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Insurance assurance: premium financing provides both a safety net for insureds and client service for agents and brokers.

Did you hear the one about the premium finance company that borrowed funds from itself to pay its insurance premiums? For those who don't quite get it, a premium finance primer is in order.

Premium financing is the practice of lending cash to a personal or commercial venture to pay its vital property/casualty insurance premiums in one lump sum, and spread the payments over the fiscal year.

Insureds like it because it frees up funds and allows for better cash management. Premium financiers like it because it's a win-win situation: The insured pays a monthly finance charge, and assigns them power of attorney to cancel the policies for nonpayment.

And brokers and agents like it because it enhances their insureds' ability to pay their premiums, said Albert R. "Skip" Counselman, president and chief executive officer of Riggs, Counselman, Michaels & Downes Inc., Baltimore. RCM&D sells commercial insurance and risk management programs.

"As many brokers do, we make premium financing available to commercial customers who have need for it," Counselman said. "In our case, we use third parties to do that; the majority of brokers use third parties. Some own premium finance companies and do the financing themselves."

RCMD is one of numerous brokers who offer premium financing via AFCO Credit Corp., Pittsburgh. A subsidiary of Mellon Bank, AFCO is one of the leading premium financing companies in the United States and Canada; its Canadian affiliate is CAFO Inc.

Premium financing is one of several sources of outside funding available for an insured beyond using its normal credit lines, said Counselman, who also is a director and former chairman of the Council of Insurance Agents & Brokers, vice president and director of Professional Agencies Reinsurance Ltd., former chairman and director of Assurex Global and director of the American Institute for Chartered Property Casualty Underwriters. The typical premium financing customer is a commercial insured that doesn't want to pay 100% of its property/casualty premiums at the inception date, in cases when an insurance company is not already offering a payment plan, he said.

"Premium financing created a tool so companies can finance their P/C coverage and pay over the year, as opposed to at one time," said Bryan Blakeman, a managing partner for risk management with Kaye-Bassman International Corp., Dallas. "If they don't pay, we drop the insurance." The largest premium finance concern is Cananwill, an Aon subsidiary, he said.

"It's an interesting tool," Blakeman added. "It's a very cyclical business; in a good economy, the cost of insurance drops. Premium financing becomes the focus in a hard market; there is less capacity and higher premiums by companies. It helps them to get insurance and cash flow over a 12-month period, as opposed to all at once."

Fill In the Blank

AFCO President and Chief Executive Officer Daryl J. Zupan likened premium financing to a "strategically correct entry" in a crossword puzzle: It fills in the blanks of a client's cash flow needs. It also creates an additional line of credit that doesn't impact a business' original line of credit, and customers don't need to make the initial cash outlay. AFCO clients range from small businesses to giant conglomerates.

"For a large company, some of these premiums are substantial; it's not uncommon to see premiums in the millions of dollars," Zupan said. "Even with our particular business at AFCO, our average-size account is probably larger than anybody else in the industry; our focus is on handling large complex transactions. A company could use that cash for other purposes and investments."

"It's very similar to going to a bank and taking out a loan," Counselman said. "The significant differences are most insureds have already done that for the operating of their business; if they also were to layer on top of that the amount they would need to pre-pay their insurance on time, it would impact their borrowing capacity and their ability to do business."

And unlike banks, premium finance lenders usually do not require any collateral for the loans other than the policies themselves.

"Typically banks will require other assets--usually machines, inventory or accounts receivable," Counselman said. "But premium financing can be done using the insurance policies themselves as collateral."

"Many commercial insurance policies are written by the insurance company on a payment plan, such as 24% down and three quarterly payments," he explained. While insurance companies once offered financed premiums in 12 equal payments, that's rarely done anymore because it does not create equity in the policy--if the insured walks away or cancels the policy, there's nothing left to cover the premium. And so insurers who do offer payment plans usually collect enough premium in the down payment to cover costs.

It's the same for premium finance companies.

"The premium financier has to collect enough upfront to cover about a 12-day period of time," Counselman said. A lender usually waits 10 days past the payment due date to consider the loan in default; it may add on a day or two for mail delivery.

