1. Presented by: Michael W. Halloran, AEP, CLU ®, ChFC ®, CFP®
Quad Cities Estate Planning Council
Financed Life Insurance with Exit Strategies
Presented by: Michael W. Halloran, AEP, CLU ®, ChFC ®, CFP®
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) (life and disability insurance, annuities, and life insurance with long-term care benefits) and its subsidiaries. Michael W Halloran is an Insurance Agent of NM.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

2. Background Large life insurance need Often a 6 or 7 figure premium
Insufficient gift tax capacity
Background on the use of life insurance in estate planning.
--Used to provide liquidity to help pay estate taxes.
--Other uses are based on non-tax objectives including equalizing inheritances, replacing wealth, etc.
To keep the death benefit out of the insured’s taxable estate, an irrevocable trust usually owns the policy (commonly referred to as an ILIT).
Premiums for the trust-owned life insurance are often paid by the trustee with money given by the insured. The gifts qualify for annual exclusion treatment through Crummey withdrawal provisions in the ILIT.
However, many clients can’t or don’t want to make cash gifts to an ILIT.
Some don’t have annual exclusion gifts available to cover the policy’s premium because:
--They are using annual exclusion gifts to transfer other property or
--The premiums substantially exceed available annual exclusion gifts

3. Background Client has $$ but must deal with gift tax limits or
Client wants flexibility
Client does not have $$ and wants to avoid selling assets
Other clients have annual exclusion gifts available, but want flexibility to get the money back that was used for premiums.
--Cash flow
--Financial instability
--Planning uncertainty
Finally, clients lack liquidity (business owners, hedge fund shareholders, etc.) to pay premiums.
Premium financing gives these clients options.

4. Life Insurance: The Basics
Single Life vs. Second-to-Die
Traditional Whole Life: portfolio based
Traditional Universal Life
New Money Based
Portfolio Based
Universal Life with secondary guarantees (“ULSG”)
Equity Indexed Universal Life
A single life policy insures one life and pays the death benefit on the insures death. A second to die policy insures two lives, but the death benefit is not paid until the surviving insured dies. This is often referred to as survivorship life. Single life policies can provide for a myriad of financial security needs. Survivorship life policies can also cover many needs, but in general are used to provide liquid funds for estate tax purposes.
These policies can be in various product types: whole life, universal life, and universal life with secondary guarantees. They will be reviewed further on the next few slides, but as noted above, there is a difference between Northwestern Mutual’s universal life and most other universal life policies in the marketplace. On Northwestern Mutual’s policy the basic design uses an interest crediting rate based on the company’s general portfolio. Most universal life policies use a new money basis which generally have been lower than the company’s portfolio return.

5. Traditional Whole Life
Insurance
$1,000
Benefit
At Risk
Let’s review how ULSG is different from whole life and universal life’s original design.
We all know how pure whole life works. There’s a fixed premium. It provides a guaranteed death benefit and cash value. By age 100, the cash value equals the insurance amount. Lifetime coverage is provided.
Cash Value $0 50
Age
100

6. Traditional Universal Life
Insurance
$1,000
Benefit
At Risk
Lapse
With traditional universal life, premiums are flexible. Policy charges are deducted from the cash value. If too little premium is paid, the policy charges can exhaust the cash value. The policy could then lapse.
Cash Value $0 50
Age
100
Results may vary by carrier

7. Universal Life w/Secondary Guarantee
Insurance
$1,000
Benefit
With universal life with secondary guarantees, even if the cash value becomes zero, the policy will not lapse if the stipulated no-lapse premium has been paid or the “shadow account” is positive and other rules have been followed.
The stipulated premium and shadow account are ULSG policy designs. The shadow account design is the most common. The shadow account is a company benchmark. It is calculated the same way as the cash value, but with more aggressive assumptions. It si referred to as a shadow account because the policyholder has no access to it.
The no lapse premiums for either ULSG design often appear to be too good to be true. They often are significantly below the non-guaranteed premiums for blended whole life policies or the current non-guaranteed premium to maintain coverage on a regular universal life policy.
At Risk
Cash Value $0 50
Age
100+
Results may vary by carrier

8. Equity Indexed Universal Life
Insurance
$1,000
Benefit
At Risk
Lapse
With traditional universal life, premiums are flexible. Policy charges are deducted from the cash value. If too little premium is paid, the policy charges can exhaust the cash value. The policy could then lapse.
Cash Value $0 50
Age
100
Results may vary by carrier

