Friday, October 19, 2018

Premium Financing: A Primer (From the P&C Files)

So the other day, I saw an interesting thread on Twitter about “Premium Financing.” It piqued my interest, and since we’ve never blogged on the subject, I asked the gentleman whose thread I was reading if he would mind explaining for our readers what it is and how it works.

Tim Randle is a Certified Financial Planner with 16 years’ experience in the financial services industry. He’s also an insurance agent, registered representative, and investment advisor representative, and lives in Alabama, with his wife, 2 kids, and 2 larger than expected dogs.

Take it away, Tim:

What is Premium Finance?

As a small business owner, I may suffer from being a bit of a control freak. Ever happen to you? With a financial planning firm that out of necessity grew its own insurance agency, we found using the available premium finance companies to be expensive and restrictive. How could we pick? Could we start our own? What were the rules on both?

To start, what is a Premium Finance Company (PFC)? At its root it’s a niche loan company that provides funding for businesses (and sometimes individuals) to purchase their larger commercial (business) insurance policies. If you’ve never purchased a commercial policy, you may be wondering “Why don’t they just select the monthly payment option like my auto insurance company offers?” Unfortunately, most commercial insurers don’t offer a periodic payment plan—and with premiums that can range from thousands of dollars to tens of thousands, it doesn’t always work well to put it on your credit card. On top of that, many companies don’t even take credit cards either…our recent investigation showed that it’s pretty typical for merchant services to cost 10 to 25 cents per transaction, plus up to about 2% of the amount charged. I guess they don’t mind paying the quarter, but the 2% of a $12,000 premium is painful! This is where premium finance companies (PFC) come in.

A PFC works by inserting themselves between the agent and the customer (insured). The customer typically pays 25% of the premium and all of the taxes and fees up front to the PFC. The PFC then pays any fees or taxes to whomever those monies are due, as well as paying the entire premium to the insurance company. The insured then pays back the PFC, typically in 8 payments starting the next month. If the customer doesn’t make their payment, the PFC has the right to contact the insurance company to cancel the policy. The PFC is hoping that the payments the customer has made plus the refund from the insurance company is enough to prevent a loss.

How to select a PFC:

As a customer, you want to take that one line that says ‘Fees, Taxes, Surcharges’ and see what’s buried there. Does the PFC charge a fee? Ok, that makes sense, I paid a mortgage origination fee…but is it a reasonable number? Does your agent charge a fee, and is it reasonable? What else is buried in there? If your agent waves his hand and says ‘taxes’ you should ask what the tax rate is and how it’s applied. Finally, there’s the service charge or the interest that the customer will be charged on the loan. Typically the larger the loan the lower the rate. High teens isn’t abnormal for low amounts, and I’ve seen as low as 8.5% on very large amounts. Some may be negotiable, some may not—a great piece of advice here is WORK EARLY. Some insurance companies give discounts for quoting policies several days before they go into effect. And if you decided you want to try a different agent or PFC, you may need a week or more to do it.

I hope that this helped you understand a little more about financing insurance premiums on the commercial side, and what impact the PFC is able to have on for both customers and agents.

Thanks, Tim!
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