Premium Financing Strategies (PFS) The Affluent and Corporate Markets Group

2 What is a Premium Financing Strategy?  Is designed to use other people’s money (lenders) to fund life insurance premiums for financially sound individuals, business entities and trusts  Leverages funds borrowed from a third party lender to finance life insurance premiums at a competitive interest rate  Includes the use of life insurance policy values as collateral A program that:

3 Why Premium Financing Works- “Cash Flow!”  Currently 1yr LIBOR is 1.30%. Prime Rate is 4.75%.  Assume Client borrows $500,000 at 3.30% (1.30% plus 200 bps) - his first year out-of-pocket cost for the interest is $16,500.  Assume Client is in a 39.1% tax bracket, and could earn 5% pre-tax on his $483,000 investment (difference in $500k premium saved and $16.5k interest gifted) or $24,150.  Client’s total out-of-pocket-cost for interest on the borrowed premium is only $7,650 for that year (interest expense minus investment earnings).

4 Types of Premium Financing Strategies  Basic premium financing strategy - borrowing only the premium client pays interest  Advanced premium financing strategy - borrowing both the premium and the interest.  Can be used with Split Dollar, Key Man, Section 419A(F)(6) plans, 412i Plans, Irrevocable Life Insurance Trusts (ILITs), (IDITs) etc.

5 The Basic Premium Financing Strategy  Policyowner is usually a trust, and applies for policy on insured’s life; normal life underwriting procedures  Policyowner provides Lender with financial documentation to underwrite financial eligibility (3 yrs tax returns and 3 yrs financial statements with ledger of approved transaction from AIG American General with PFS illustration.)  Lender performs credit review and financial analysis  Insurance policy typically used as collateral, with assignment to Lender  Lender requests additional assets of Borrower to be pledged as collateral  The lender will require the personal guaranty of the Insured

6 Basic Premium Financing Process  AGL underwrites and approves policy  Lender underwrites and approves loan (typically takes a minimum of 5 days)  Offer Sheet is sent to borrower for acceptance of lenders’ loan terms.  Borrower returns same with signature to lender  Lender provides Borrower with loan documents and formalizes loan arrangement (typically takes 3 additional days to close loan)  Lender provides premium to AG typically takes 1-2 days

7 How Basic Premium Financing Works Life app Loan application Annual interest Premium Assignment Policy Lender Life Insurance Policy AGL Borrower

8 Eligible Borrowers  Business entities - corporations, partnerships (including FLPs)  Trusts - ILITs, IDITs, revocable trusts, CRTs,etc The program is available to:

9 When to use a Premium Financing Strategy  An independent need for life insurance coverage exists, such as for business, estate or charitable planning  and  Cash is readily available for premium dollars, however, client chooses to leverage other people’s money and take advantage of the spread between the cost of the money and earnings on his investments  or  Client/Borrower wishes to take advantage of favorable interest rates to leverage current investments

10 Ideal Premium Financing Candidate  High net-worth client (typically has assets of $10 Million or more)  Good credit rating and solid financials  Sufficient liquid assets to be used as collateral  High annual premium policy (minimum annual premium is $100,000) For the basic strategy:

11 Tips on PFS Case Design  Before soliciting a prospect for premium finance sale, call Affluent Markets PFS Unit to discuss your client fact pattern and get an illustration(s) run that has potential to close from the beginning.  PFS not for everybody and does not fit all cases  Do not go in selling ‘no cost’ insurance. Every plan has a ‘cost’. If your ‘no cost’ plan does not work economically (many reasons) then you have no where to go.

12 Final Note on PFS Case Design  The goal is to make a sale of life insurance to solve the clients problem. Premium financing can open the door and expand the thought process with the advisors. The end result may be they finance it with their own bank or purchase the policy outright…….still a successful result!

13 Factors Affecting Premium Financing  Age of client(s) - Survivorships work best, can work at any age, but fact pattern for each client important  Interest rate - Annual rate will fluctuate but spread over libor established at outset will remain constant  Number of borrowed premium payments (single-pay and limited-pay scenarios can cap interest payments, subject to annual variable rate)  Type of product - works best with cash accumulation products if policy to be used for collateral(no VUL)  Available liquid funds for making interest payments and providing additional collateral

14 Life Underwriting  AG life insurance app and all normal underwriting requirements  Signed AG Life illustration  Signed premium financing strategy illustration To initiate the process, submit:

15 Lender requirements for Credit Approval  Lender’s credit application with copies of signed AGL illustration and premium financing illustration  Proof of entity: Executed trust document, articles of incorporation, partnership agreement (need before funding)  Last 3 years financial statements and 3 years of signed tax returns for both trust (if applicable) and insured/guarantor

16 Notes on Lending Process  Typically only premiums are borrowed  Each borrowed premium is usually considered a separate, annually renewable loan (interest rate may change each year, on total outstanding loan)  Each Borrower needs a premium loan repayment plan (ie. Exit strategy)  All lending decisions are made on a case-by-case basis  Affluent Markets does not make the decision to lend or not to lend money, up to the lender and borrower.

17 Notes on Loan Collateral  Lender will require 100% loan collateralization  Lender typically requires policy net surrender values as collateral via assignment of policy (Note: collateral assignment grants Lender an interest in both death proceeds and cash value)  Other liquid assets will be necessary as collateral if the cash value is less than the cumulative loan balance. Cash equivalents such as CD’s, money market accounts or Letters of Credit from local (approved by AIG) bank.  Diversified securities portfolio is acceptable at a 2 to 1 ratio.

