By Editorial Staff

Giving Your All

by Donald Jay Korn

Premium financing may allow wealthy clients to make huge charitable bequests with a checkup instead of a checkbook.

When the plans of a hospital in Cincinnati were threatened by the bear market, local insurance agents prescribed a creative remedy. "A major donor agreed to be covered by a life insurance policy that eventually will benefit the hospital," says Milt Liss, one of three principals at the Churchill Group, a Cincinnati-based insurance agency. "Neither the hospital nor the donor put up any cash initially, yet the hospital stands to receive at least $5 million."

The cash to pay for the insurance came from a loan, using a technique known as premium financing. Planners who work with ultra-high-net-worth individuals might want to explore such transactions, because wealthy clients may be able to enrich their favorite causes by literally putting their lives on the line without drawing heavily on their cash balances. All they need to do is volunteer to be insured.

"Premium financing is not for everyone," says Irv Blackman, who runs an accounting firm in Chicago. "You need a client who is acceptable in terms of net worth and physical health. In the right circumstances, these transactions may work well because they combine two tax-advantaged environments--life insurance and charitable giving."

Premium financing involves borrowing money to buy permanent life insurance, which then collateralizes the loan. "Some of the policy designs do provide a great deal of cash value up front, but there won't be 100% collateralization of the initial loan," Blackman explains.

So if $200,000 is needed to collateralize a loan, and the policy's cash value is $150,000, the other $50,000 must come from somewhere, perhaps from the person covered by the policy. Even if that person only puts up a bank line of credit as collateral rather than cash, there still must be sufficient unencumbered assets. "In general, lenders like to see that the insured individual has $10 million in net worth, including substantial liquid assets," Blackman says.

Moreover, $10 million might not be sufficient. "Some lenders won't enter into these types of transactions unless the insured individual has $25 million in net worth," says Jeff Tate, another principal at Churchill. "Few individuals will be that wealthy. However, many not-for-profits can meet that test, even after stripping away all the restricted funds in their endowments." Thus, a not-for-profit (NFP) organization may use its assets to help obtain the loan and the resulting insurance coverage.

This is the type of transaction that the Churchill Group has pursued lately. Although the agency has used financed life insurance to provide estate liquidity, in recent years its focus has shifted to charitable contributions. "These not-for-profits are facing tough challenges," says Bob Czerwinski, Churchill's third principal. "Their endowments lost lots of money during the extended bear market in equities. At the same time, some donors had less to give because of their own losses in the stock market. Yet many not-for-profits already had extensive commitments to expensive expansion plans, which they had made during better times."

So NFPs might be more receptive to innovative suggestions, and stock-struck donors may be willing to be insured for charity. "Typically, not-for-profits prefer to work with donors in their late 70s up to age 85 in these situations," Czerwinski says. "With younger individuals, the wait for insurance proceeds could take decades. At the same time, they must have a net worth at least double the net death benefit to the charity. They must be insurable and also willing to give up their insurability to the NFP." Czerwinski's firm has worked on at least one "rated" case (i.e., covering an individual in substandard health), but such cases leave less of a net death benefit for the NFP.

"In the case of the local hospital, they introduced us to an 80-year-old donor who already had contributed to that institution," Czerwinski says. "As a further contribution, she agreed to be the body used in this plan. The policies in these situations are fully underwritten, because the insurers don't want to take on unexpected risks, so she went through a battery of tests." She passed the tests with flying colors, and a $10 million premium was paid with borrowed funds on a $15 million policy covering this octogenarian.

At the time of her death, the loan will be paid off, and the hospital will receive a $5 million net death benefit. In a typical transaction, according to Churchill's principals, the net death benefit the NFP organization receives will vary based on the length of each insured individual's life, because the death benefit keeps growing as long as the insured individual lives. Low interest rates help to make the deal more attractive, while Churchill also looks for other ways to hold down interest costs, such as using yen-based loans.

"Getting a loan in yen pegged to LIBOR [London Interbank Offered Rate], rather than a dollar loan at the prime rate, makes premium financing less risky," Blackman says. "The key is to get a favorable spread between the interest that accumulates on the loan and the amount an insurance company's general account can earn. A yen-based loan will have a lower interest rate and a wider spread."

Lining up a low-rate loan, however, is just one hurdle that must be cleared. "These kinds of transactions are incredibly time-consuming," Tate says. "You need to meet with a not-for-profit's CEO, CFO, its board of directors, and various committees. Invariably, you run into someone who thinks it can't be done or can be done better. It's easier now that we've done this a few times, but writing the application is still much easier than completing the process."

