Author: Jeffrey Kirk and Rupen Shah, Appleby Global
30 Jan 2015
What is premium financing?
Premium insurance financing enables HNWIs, family offices and companies to obtain life insurance at no or minimal cost by arranging financing from a third party to cover the cost of the policy premiums. Premiums for such affluent individuals can be expensive and they are unlikely to want to liquidate assets to pay for them. The underlying need for the life insurance may vary. For instance, it may be due to estate planning purposes, a corporate buyout and sale or the need for key person insurance.
Over the past five years, our experience has shown that premium financing is an exponentially growing financial technique
In a nutshell, the basics of premium financing are as follows:
- often a HNWI will settle an irrevocable life insurance trust (ILIT) or the HNWI will incorporate a new or utilise an existing investment holding company to act as borrower, policy owner and policy beneficiary;
- a lender bank provides premium loan financing to the borrower;
- the borrower utilises the loan to purchase a life insurance policy (the loan will either provide full financing or partly finance the purchase of the policy) from a life insurance carrier;
- there may be an arrangement between the insurer and the bank whereby the premium amount from policy will held by the bank to be used by the former for making investments. The insurer and the bank may enter into a discretionary management agreement whereby the bank or one of its affiliates will act as investment manager or advisor investing the money on behalf of the insurer. The customer will either receive a rate of interest upon expiry of the policy or on a fixed basis; and
- as security for the premium financing, at the very least, the bank will require that the borrower enters into an assignment to its rights under the policy, including the cash surrender value in favour of the bank.
Which banks, insurers and what life insurance products?
Over the past five years, our experience has shown that premium financing is an exponentially growing financial technique. Historically, premium financing has been utilised in the sophisticated life insurance sectors in North America and Europe. However, it is in the Asian market, which is undergoing a boom in the number of HNWIs, where we have seen the largest growth.
In essence, there are the types of banks involved in premium financing. First, the non-relationship banks that do not have an on-going involvement with the HNWI. Their aim is to provide the financing and earn profit on interest and fees. Consequently, these banks will have higher rates.
The second type is the relationship bank. These lenders are eager to build a relationship with the HNWIs and the premium financing is merely one additional product that they offer to these high-value clients. Meaningful banking relationships offering a myriad of products and services result in better pricing than that which is offered by the non-relationship banks. In particular, we work with a host of private banks based and operating in Asia that offer this type of relationship bank premium financing.
More often than not, the insurer issuing the policy is a Bermuda-domiciled life insurer underwriting business through its Asia-based offices. As a result there are several offshore specific issues to consider. Ordinarily, the life insurance policy will be Bermuda-law governed and as a result the assignment will be Bermuda-law governed. There are certain requirements under the various Bermuda insurance laws (in addition to any requirements stipulated in the policy) that must be complied with for the assignment to be valid. These legislative requirements include that the insurer must be provided with notice of the assignment and that any beneficiary irrevocable to the policy (i.e. an irrevocable named beneficiary in the policy) must consent to the assignment. The Bermuda Companies and Life Insurance statutes provide that the priority of security interests granted under any assignment of a life insurance contract is subject to the Life Insurance legislation. Accordingly priority of security interests is determined by order of giving written notice of the assignment to the insurer, rather than under the Companies legislation public security interests filing regime.
It may be that the Bermuda insurer is incorporated as a segregated accounts company (SAC) and that specific policy products or tranches of life insurance business are held within individual segregated accounts. SACs are useful in circumstances where an insurer seeks to take advantage of the legal segregation of reserves among different programmes and products. Such companies are not unique to Bermuda (for example they segregated portfolio companies are regularly used in the Cayman Islands), but they are not as common as regular incorporated companies. SACs allow for separate segregated accounts to be created, where each account will hold a separate set of assets/ liabilities, which are legally separated from the assets/ liabilities of another segregated account. This segregation is a statutory creature, and does create separate bodies corporate. The assets/ liabilities of one segregated account only relate to that segregated account. Therefore a creditor of a segregated account only has a claim to that segregated account, and no other segregated accounts of the segregated account company. When a counterparty borrower contracts with an SAC (on behalf of one of its segregated accounts), the SAC must identify which segregated account the contract applies to.
