I’m for reducing lawsuit abuse Faces of Lawsuit Abuse.

Since my legal work is more about wealth creation or transfer than wealth deletion, we speak with many of the top financial firms and hedge fund managers. I have found in speaking to these financial professionals that many are concerned with being a victim to either a baseless lawsuit or one that could have been settled between the individuals. In times like this you can never satisfy investors when the market goes down or the investment does not work out as expected. It is difficult to perform your profession while a huge black cloud hangs overhead or you try to sleep after an investment tanks and you know the clients will be calling and accusing you of their financial demise as if you personally made the investment go down.

This is when a high quality and legitimate asset protection plan should be integrated into your overall risk management and personal estate/succession plan. All financial planners who advise clients on risk management owe it to their clients to do what they say and be a product of the product by having a proper estate and asset protection plan.

For clarification, asset protection is the use of risk management tools and legal strategies to preserve a person’s wealth so that it is not unfairly confiscated from them in a court proceeding. Because of the litigation lottery where predators go to the 12 person lotto (jury) and other fear and societal norms of solving problems with large pay days in court we see a rise in the abuse of the system and whether you win or not you’re a loser because you’ve had to pay to defend yourself at a cost of time, money and personal unrest.

A recent study of hedge fund professionals revealed that 39.8 percent had been involved in unjust lawsuits or divorce proceedings and 83.3 percent of hedge fund managers had a concern of their own personal wealth derailment through court proceedings. It should be said that it would be very difficult to get a jury of 12 people in this economy that would feel anything but contempt for a hedge fund manager or other wealthy person since they appear filthy rich and easily able to absorb the damages they caused to the poor person who is less fortunate. The case would ready like the quintessential “David meets Goliath” in the eyes of the jury since they are usually comprised of the folks who either don’t work or hate work so they are getting paid to be there by their company through a trial.

The cost of being caught with your pants down can be more than embarrassment and in some instances can wipe 0ut all of the hard work that went into building a business of a family legacy. It most attacks against you it might comes as a Pearl Harbor sneak attack or it might be something you knew was coming but failed to realize the gravity and that someone who thinks you’ve wronged them wants to be vindicated in dollars.

All this can be avoided and what we do every day is help folks incorporate proper tax and risk management strategies into their business, estate and retirement planning because you often do not get a second chance and by the time the complaint is served, it is too late to consider your options to save what you’ve worked for. I have had many professionals with practices they build up over a 20 year period see the light that it all could be lost if this person was to strike a chord with a group of 12 and take away everything.

I leave you with this thought – Q: If you have assets when might a good time to protect them be? A: Right now is the winning answer.

James Burns, Esq.

The Asset Protection Guy