【Premium Financing】Major Reveal of the Pitfalls — The Risks Behind "High Returns" Are... | 10Life

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In a low interest rate environment, premium financing with leverage is very popular — some insurance advisers even liken it to "buying property". But is premium financing really as attractive as it seems? What "pitfalls" should policyholders watch out for?

Premium financing refers to buying savings-type life insurance through borrowing, with the policy pledged to the bank as collateral. Loan-to-value ratios can be as high as 90% or even 95%, thereby achieving a high-leverage effect.

For example, if the policy premium (including prepayment) is HK$2,000,000, and the guaranteed annual return is assumed to be 3%, the interest return after five years would be HK$320,000. If a cooperating bank is willing to provide a 90% loan at an annual interest rate of about 1.2%, interest-only with no principal repayment, the expected total interest cost is HK$108,000. This means the policyholder only needs to put up HK$200,000 to obtain about HK$210,000 in net return (excluding fees), a total net return of 105% over five years.

In an optimistic scenario, premium financing can bring substantial profits to policyholders; but if the investment and interest rate environment reverses, it can also lead to significant losses. The underlying risks should not be overlooked:

1. Hong Kong may enter an interest-rate hiking cycle

The attractive side of premium financing is that it’s easy to arbitrage in a low-rate environment. For some popular premium financing schemes on the market, rates are calculated as 1-month HIBOR (H, currently as low as 0.1%) plus 1% to 1.2%, or Prime (P) minus 2.75%, taking the lower of the two, while savings insurance guarantees a return of around 3%.

However, the market expects the US Federal Reserve to raise rates three times before the end of next year, each by 0.25%, and thereafter enter a rate-hiking cycle. Assuming rates are raised three times per year until normalization, under Hong Kong’s linked exchange rate system, HIBOR in Hong Kong will gradually rise, and Prime may even increase, causing policyholders’ interest costs to go up.

2. Expected returns may fall short

The insurance example above is for a guaranteed return, but many savings insurance products that permit premium financing on the market are mainly non-guaranteed, or even have no guaranteed return. These "expected returns" often look very attractive and are a major selling point for advisers to attract clients.

But if expected returns underperform and Hong Kong enters a rate-hiking cycle, with rising interest expenses and lower-than-expected returns, losses can occur. Therefore, before buying, you must check whether the premium-financed product’s returns are guaranteed or non-guaranteed.

3. Advisers encourage refinancing property mortgages

Over the past decade-plus, local property prices rose substantially. Many insurance advisers have encouraged homeowners to refinance their flats to cash out and obtain low-interest mortgages. Suppose a homeowner successfully cashes out HK$3,000,000; the adviser then recommends using that HK$3,000,000 for premium financing. With 5x leverage (80% mortgage LTV), the premium could reach HK$15,000,000, and assuming a 3% return, returns over five years could easily double, effectively yielding HK$3,000,000 profit.

However, if market interest rates reverse, not only will the premium financing rate rise, mortgage rates will rise too, and the property could even become negatively geared. If the policy is surrendered it may incur a loss; moreover, if non-guaranteed returns disappoint, the combined effects can sharply increase the policyholder’s repayment risk.

4. If the insurer runs into trouble the policy can become "negative equity"

If the policy has guaranteed returns, its value is normally fixed. But if the insurer’s credit rating falls, it faces a liquidity crisis, or even collapses (i.e., credit risk), the policy value can drop. The bank’s lending facility to the borrower would then be reassessed and may require additional collateral.

If the policy’s value mainly comes from non-guaranteed returns, and the cash value performs poorly, the bank would likewise require additional collateral.

5. Policy rights assigned to the bank

Because the policy has been assigned to the bank (assignee) as collateral, the bank can effectively exercise rights on behalf of the policyholder, such as collecting payable benefits and requesting information from the insurer. If the borrower fails to pay loan interest, the bank can surrender the policy and take the surrender value, deduct the debt, and pay the remainder to the policyholder; if the surrender proceeds still do not cover the debt, the borrower remains liable for repayment.

