Insurance operations should think long and hard before getting into any type of lending. But consideration of premium finance must acknowledge not just money left on the table, but the opportunities, too.

A TIME OF TESTING—AND VINDICATION?—FOR PREMIUM FINANCE

Tech-driven vendors say they can help agencies reduce the risk and expense of financing premiums

By Joseph S. Harrington, CPCU

2020 could have been a very bad year for premium finance companies. The fact that it hasn’t been—at least not yet—may give agents and brokers added reason to consider establishing a premium finance operation.

Premium finance is essentially the use of borrowed money to pay insurance premiums. Like most financing, it generally involves having a lender (the premium finance company) pay a provider (an insurance company) the complete price for a product (a policy) on behalf of a buyer (an insured). The insured generally provides a down payment of 15%-25% of the premium and pays the remainder through a series of installment payments.

Premium financing looms large in purchases of life insurance, but this post focuses on its use in property/casualty lines.

Producers have heard for years how they might benefit from providing premium finance, either through interest income on credit they extend on their own, or through fee income collected from third-party creditors, where permitted. More importantly, premium finance allows some insurance buyers to purchase more coverage at higher limits than they would without it, thus generating more commission income.

[The] ability to expand a buyer’s purchasing power will be a valuable service to enterprises increasingly required … to have coverage for cyber losses, environmental liability, and a growing range of other exposures … in a market that is hardening for the first time in years.

It is undoubtedly the last factor, the potential for an incentive to sell more coverage than an account can afford, that has led many states from prohibiting producers from collecting fees for premium finance referrals. As a practical matter, agents and brokers have been forced to provide referrals at little or no charge or to accept the operational costs and regulatory headaches of establishing their own premium finance company.

Viability

Today, a new generation of technology-driven vendors claims they can help producers reduce the risk and expense needed to provide premium finance. Producers will decide for themselves whether and which vendors can make premium finance viable for their agencies and brokerages. Producers need confidence, however, that a premium finance initiative will not suffer an external shock to its basic economic model.

The COVID-19 pandemic could have been such a shock. The fact that it hasn’t been, at least not yet, is one reason among others why now may be a time for agency leaders who haven’t already done so to give serious consideration to establishing an in-house premium finance company.

David Gebhardt, chairman and CEO of COST Financial Group, a large premium finance manager, explains that premium finance companies fundamentally rely on their ability to cancel policies and reclaim unearned premium balances—their collateral—in a timely manner.

While some states have mandated extended grace periods for premium payments in 2020, Gebhardt reports he has seen no serious threat to the ability to cancel a policy for non-payment of premium. The basic economics of the business remains intact.

If this regulatory forbearance persists, there are other reasons why the time might be right for agents and brokers to consider a plunge into premium finance. As long as interest rates remain at historic lows, the returns on premium finance will be attractive compared to other investments of equivalent risk, especially given the short-term nature of P-C premium financing.

As stated above, premium financing can allow buyers to purchase more coverage at higher limits than they might otherwise be able to. Apart from boosting premium volume and commission revenue, this ability to expand a buyer’s purchasing power will be a valuable service to enterprises increasingly required under contract to have coverage for cyber losses, environmental liability, and a growing range of other exposures, as well as higher limits for commercial auto, general liability, and excess/umbrella coverage. All this coverage needs to be acquired in a market that is hardening for the first time in years.

Any insurance operation certainly needs to think long and hard before it gets into any type of lending. As of August 2020, we’re not out of the woods yet with COVID-19. But consideration of premium finance must acknowledge not only the money left on the table, but the opportunities as well.