18 Notes on Loan Interest Rate  Typically based on some banking standard, such as U.S. Prime Rate or London Interbank Offered Rates (LIBOR), plus a spread  Rates may fluctuate daily, so actual loan rate may differ from assumed rate on premium financing illustration, unless updated  Determine how long Lender will lock in rate, caps, etc.  Determine how interest to be paid - annually, in advance, etc.  Determine interest rate policy on renewals

19 Notes on Renewal Process  Give yourself plenty of time prior to anniversary date  Renewal is not guaranteed, so repayment plan may need to be implemented if loan is not renewed  Determine Lender’s policy renewal requirements and process in advance - timetable, applicable interest rate, financial underwriting requirements, collateral requirements, etc.  Usually have to provide Lender with current financial statement, tax return and policy statement showing net surrender values American General Life Insurance Company, Houston, TX

20 Premium Financing and AIG/A.I. Credit  A.I. Credit bases annual interest rate on LIBOR plus spread ( basis points)  Loan interest paid annually  Typically requires sufficient liquid collateral to cover 100% of the outstanding loan amount (collateral usually includes policy net surrender value)  Financial underwriting applied at renewal (need to provide updated tax and financial data)  Loan may be repaid over time, or paid at death of Insured or termination of policy

21 Notes on Borrowing the Interest  New Business must be informed of this - requires “forward underwriting” since death benefit expected to increase to cover additional “interest loans”  Note that borrowing the interest increases overall costs - there is a “cost” to borrowing the interest along with the premium loan  Agent/Policyowner/Lender will be contacted annually, 90 days prior to renewal to increase DB each year, in amount equal to actual interest charged on the outstanding debt. Increases will be made subject to the maximum allowable net amount at risk as determined at issue (maximum annual increase 12%).

22 Product Considerations - Indexed Products  Renewal Premiums on AGL Indexed UL products must be received on or before the policy anniversary date to be eligible for participation in subsequent year-end indexed interest bonus  Because loan renewal process may be delayed, Borrower/Client should be prepared to pay renewal premium and get reimbursed by loan  For this reason, be careful when using Indexed UL products for premium financing strategies

23 Product Considerations - UL Products  Low cost high death benefit UL with strong cash values  Since UL products are not considered securities and are not subject to margin-lending rules, up to 100% of UL cash values may be eligible for collateral  UL products that emphasize cash accumulation are ideal, since they may provide more collateral than other products.  Guaranteed death benefit products may also be used

24 Product Considerations - ROP Rider  Return of Premium Rider provides a Death Benefit equal to the Specified Amount plus the cumulative premiums paid  ROP rider assures that, if loan repaid at death out of policy proceeds, a basic death benefit will still be paid to the beneficiary, after deducting loan  ROP rider can offer additional reassurance to Lender  ROP rider available on most UL products  ROP rider will increase total policy costs

25 CPTI Endorsement and Honeymoon Provisions  “Change of Plan to Term Insurance” endorsement allows the policyowner, within the first 5 years, to elect to treat the purchase as term insurance from day one, with a refund of the investment portion of the policy  Using the CPTI endorsement, the alternative “enhanced” CSV may be enough “additional collateral” to satisfy lender  Use of CPTI endorsement requires that first-year annualized commissions be levelized over 5 years  “Honeymoon” provisions may also be available, allowing the lender access to the Accum Value upon Full surrender.

26 Premium Financing - Exit Strategies Premium loans can be repaid in several ways:  During life, from borrower’s available cash or liquidation of other assets  Use of special trusts (consult Affluent Markets)  During life, from policy values (will need Lender’s permission if Lender is assignee on policy)  At death, from policy proceeds (will occur automatically if Lender is assignee on the policy)

27 Income Tax Considerations  Interest on indebtedness to acquire or maintain a life insurance contract is generally considered personal interest and almost always nondeductible under IRC Section 163  Tracing rules disallow an interest deduction on loans disguised as investment or business purpose debt that are used to purchase life insurance  Loans used for premiums on key executive life insurance or for employee retirement benefits do not meet the trade or business exception under IRC Section 264

28 Estate Tax Considerations  Life insurance proceeds will be included in Insured’s estate if Insured owns the policy or possesses any incidents of ownership in the policy  Providing a personal guaranty on a loan has not been considered an incident of ownership in the policy, and should not, by itself, cause the proceeds to be included in the Insured’s estate  If a Trust borrows from the Insured to pay premiums, proceeds payable to the Trust are not included in the Insured’s estate

29 Gift Tax Considerations  If a person guarantees another’s debt, there is a gift if payment is actually required from the Guarantor  IRS has not provided guidance on those situations where there is no certainty that a payment will be required from the Guarantor.  Loans made by the Insured to a Trust for premium payments are not taxable gifts (However, there may be a taxable gift for the interest on the loan if no interest is charged to the Trust)  Opinion letters are available from Affluent Markets.

30 Special Advisory Note Premium Financing Strategies involve complex tax and legal issues Be sure to have your Client consult his or her Advisors for any legal and/or accounting advice The Advanced Sales Department is not permitted to provide tax or legal advice to you or your Clients However, we are available to work with you and/or your Client’s Advisors to answer questions and help implement any planning decisions

31 For Questions or Support... Affluent & Corporate Markets Group ADVANCED MARKETING & SALES SUPPORT / Premium Financing Support Prompt 4 Marie Large (x4608) David McMurray (x3390) © 2003 AIG International Group, Inc.