By Alain Theriault, October 21, 2014

Insurers are denouncing a scheme in which a third party pays the premiums on a life policy in exchange for giving the insured person a loan, often at a higher than average rate of interest. The lender is reimbursed at the insured’s death. Several companies are prohibiting their advisors from participating in these kinds of activities.

In this type of scheme, a policyholder buys a life insurance policy and, a few weeks after it is issued, the insurer receives a request to assign the contract to a financing company. The insured party receives a loan that is secured by the face amount of the policy and the firm financing the loan pays the premiums on the insurance contract. The lender has no relationship to the insured.

In memos obtained by The Insurance and Investment Journal, Manulife Financial, Sun Life Financial, Industrial Alliance, and La Capitale, as well as managing general agency PPI Solutions, have all denounced this practice. The insurers say they will not issue policies for this purpose. La Capitale, Industrial Alliance, and PPI have threatened to cancel the distribution contracts of advisors who may have participated in financing schemes. Manulife is asking its compliance department to investigate any advisors who have been a party to these kinds of transactions. Finally, Sun Life has not only forbidden its advisors from participating in these arrangements, but has also told them to encourage clients to seek legal advice should they decide to go ahead with a different insurer.

Non-recourse loan

A loan in which the insured’s premiums are paid by a third party is commonly referred to as a non-recourse loan or non-recourse premium financing. Should the amount of the loan exceed the death benefit, the beneficiary will not receive anything. In the reverse situation, the financing firm cannot require the loan to be paid off. The single object of value in the entire transaction is the life of the insured. “The loan and the premiums paid constitute a loan which may bear an interest rate of up to 12%. This loan will be paid off by the death benefit. All amounts over the loan, if there are any, will be paid to the designated beneficiary,” reads the memo from Industrial Alliance.

In its message to advisors, PPI Solutions notes that the kind of policy purchased with premium financing in mind tends to have a face amount of between $500,000 to $1million dollars. At death, all of the premiums paid by the financing company plus the loan of $25,000 or $50,000, plus capitalized interest, is deducted from the death benefit. The PPI memo also notes that non-recourse loans are made with unreasonably high interest rates. La Capitale’s memo observes that the insurance purchased for this purpose is often Term to 100 coverage.

Opponents to non-recourse premium financing arrangements believe that the scheme violates the principle of life insurance by allowing a third party with no insurable interest in the insured to become the policy owner.

Too good to be true

Karen Cutler is vice president and chief underwriter of retail and affinity markets at Manulife. In a memo, she notes that this scheme is presented to consumers as an opportunity to obtain a free insurance policy, and points to the old adage: “If it sounds too good to be true, it probably is.”

In her opinion, the principle of insurance requires that a policyholder be able to pay his premiums. She does not believe it makes sense to borrow money specifically to pay premiums on an insurance policy that was taken out for the purpose of pure protection. “The policyholder should have the resources to purchase it, based on the amount money he earns, and the face amount should be reasonable,” she comments.

While she is comfortable with the kind of financing offered by insurance companies that are based on the cash surrender value of a policy, she disapproves of non-recourse schemes, which she describes as high-risk financing. “This is a concept that does not require collateral on the loan and is sometimes presented as a way to get ‘free insurance’,” she says. “This non-recourse financing has many disadvantages to the lender and is generally offered at an interest rate that is higher than what traditional lenders would offer.”
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In its memo, La Capitale points out that there is a variation to this scheme. Rather than buying a Term 100 policy at the outset, the insured first applies for shorter term coverage and only exercises the right to convert to Term 100 after the policy has been assigned to the financing firm.

Cutler explains that advisors who are involved with non-recourse funding use lower-priced term insurance because they are trying to avoid the in-depth review conducted by underwriting for high-premium policies. “Then, without indicating their intention, they quickly exercise their contractual right to transform it into permanent insurance,” she says.

Industrial Alliancecalls it new. La Capitale says it appeared a few weeks ago. Sun Life says it became aware of it in a memo dated September 11. Christian Dufour, vice president of administration and customer relations for individual insurance and banking at La Capitale Financial Group, confirms that it is a recent phenomenon. “The scheme spread this summer, always from the same company and the same four or five advisors.” says Mr. Dufour. “We were issuing policies and not long after they were assigning them to this firm,” he revealed in an interview with The Insurance and Investment Journal.

He said he has spent a lot of time with his legal department looking at the issue to determine whether the practice is legal, or even profitable for the insurer. He also says he has discussed the subject with Industrial Alliance. “It’s perfectly legal, but it is neither a healthy practice, nor a profitable practice,” he says.

“There are a few of us who have agreed to modify our insurance applications accordingly. If your intent when applying for insurance is to pledge it as collateral for a loan in the next two to three years, for example, we may refuse to issue the policy,” warns Dufour. He has also received a call from one of his managing general agents who wanted to understand the scheme and know how to respond.

 Actuarial assumptions

The practice is not profitable for the insurer since it throws off actuarial assumptions. It keeps insurance in force for people who may not have the means to pay their policy premiums. “These insured people will have no interest in cancelling their policies because the premiums are paid and, moreover, they receive a sum of money,” comments Dufour.

In a typical case, he says that someone buys $1 million of insurance and then assigns his policy as collateral for a loan. “This person receives a lump sum that varies depending on age at policy issue. For example, $50,000 or a percentage of the annual premium. His premium is paid throughout the term of the policy. At the death of the insured, the financing firm is reimbursed and the rest goes to the beneficiary. If the person lives longer, it is the company that is taking a risk,” explains Dufour.

In his opinion, financing firms have been able to take advantage of the difference between the actuarial value of a policy and its cash value, which is lower. “If the cash value of your policy is $20,000 and a financing firm offers you $60,000, you just made $40,000,” illustrates Dufour. The actuarial value is based for the most part on the reserves set aside by the insurer, he explains. This reserve increases with age. Although it has no cash surrender value, a $1 million Term 100 policy issued when someone is aged 40 will have significant reserves should he or she reach age 90.