If the insured dies while the loan is still outstanding, the bank can instruct the insurer to apply the death benefit to repay the loan first, with any remainder paid to the beneficiaries.

Generally, the policyholder must obtain the bank’s consent before exercising policy rights, including exercising cooling-off rights, changing beneficiaries, withdrawing policy account value, changing premium payment methods, etc.

Deficiencies in sales by banks and intermediaries

In fact, beyond the inherent risks of premium financing, the Hong Kong Monetary Authority and the Insurance Authority jointly investigated premium financing and published their findings at the end of September this year, discovering many deficiencies in intermediaries’ sales conduct. 10Life excerpts some of them here:

Excessive leverage

Normally, when granting premium financing, the borrower’s affordability test should consider the appropriate loan size. Yet some insurers and advisers used the loan itself as evidence that the client could afford it, resulting in over-leveraging. Insurers also did not verify which of the client’s existing in-force policies were having premiums paid, nor whether those policies were already pledged as collateral for other loans.

Insufficient supporting documents

When underwriting and conducting due diligence, insurers should request proof of financial capacity to show sufficient assets to repay. But often clients could not prove the funds came from "liquid assets" and instead relied on "illiquid assets", including property market value, life insurance cash values, joint account funds, etc.

Insurers even asked banks to declare clients’ asset levels, especially when the bank itself acted as an insurance intermediary. In practice, insurers accepted such asset declarations even when the bank had not provided the supporting documents. Some insurers became aware of clients’ other debts, such as overdrafts and mortgages, but chose to ignore them.

Risks not clearly explained

Premium financing means the client pledges policy rights and benefits to the bank as collateral to obtain financing, so clients need to fully understand the associated risks. However, some insurers only informed clients of the risks after issuing the policy or after the policy became effective, and risk disclosure statements did not require the client’s signature. One insurer issued a large number of premium-financed policies without obtaining signed risk disclosures. Some insurers incorporated collateral risk into the insurance proposal as a general risk disclosure, without providing additional warnings or explanations.

Mis-selling

Some agents bundled premium financing and the policy into a so-called "bank product" for sale. One agent even produced sales materials claiming the product was "no risk" and "the strongest term deposit", which is misleading. Other intermediaries presented premium financing merely as a payment method without discussing its practical implications, causing policyholders to overlook that actual returns could be lower than originally stated by the intermediary because some gains would be offset by interest.

Cooling-off period

In premium financing, the right to cancel under the cooling-off period is actually held by the lender (the bank), but insurers did not inform clients of this, which can be misleading and confusing. Also, once premium financing is drawn it immediately accrues interest even if the cooling-off right is exercised. Some banks, acting both as intermediaries and lenders, failed to inform clients of this interest cost during the sales process.

Understand the insurance product and financing terms

The biggest worry for policyholders is that, if banks and insurers allow excessive leverage to exist and clients willingly accept it to try to amplify gains, liquidity problems can leave them unable to repay.

Finally, before participating in premium financing, consumers must clearly understand the nature of the insurance product — for example, whether returns are guaranteed or non-guaranteed — and carefully read all the risks, including the risk of rising interest rates involved with borrowing. Insurance advisers and banks should also assess the policyholder’s financial situation and avoid encouraging them to refinance property and then enter into financing, which could lead to excessive borrowing.

This English version of this article has been generated by machine translation powered by AI. It is provided solely for reference purposes. In the event of any discrepancy or inconsistency between this translation and the original Chinese version, the Chinese version shall prevail.

10Life 編輯團隊

團隊成員由一群資料搜集員組成，主力保險相關資訊研究。

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10Life 編輯團隊

團隊成員由一群資料搜集員組成，主力保險相關資訊研究。

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【Premium Financing】Big reveal of hidden pitfalls — the risks behind "high returns" are...

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