9. Extremely Low Guaranteed Premiums - How Do They Do It?
Lapse-supported pricing
Aggressive experience assumptions
Interest
Mortality
Expenses
Subsidies
Under-reserving
They are able to drive the premiums so low by incorporating aggressive assumptions.
One aspect is probably a lapse support. In other words a high lapse rate. Under this practice, people terminating coverage do not receive a fair market surrender value. The company is then supposed to use this ‘savings” to support the policy’s that persist. The problem is that sales for this product are concentrated in the estate market where our annual lapse rate is about 1%. These assumption being used may be as high as 4% in some cases.
The lapse support assumption becomes even more precarious given life settlement firms to which the policy could be sold to receive more value. The policy would then never lapse.
If the lapse support does not materialize, the company has a problem. How will it support a much the larger block of business than anticipated?
In pricing the guarantee, companies also assume a higher interest rate than the policy’s guaranteed rate and project improvements in mortality and expenses.
Another way to keep the ULSG premiums low is to subsidize the business from other products. One might then question purchasing other types of business from the company.
Last, through reserve regulation loopholes some companies have figured out how to hold below statutory reserve levels.

10. Financing Methods to Consider
Bank financing
Private financing
Private split dollar
Explanations of the financing arrangements.

11. Premium Financing Overview
Exit strategy
Regular bank loans
pay interest in cash
accrue interest
Personal (“private”) loans
Current trends: interest rates, estate taxes
Planning flexibility  lend, don’t give
Concept is simple-use someone else’s money to buy life insurance.
--Lenders charge interest
--Loans must be repaid

12. Bank Financing: How It Works
Lender
Interest
Loans
TRUST
Premiums
Life
Insurance
Policy IC
Overview of a bank premium financing arrangement:
--The bank lends annually to the ILIT.
--The trust uses the borrowed funds to pay premiums on a policy insuring the life of the client/ grantor of the ILIT.
--The policy is assigned to the bank as collateral. The bank often requires additional collateral and/or a guarantee from the client/grantor.
--The client/grantor typically gives money to the ILIT each year to pay the loan interest.
--The ILIT pays the interest to the bank. The payment is not deductible by the ILIT.
--The ILIT repays the bank according to the terms of the loan.
Gifts (= interest)
Client(s)

13. Bank Financing: Why Do It?
Lower out of pocket cost
interest < premium
Gift tax efficient
Other people’s $$
Minimize the need to sell performing assets
How the client benefits:
--The loan interest is lower than the annual premium. This lowers the client’s annual gift.
--The client avoids the opportunity, transaction and tax costs of liquidating another asset or redirects cash that would otherwise have been used to pay premiums.

14. Bank Financing: Risks & Drawbacks
Does it make financial sense?
Interest rates
Bank might not lend future premiums
Will there be enough death benefit?
What if lender takes the collateral (policy)?
Is grantor’s personal guarantee a gift?
Issues to consider:
--Positive arbitrage exists when the assets that would have been used to pay premiums return a higher rate than the interest cost charged by bank.
--The bank’s interest rates usually are tied to LIBOR.
--Bank may not commit to lending indefinitely or may call loan unexpectedly.
--If loans are to be repaid with death benefit, the amount of death benefit paid to the ILIT is decreased.
--Possible gift tax consequences of a personal guarantee.

15. Case Study: NM Survivorship UL
Married Clients, both age 50
$20,000,000 life insurance need
Goal: stop paying premiums in 16 years
Illustrated annual premium = $210,000
Lifetime gift exemptions exhausted
Some annual exclusions available

16. Annual Gift: Pay vs. Accrue Interest @ 5.0%
End of Year Pay Interest Accrue Interest
$ 10,500 $0
$ 21,000 $0
$ 31,500 $0
$ 42,000 $0
$ 52,500 $0
$ 63,000 $0
$ 73,500 $0
$ 84,000 $0
$ 94,500 $0
$105,000 $0
$115,500 $0
$126,000 $0
$136,500 $0
$147,000 $0
$157,500 $0
$168,000 $0
Loan interest example
--Where the bank requires annual interest payments, the ILIT typically pays with gifts from the client/insured. Assuming a constant rate of interest:
Year 1: $212,000 loan * .075 interest rate = $15,900 interest Year 2: $424,000 loan * .075 interest rate = $31,800 interest
--The client/insured can avoid making gifts to the ILIT to pay interest if the bank allows the interest on the loan to accrue. Compounding of interest increases the ILIT’s repayment obligation.
--In an increasing interest rate environment:
--Annual gifts for interest increase or
--Repayment amount increases (accrual)

17. Loan Balance: Pay vs. Accrue Interest @ 5.0%
End of Year Pay Interest Annually Accrue Interest
$ 210, $ 220,500
$ 420, $ 452,025
$ 630, $ 695,126
$ 840, $ 950,382
$ 1,050, $ 1,218,401
$ 1,260, $ 1,499,821
$ 1,470, $ 1,795,312
$ 1,680, $ 2,105,578
$ 1,890, $ 2,431,357
$ 2,100, $ 2,773,425
$ 2,310, $ 3,132,596
$ 2,520, $ 3,509,726
$ 2,730, $ 3,905,712
$ 2,940, $ 4,321,498
$ 3,150, $ 4,758,073
$ 3,360, $ 5,216,477
Example of the effect of compounding interest (assuming constant interest rate).

