Author
Bowtie Team
Updated on
2025-05-28
Disclaimer: This article is translated with the assistance of AI.
Premium financing is becoming a hot topic online, with many discussions highlighting both its potential benefits and the associated pitfalls. What is premium financing, and why are there risks involved? To help you make an informed decision, Bowtie’s senior financial planner, Lam Ching-hung, breaks down the process, benefits, and risks you need to know.
What is Premium Financing?
Premium financing refers to using bank loans to purchase insurance products that have Cash Value , usually policies with a single premium payment.
Imagine a life insurance policy that requires a one-time premium of HK$2 million but is expected to grow to a cash value of HK$3 million in 10 years, yielding a net profit of HK$1 million. While such a policy may sound appealing, you might not want to use HK$2 million in cash upfront.
With premium financing, individuals can apply for a bank loan to fund the policy purchase. High Day 1 surrender value policies are particularly suitable for this strategy, as banks are willing to offer low-interest loans using the policy as collateral.
- For example, if a bank lends HK$1.5 million, you only need HK$500,000 in cash to purchase the HK$2 million policy.
- Over 10 years, the policy’s growth could yield HK$1 million in profit—effectively leveraging your investment.
This approach is similar to taking out a mortgage for property, where the buyer pays a down payment and finances the remainder through a loan. By using premium financing, you can maximize returns while reducing the upfront capital required to secure a high-value life insurance policy.
Bear in mind that, not all policies qualify for premium financing; they generally need to meet the following conditions:
- Policies paid in a single premium
- High Day 1 surrender value, typically 80% or more
- Issued by a highly rated insurance company
Why Consider Premium Financing?
Premium Financing: Boosting Returns While Maintaining Liquidity and Flexibility
Premium financing is a powerful strategy that allows policyholders to leverage low-interest loans to purchase life insurance policies, keeping their funds available for other uses. This approach improves liquidity, flexibility, and overall financial efficiency.
How Premium Financing Works: A Practical Example
Let’s revisit the example of a one-time premium of HK$2 million, expected to grow to a cash value of HK$3 million over 10 years. Without leveraging, the total return is 50%, with an approximate compounded annual return of 4%.
Now, let’s apply premium financing:
- Loan Ratio : Assume a 75% loan-to-value (LTV) ratio.
- Down Payment : The policyholder pays HK$500,000 upfront.
- Bank Loan : The bank lends the remaining HK$1.5 million.
- Profit : The policy still yields HK$1 million in profit, but now, with an initial investment of just HK$500,000, the total return skyrockets to 200% before interest.
Factoring in Interest Costs
Assume the bank charges an annual interest rate of 2%:
- Yearly Interest Expense : HK$30,000.
- Total Interest Over 10 Years : HK$300,000.
- Net Profit : HK$700,000 (HK$1 million profit – HK$300,000 interest).
- Adjusted Return : This results in a 140% return on the principal with an Internal Rate of Return (IRR) of 7.6% , far exceeding the original return.
Why Premium Financing Outperforms Direct Investment
Without premium financing, investing HK$500,000 directly in the same policy would yield a net profit of just HK$250,000, significantly lower than the HK$700,000 achievable through leveraging. This demonstrates the potential of premium financing to amplify returns while reducing the upfront capital required.
By carefully analyzing these factors, premium financing can serve as a powerful tool to maximize returns, boost liquidity, and achieve long-term financial success.
Benefits of Premium Financing
-
Leverage Lower Principal for Greater Returns
You can purchase a large policy with a lower principal to achieve greater returns. As the policy has guaranteed returns, and its value only increases, you can gain higher returns through leverage under relatively controlled risks.
-
Increase Flexibility in Fund Utilization
Through premium financing, you can retain part of the funds for other purposes, such as other investments or expenses.
-
Interest Only Repayment
During the loan period, you only need to pay interest, not the principal, reducing the monthly payment pressure.
-
High-Interest Current Account
Some banks offer high-interest current accounts similar to mortgage-linked ones. If you have idle funds, you can earn high interest and reduce loan interest expenses.
-
Simple Application Process
Compared to property investment, the premium financing application process is simpler and does not require handling through a lawyer. It also involves fewer fees, such as property stamp duty. However, because there is no professional lawyer to explain clearly, investors must understand thoroughly before making a decision. If in doubt, consult a professional and experienced financial advisor to avoid purchasing unsuitable products or incurring losses.
Risks of Premium Financing
Return Risks
- Rising loan interest rates will increase borrowing costs and reduce overall investment returns.
- If the policy currency and loan currency differ, there may be exchange rate risks.
- Some policy returns are non-guaranteed and may differ from expectations.
Borrowing Arrangement Risks
- The credit rating of the insurance company may affect your loan arrangements.
- Bank loans have a fixed term, and they may not be renewed after expiry, so ensure sufficient fund flexibility.
- Some banks will refer to the borrower’s TU (credit rating report), which may also affect future loan applications.
Why are banks willing to provide premium financing loans to policy applicants?
Banks’ primary business is providing loans, as long as they comply with risk management rules and have sufficient funds, they are willing to offer more loan services. Premium financing has existed in the financial market for a long time, but it was mostly available to private banking or high-end clients.
In the past, retail banks mainly focused on mortgage loans. Yet, in recent years, due to abundant bank liquidity, ultra-low interest rates, and intense competition in traditional mortgage business, more retail banks are offering premium financing services, lowering the entry barriers.
The Process of Applying for Premium Financing
1. First, submit a life insurance application to the insurance company.
2. Apply for a loan from the bank.
3. Submit all required documents and deposit the initial premium with the bank.
4. Wait for loan approval (generally takes about a month).
If the loan is approved, the bank will deposit the full premium (initial premium + bank loan) directly into the insurance company’s bank account. Once the insurance company receives the full premium and completes all underwriting, they will issue the policy and hand over the original policy to the bank as collateral. The entire premium financing application is then complete, and the policy applicant can make timely repayments.
FAQs About Premium Financing
1. What is P-rate/H-rate?
P-rate is a loan interest rate based on the Prime Rate , while H-rate is based on the Hong Kong Interbank Offered Rate (HIBOR). P-rate is more stable than H-rate, but the interest rate is higher.
2. What is the general annual return for insurance?
Typically, the net annual return rate for policies suitable for premium financing is approximately 3.5% – 4%.
3. Does the bank provide a ‘cap’ interest rate? If so, what are the benefits?
Compared to HIBOR, the Prime Rate is more stable. After the 2008 financial crisis, the US introduced quantitative easing (QE), leading to abundant global funds, and Hong Kong’s Prime Rate has remained at a low level. Even when the US raised interest rates in 2015, Hong Kong banks only adjusted P by 0.125% in 2018. Some banks’ H-rate plans offer a cap interest rate based on P, reducing the impact of interest rate fluctuations on investment returns.
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