"In theory, the way it works is the premium financier collects 25%; after 30 days--one-twelfth of the policy period--if they don't receive a payment for the next installment, they can cancel the policy," he said.

"Premium finance companies are likely to get all of it back. They're likely to cover all of their costs. It's a pretty secure loan and the interest rates are usually pretty attractive," Counselman said. "They're usually at prime [rate] or close to prime because it's generally not a high-risk loan. If a premium finance company has a very good system and knows to act right away when not paid on time, there's not much risk. If their system is not very good and they don't act quickly, then they have a big risk."

"I typically don't have to look at the financials of the borrower in most cases," Zupan said. "It's a very straightforward business. The contracts are one sheet of paper, front and back. It's basically a promissory note. But it also gives us the power of attorney to cancel their insurance for nonpayment."

The insured also assigns any unearned insurance premium refund to the premium finance company as security, said spokesman Ron Sommer of Mellon Corporate Affairs. If an insured defaults, the unearned premium held by the carrier is returned to the premium financing company, as required by law.

Premium financing is used to cover several lines of insurance: property, general liability, auto, workers' compensation, umbrella and excess policies, Counselman said. While standard insurance companies normally do provide premium payment plans, "The surplus lines market rarely provides premium payment plans" he added.

A Personal Start

Premium financing has its origins in the mid-20th century, when it was less focused on business and more focused on personal lines and consumer borrowers. General agents soon began to view premium financing as a means to increase profits and customer service. Before long the commercial market discovered it, and premium financing became a common tool.

One of the first large companies to have its own premium financing division was the now-defunct Continental Insurance Co., which spawned AFCO in 1952. The unit was sold to Mellon Bank in the early 1990s.

AFCO's premium finance business today depends upon its education of the agent and broker community, according to Zupan. "They're really our distribution channels; we're not selling this product directly to the borrower. Through educating the broker and agent, it helps even large borrowers understand the importance of their ability to finance the premium at a very attractive rate," he said.

The premium finance market is driven by external factors such as the prime rate. In December 2004 there was a 200-basis-point increase in the Federal Funds Rate, Zupan said. That's the rate banks charge each other for overnight loans to help satisfy the Federal Reserve's stockpile requirements. One hundred basis points equals 1%, so rates have gone up by 2% over the past two months. Since June 2004, the Federal Fund Rate has increased by 300 basis points, he said.

"It increases my cost of funds when I'm buying money, which impacts the profitability of the business," he said.

One of the mysteries of premium financing is just how much of it is out there in the industry at any given time: The percentage of premiums financed remains undetermined.

The premium finance industry is made up of "literally thousands of small companies," Zupan said. "It's a large market, but it's highly concentrated with key players." The top six premium finance companies represent roughly two-thirds of the total premium finance market; the top 10 premium financiers represent about 80% of the market, he said.

"On the commercial side, the larger P/C side provides about $200 billion in total written premiums," Zupan said. "Right now our estimate of the premium finance market is $35 billion, so we're probably financing over 15% of the total premiums."

"The business is very cyclical; probably a lot of it is driven by the P/C market," said Zupan, who's been with Mellon/AFCO for 28 years. He moved to the premium finance side at the end of 1997--which was the last year in which he saw a premium finance market similar to today's soft market.

Over the past two years or so, the industry has faced its most challenging environment in more than a decade, he said. In today's economy, companies are more liquid: Comparatively low levels of capital investment, despite low interest rates (by historical standards) are making many companies cash rich. And so companies tend to pay premiums in cash rather than financing.

"In the fourth quarter of 2000 we started to see prices firm and harden, more so in the P/C segment," Zupan said. After the Sept. 11 attacks, pricing started to increase dramatically. "Of course, the higher the premium, the more we finance. In the fourth quarter of 2003 we saw prices start to soften, and that continues into this year."

For insured parties taking property coverage, the rate for premiums has decreased as much as 20% since 2004, Zupan said. A company paying a premium of $1 million for property coverage in 2004 would have renewed in 2005 for only $800,000.

The premium finance business can also be counter-cyclical, Zupan said: "When the economy is doing fairly well, this business is probably not. We do better in a poorer economy."

Premium financing is highly specialized and requires "extremely good" knowledge of the insurance industry-all of the legal and regulatory requirements that oversee the business. More than 40 states have specific laws and regulations regarding premium financing, Zupan said.