18. Private Financing: How It Works
Loans
TRUST
Premiums
Client(s)
Life
Insurance
Policy IC
Gifts (= interest)
Overview of a private financing arrangement:
--The client/insured lends money to the ILIT to pay some or all of the policy’s premiums.
-- The client/insured typically gives money to the ILIT each year to help pay the loan interest.
--To avoid estate inclusion for the client/insured, the loans are not secured by the policy.
--The loan can be repaid before or after the insured’s death.
Interest

19. Private Financing: Why Do It?
Lower out of pocket cost
interest < premium
Generally lower interest rate than bank loan
Gift tax efficient
Flexibility
How the client benefits:
--Reduces the client/insured’s gift from the premiums to the loan interest amount.
--Interest rate is typically less charged by a bank.
--Based on the Applicable Federal Rate (AFR) provided by the IRS.
--Depends on whether the loan is designed as a term or demand loan
--Saves annual exclusion and lifetime exemption gifts for other purposes.
--Avoids complexity and cost of a bank financed arrangement.
--Provides flexibility to handle changing financial, personal, and estate planning circumstances.

20. Private Financing: Risks & Drawbacks
Does it make financial sense?
Interest rates
Will there be enough death benefit?
Issues to consider:
--Client/insured must have the money to pay the premiums.
--Interest rate environment
-- Policy must be provide enough death benefit to meet planning objectives.
--How will the ILIT repay the loans?

21. Annual Gift: Pay vs. Accrue Interest @ 3.0%
End of Year Pay Interest Accrue interest
$ 6, $0
$ 12, $0
$ 18, $0
$ 25, $0
$ 31, $0
$ 37, $0
$ 44, $0
$ 50, $0
$ 56, $0
$ 63, $0
$ 69, $0
$ 75, $0
$ 81, $0
$ 88, $0
$ 94, $0
$ 100, $0
Loan interest example
--Where the loan requires annual interest payments. The ILIT typically pays with gifts from the client/insured. Assuming a constant rate of interest:
Year 1: $212,000 loan * .005 interest rate = $10,600 interest Year 2: $424,000 loan * .005 interest rate = $21,200 interest
(AFR is usually lower than rate a bank charges)
--The client/insured can avoid making gifts to the ILIT to pay interest if the loan allows the interest on the loan to accrue. Compounding of interest increases the ILIT’s repayment obligation.
--In an increasing interest rate environment:
--Annual gifts increase or
--Repayment amount increases (accrual)

22. Loan Balance: Pay vs. Accrue Interest @ 3.0%
End of Year Pay Interest Annually Accrue interest
$ 210, $ 216,300
$ 420, $ 439,089
$ 630, $ 668,562
$ 840, $ 904,919
$ 1,050, $ 1,148,367
$ 1,260, $ 1,399,118
$ 1,470, $ 1,657,392
$ 1,680, $ 1,923,414
$ 1,890, $ 2,197,416
$ 2,100, $ 2,479,638
$ 2,310, $ 2,689,638
$ 2,520, $ 2,986,627
$ 2,730, $ 3,292,526
$ 2,940, $ 3,607,602
$ 3,150, $ 3,932,130
$ 3,360, $ 4,266,394
Example of the effect of compounding interest (assuming constant interest rate).

23. Private Split Dollar: How It Works
Prem. Payments
TRUST
Premiums
Client(s)
Life
Insurance
Policy IC
Gifts (= term cost)
Overview of a private split dollar arrangement (aka “nonequity split dollar”):
--Client/insured pays premiums for ILIT-owned policy and is entitled to an amount equal to the policy’s cash value.
-- ILIT is entitled to some, but not necessarily all, of death benefit paid by the policy.
--Client/insured gives the ILIT an amount equal to the cost of the death benefit it controls. ILIT pays this amount to client/insured. This is based on term rates provided by the government (Table 2001) or the insurer.
--To avoid estate inclusion for the client/insured, the arrangement is unsecured.
--When the arrangement is terminated, the ILIT is buying the client’s interest in the policy. The purchase price is its cash value.
Term cost

24. Private Split Dollar: Why Do It?
Term cost < Premium
Term cost < Interest
Gift tax efficient
How the client benefits:
-- Reduces the client/insured’s gift from the premiums to the term cost.
--Term costs are typically less than interest costs making this financing arrangement less expensive than loans. However term costs increase with age.

