Leveraged loans are risky, but that hasn’t stopped insurance advisors from touting them.
Life insurance that is sold as an investment is concerning, says Norm Ayoub, director, business advisory board at HighView Financial Group.
Read: Insurance loans carry risk for advisor
A leveraged loan occurs when a Canadian policy owner:
- leaves the cash or fund values that have grown tax sheltered in their whole life or universal life policy intact;
- no policy loan is taken, so no policy gains are assessed/attracted;
- the policy is assigned to the bank as collateral for a loan in the amount of the cash or funds value (or less);
- as a personal bank loan, no income tax is payable;
- if any of the borrowed money is invested “to earn income,” the interest on that portion of the loan is a personal income tax deduction;
- some believe they don’t have to make any interest payments on the loan because the death benefit of the life insurance policy will be enough to pay off the loan plus accrued interest.
Advisors often position the leveraged-loan concept as the ultimate living benefit of a death benefit product.
However, Ayoub warns, “Banks are cited as the lender in most (leveraged loan) cases of course. While the provision is certainly available, and some banks are presently providing the loans, there are considerations to be aware of, even if there are cash values that are guaranteed in the contract.
“Banks are not obligated to provide these loans and many will not accept life insurance products as collateral on these types of loans. In our experience, most banks will not allow this because the loan could be identified as nonperforming if at least interest is not being paid. This can result in the bank being taken to task by OSFI, the regulator, and penalized.”
Ayoub says advisors who want clients to use leveraged loans should ensure they have a bank ready to cooperate — and which has agreed to do so in writing.
Read: Talk to clients about leveraged investing
That being said, it is important to understand the policyholder must qualify based on their total financial situation. The bank can still say no if there is only a well-funded insurance policy as collateral, and the rest of the finances are not in good shape.
If this is a new arena for you, use an insurance specialist or a savvy insurance company wholesaler so that full disclosure is guaranteed.