From the perspective of the banks providing premium financing in relation to an underling policy that is issued by an SAC, the bank needs to be aware of the implications of the SAC structure.
While the segregated account concept has been tested in the Bermuda courts, the question arises as to whether courts of other jurisdictions would recognise the segregated account concept. Such a question would require the assistance of local legal counsel, however the risk of ‘non-recognition’ usually relates to the recognition of procedural laws as opposed to laws creating substantive rights. In considering the viability of the segregated account regime, the Bermuda Law Reform Committee – which prepared the legislation in Bermuda – obtained advice from English Counsel. They sought to ensure that the provisions of the Bermuda legislation were substantive in nature (and not merely procedural) and so likely to be recognised and enforced by, at least, the English courts.
The insurance product policies, whether issued by a Bermuda SAC or non-SAC insurer include whole life, universal life and index universal life.
Investment options and opportunities for HNWIs
As noted previously, in our experience, the bank’s customer will often incorporate, or utilise an existing, British Virgin Islands (BVI) company (investment holding company) to act as borrower in these premium insurance financing structures.
Assuming that the policy is an investment-linked policy with no stipulated absolute death benefit, than the advantage of using a BVI company or an ILIT is that the HNWI may have a direct involvement in the decision as to which underlying assets and investments that the policy will invest into. Assuming the insurer is agreeable and, for instance, appoints the bank or one of its affiliates as an investment manager to manage the underlying investments linked to the policy, the HNWI is then in a position to direct that the financing provided is invested in securities, assets and other investments of the HNWI’s election. This is another mechanism by which relationship banks are able to grow the relationship with their HNWI borrower clients.
In situations where a BVI company is being utilised, it may be possible to register the assignment as a charge in the BVI. BVI companies are required to keep a register of charges, and any charges created over its assets must be registered. This register is either maintained at the BVI company’s registered office or the registered office of its registered agent. The bank should insist that the particulars of assignment are entered into the BVI borrower’s register of charges and a certified copy is provided to the bank. Further, an application may be made to the BVI Registrar of Corporate Affairs to register details of the assignment in the Register of Registered Charges as maintained at the BVI Registry of Corporate Affairs. For both the BVI borrower’s internal register of charges and the Register of Registered Charges, there is no time limit when details of the assignment need to be entered, and failure to enter the particulars will not affect the validity of the assignment. However, registering the assignment at the Register of Registered Charges does determine priority of security interest. Either the bank (through its BVI legal counsel) or the BVI borrower (through its registered agent) can register the assignment with the BVI Registry of Corporate Affairs. As this registration may affect the bank’s priority, we would recommend that its BVI legal counsel attends to the registration.
The future of premium financing
With the continuing growth of premium financing, in terms of volumes of transactions, types of insurance products being purchased, geographical spread and the increase in HNWIs globally, there is a good likelihood that substantially more focus will fall on these transactions in the future. This is likely to translate into greater competition between lender banks in the future and corresponding pressure on interest rates and fees levied. Similarly, long-term insurers globally are aware of the attraction of having their life products being utilised in premium financing and are likely to want to be able to expand their future product offering. This may, in turn, lead to greater regulatory oversight.
It has been our experience that the banks and the insurers are increasingly seeking the advice and services of offshore counsel and other professionals in protecting their interests in their specialised premium financing platforms and products, including both the Bermuda and BVI aspects.
Jeffrey Kirk is Managing Partner of the Appleby BVI office and Group Head of Appleby BVI Corporate and Commercial Team. He was based in the Appleby Hong Kong office until June 2014 and the Appleby Bermuda office until June 2009.
Rupen Shah is Corporate and Commercial Senior Associate at Appleby’s Hong Kong office.