25. Private Split Dollar: Risks & Drawbacks
Failure to terminate plan before:
CV significantly > premiums
Term cost gets too big (leverage is lost)
Does it work?
Issues to consider:
--Since term costs increase with age the cost of maintaining this arrangement also increases with age.
--As the policy’s cash value increases so does the amount to which the client/insured is entitled.
--Because client/insured’s interest in the arrangement will not be secured by, or necessarily paid from, the proceeds of the policy, the arrangement does not technically meet the definition of split dollar under Treasury regulations. This leaves some question as to the tax treatment of the arrangement.

26. Annual Gift with Split Dollar = Term Cost
End of Year Gift = term cost
$107
$127
$157
$201
$260
$332
$415
$507
$594
$673
$768
$905
$1,121
$1,442
$1,872
$2,416
Example of term costs for a second to die policy beginning at insured’s age 50.

27. Annual Gift Comparison
End Bank Private Private
of Year Financing Financing Split Dollar
1 $ 10, $ 6,300 $ 107
2 $ 21, $ 12,600 $ 127
3 $ 31, $ 18,900 $ 157
4 $ 42, $ 25,200 $ 201
5 $ 52, $ 31,500 $ 260
$ 63, $ 37,800 $ 332
$ 73, $ 44,100 $ 415
$ 84, $ 50,400 $ 507
$ 94, $ 56,700 $ 594
10 $ 105, $ 63,000 $ 673
11 $ 115, $ 69,300 $ 768
12 $ 126, $ 75,600 $ 905
13 $ 136, $ 81,900 $ 1,121
14 $ 147, $ 88,200 $ 1,442
15 $ 157, $ 94,500 $ 1,872
16 $ 168, $ 100,800 $ 2,416
Total $1,260, $756,000 $9,481

28. Exit Strategies Early death Cash value Other property:
Gift (forgiveness)
Sell assets
GRAT
Installment sale
Discounted gifts
Charitable Lead Trust
All of these financing arrangements require an exit strategy to keep the life insurance owned by the trust:
-- ILIT owes premiums to the bank or client/insured or
-- ILIT pays client/insured an amount equal to policy’s cash value
Possible exist strategies:
--Use the policy’s death benefit. This is difficult because date of death is uncertain.
--Use policy cash values. Affects policy performance. Often used in combination with another exit strategy.
--Client/insured gives assets to “fund” the ILIT.
--Excess annual exclusion amounts.
--Discounted property
--Leverage gifts through use of a split interest trust

29. The GRAT as an Exit Strategy
Allows client to minimize or reduce gift
Potential to remove appreciation from estate
Remaining GRAT assets pass to life insurance trust, which trustee uses to repay client for loans or split dollar payments
If bank financed premiums, trustee liquidates assets before repaying bank loans
Where client is considering giving assets to the trust to repay under a financing arrangement, a GRAT can be an effective tool.

30. The GRAT: How It Works Client(s) GRAT Ins. Trust $2,000,000 transfer
Transferred
Property
Client(s)
Assets remaining after 10 years ($4,480,261) pass to ins. trust
$236,860 = annual annuity payment for 10 years
How it works
--Grantor/insured establishes the GRAT and transfers property to it.
--The remainder beneficiary of the GRAT is the ILIT.
--The GRAT pays the grantor/insured an annuity amount each year for the number of years named in the GRAT (the term).
--The grantor/insured’s gift in the 1st year equals the value of the property transferred less the present value of the annuity payments.
--At the end of the term any assets remaining in the GRAT are distributed to the ILIT.
--The remainder amount can be used by the ILIT to repay an amount owed under a financing arrangement.
Ins. Trust
Repayment
Client(s)/
Bank

31. GRAT Assumptions $2,000,000 transferred to GRAT Annual growth = 12%
Annual income = 5%
Annual annuity payment = $236,860
No gift upon formation of GRAT (“zeroed-out”)
7520 rate = 3.2% (April 2018)
Remaining assets to insurance trust = $4,480,261
Keys to a GRAT:
--Assets transferred should be expected to outperform the rate (the government’s assumed discount rate). This creates gift tax leverage.
--A zeroed-out GRAT is one where the grantor/insured’s retained interest equals the fair market value of the property transferred to it.
--Valuation discounts may apply to the transferred assets.
--When using a GRAT to exit a financing arrangement, target the remainder interest to the amount owed under the financing arrangement.