"We're constantly being audited by someone," he said.

A minority of agencies do their own premium financing, Counselman said. "It's easier for a larger company. You need to have the working capital to be able to do it, so you can pay the premium and collect it back over time from the insureds," he said.

If premium financing one day dried up, and insurance companies did not provide any payment plan, a company would have to upfront 100% of its premiums.

"That creates the need," Counselman said. "If it were not available, they would have to use their bank credit lines, which they use for normal business operation. There would be less cash available for routine needs, such as funding accounts receivable."

Zupan expects to see increased activity from the 3,000 brokers and agents that AFCO calls on. "Contingent commissions are leading brokers and agents to seek more competitive quotes for their clients, so we are seeing activity pick up from that," he said. They also need to provide additional disclosure. "They are asking us to help them in that area as well."

For example, "Broker A" may typically refer all business to a particular premium finance company, providing one quote to their client. "Now with all the issues in general, they're more apt to seek a competitive quote from other clients to get the best option," Zupan said.

Despite a soft market, the outlook for this year is good. "We think things should improve in 2006. In summary, we will see premium pricing stabilize, if not increase, because of last fall's catastrophic hurricanes. We'll have a more friendly interest rate environment," Zupan said. "Our forecast from a Mellon standpoint is for only a few more increases in the Federal Funds Rate this year."

The economy also should continue to improve, he said. "Large companies should start to increase their capital investments. Hopefully, this will provide more opportunities with actual refinancing of the premium instead of paying cash."

Zupan said the premium finance market likely will continue to see further industry consolidation, especially with brokers and agents. He also projects a tougher market.

"There probably will be companies who exit and leave the business," he said.

Premium Finance Fundamentals

Premium financing is a contracted loan made by a lender to an insured party--personal or commercial to cover the insured's nonlife insurance premiums with monthly installments instead of one large payment. The lender can be an insurance company, brokerage or a dedicated premium financing concern. Many large companies have in-house entities.

1. Typical lines of insurance coverage financed include property, general liability, auto, workers' compensation, umbrella plans and excess policies.

2. The advantages for the insured include enhanced plan flexibility, an additional line of credit, consolidation of multiple insurance policy premiums, more funds on hand and affordability due to competitive rates among premium financiers.

3. If premium financing were not available, a company would have to dip into its bank credit lines to pay its insurance premiums and would have less cash available for routine business needs such as funding accounts receivable.

4. Several companies have their own premium finance companies. Among them are:

* Aon Corp., Chicago, owns Cananwill Premium Funding, Philadelphia.

* American International Group owns Imperial A.I. Credit Cos.

* Mellon Financial Corp., Pittsburgh:, owns AFCO (CAFO in Canada).

* SunTrust Banks Inc., Atlanta, owns Premium Assignment Corp.

* Independent Bank Corp., Michigan, owns Mepco Insurance Premium Financing Inc.

* BB&T Corp., Winston-Salem, N.C., owns Prime Rate Premium Finance Corp.

* 21st Century Holding Co., Florida, owns Federated Premium Finance Inc.

* The Rigg Group, Fort Worth, Texas, owns AFS/IBEX Financial Services Inc., Dallas.

* Insurors Bank of Tennessee, Nashville, Tenn., owns Insurors Finance Inc., also known as IBOT Finance.

* Anco Insurance Managers Inc. owns AIM Premium Finance, both of Bryan, Texas.

5. Premium financing is governed by individual state laws.

* California's Industrial Loan Law requires premium finance agencies to form a California corporation (or amend the articles of an existing California corporation) specifically for the purpose of offering premium finance services.

* In Texas, before an insurance premium finance company can finance a policy insured through the Texas Automobile Insurance Plan Association, it must disclose to the insured (or prospective insured) the payment plan available through TAIPA. It also must offer a comparison between the terms of financing the policy with an insurance premium finance company vs. the TAIPA payment plan.
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Comment:Insurance assurance: premium financing provides both a safety net for insureds and client service for agents and brokers.
Author:Cavanaugh, Bonnie Brewer
Publication:Best's Review
Geographic Code:1USA
Date:Mar 1, 2006
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