Churchill has done five of these transactions, with initial premiums in the $3 million to $10 million range and net death benefits of $2 million to $5 million. Another 20 or so proposals are in the works; past and potential recipients include additional hospitals, religious groups, foundations, and zoos. "We've expanded to three other locations around the country and have a total of 25 agents working on these proposals," Czerwinski reports.

Not surprisingly, the prospect of being able to sell $10 million life insurance policies appeals to these agents. What are the commissions like on premiums this large? "We have given up quite a bit in terms of percentage," Liss says. "In general, our commission is in the 1% to 3% range with no trail."

So these deals seem to deliver the proverbial win-win-win. The donor gets recognition now for a major future gift (although no tax deduction if the donor pays no premiums); the charity locks in a generous contribution not many years in the future; and the insurance agent pockets a substantial commission. But does the insurance company also come out ahead at the end of the day?

"They have their underwriters, and they've determined that such arrangements make sense through their underwriting process," Liss says. "Someone might die before their life expectancy, but other policyholders will live longer, so the insurance company will get its money. People may think it is strange that a company will take $10 million and agree to pay $15 million on the life of an 80-year-old, but that doesn't seem as unusual to me as the idea that someone can buy a $500,000 term life policy for $50 a month. With these transactions, getting all the money up front is a better deal than collecting premiums over time for the insurance company."

Jim Gelder, president of individual insurance and specialty markets distribution for ING U.S. Financial Services, which has provided the insurance in such situations, affirms that this concept has a great deal of value. "In fact, ING created a finance company last year to handle these types of transactions," he says. Despite its enthusiasm, though, ING is approaching big-ticket premium financing with caution.

"If the leverage ceases to work, perhaps because interest rates go up, everyone can walk away," says Gelder, who is based in ING's Minneapolis office. "The donor and the charity can claim, no harm, no foul.' But the party harmed will be the insurance company, which has incurred substantial up front costs, including the sales commission."

So Gelder likes to see "some skin in the game," as he puts it. "We want the other parties to bear some risk if the policy doesn't remain in force," he says. "Someone should be paying the origination fees, which can be substantial, or the loan interest. For example, we've seen the donor make a deductible contribution to the charity, which can use the money to pay these costs."

While insurers try to ensure they're not the only risk-takers, charities also may want to appraise their vulnerability. "Many charities are uncomfortable dealing with life insurance, especially new policies," says Vaughn Henry, a Springfield, Ill., consultant who specializes in estate and charitable planning. "They've been burned in the past because promises haven't been kept."

What might the charitable beneficiary of a life insurance policy have to fear in a premium financing transaction? "If interest rates go up, the interest due on the loan will increase, and it may be necessary to put up more collateral," Henry says. "You can't assume that there will always be low interest rates to provide favorable leverage."

A planner's client may not be at risk if the charity is willing to pledge its assets, but that means the charity's assets are subject to a creditor's call. "In a worst case, money will have to come out of current programs to keep the policy in force," Henry says. "Yet there's no way to project what the charity will receive, or when the contribution will be received. In these transactions, the only fixed number is the commission."

Nevertheless, some charities are willing to work with donors, lenders, and insurers for a prospective future payoff. "We needed a body to insure," says Paul Ditlevson, director of legacy estate programs at Ashland University in Ashland, Ohio. "One of our donors, an 85-year-old man, agreed to give up some of his insurability for a policy where we're the beneficiary. He's considered a preferred risk because of his health, so we were able to get a $10 million policy with an $8 million loan."

The transaction was set to be finalized in October, according to Ditlevson. "The donor is pleased to be able to make a contribution that is beyond his assets," he explains. "And the insurance proceeds will help us to build an addition to our science center here."

If the insured individual is a preferred risk, he could live another 10 or 20 years or longer, thus delaying the payout. Is that a problem? "Even if he outlives his life expectancy by many years, the death benefit still will endow the science center," Ditlevson says.

Ashland University is so comfortable with this arrangement--and the promise of a future contribution--that it has obtained a letter of credit to serve as collateral. "We're guaranteeing the difference between the policy's cash value and the total collateral that's necessary," Ditlevson says. "This is a theoretical liability, off the books as long as there's no draw. It won't have an impact on our ability to borrow."

In effect, Ashland's donor is giving up some of his insurability by donating his good health now to the college. (His estate plan doesn't call for additional coverage.) Consumers generally can buy a lot of life insurance, as long as they don't buy too much of it. In the life industry, the upper limit placed on the ability to buy coverage is known as "capacity." A person's capacity will be based, in large part, on net worth.

Insurers and reinsurers say they look for financial justification for any life insurance that's purchased. As Kevin Warner, director of international and premium financing sales for ING U.S. Financial Services, puts it, "The industry wants to make sure that you're not worth more dead than alive."