Ian Jerrum offers a guide to the increasing number of brokers who in recent years have begun offering their clients the option of taking out premium finance via third-party finance providers
Simply put, third-party premium finance works like this: the broker arranges with the premium finance company for them to provide the funds to pay the insurer in full for the premium, or premiums, on a particular policy or combination of policies. The client then pays the finance company back in instalments.
The main benefit of premium finance to the broker is the additional source of income it provides - through some combination of commission and/or profit share from the finance provider and interest earned in the interval between receiving funds from the provider and forwarding them to the insurer.
Providing a premium finance facility also means that brokers can offer their clients the option of spreading payments over a period of time and/or paying for several policies with different insurers through a single payment. It can also help the broker cement client relationships by offering an additional valued service.
The downside is mainly limited to taking on a certain amount of additional administration, although as explained later, recourse can be a added burden.
To arrange premium finance for a client the broker needs the name of the insurer and the premium value and inception date for each policy. The premium finance company will want to know whether policies are pro-rata, short rate or minimum and deposit (M&D). Different finance companies have different additional criteria, for instance they might want to know how long the broker has known the client, or - for commercial clients - how long they have been in business.
The finance company will normally supply a rate card indicating the cost of a loan in flat rate and APR terms and what repayment options apply. While most premium finance loans are repaid over 10 months, sometimes loan periods of three, six, eight or even 12 months may be agreed. Often, the larger the loan amount, the better the flat rate and APR.
The client's cost of borrowing can often be lower than they could get from a bank because - to a greater or lesser extent, depending on whether the policy is pro-rata, short term, or M&D - the finance company holds a security in the form of the insurance policy.
Pro-rata policies are low risk for the premium finance industry because there is a returned premium to cover a loan. The less returned premium on the policy, the greater the risk for the finance company, and hence the higher the rate they will charge for the loan. Rates are therefore lowest for pro-rata policies (for example, most property and buildings) and highest for M&D (liability), where there is no return premium. Short rate policies, such as personal lines motor and motor fleet policies, fall somewhere in between the two.
Premium financing offers a number of benefits to both personal and commercial lines clients, for example convenience, flexibility and better cash flow management. The advantage for cash-strapped clients is obvious. However, even for cash-rich clients paying the premium in one lump sum may not be the best option. Cash flow analysis will often show that a client's money can work harder used in other ways.
While a policy purchased using premium finance can often offer a better deal to the client, the insurer still receives the same amount of money at the same time (when the policy is taken out), and may be able to sell a higher value package because of the less daunting payment terms.
The downside for the client is that if they fail to pay the finance company for a policy, it has the option of cancelling not only that policy, but also any other policies the company has, in order to recover the return premium. Brokers need to stress that - as with any other loan - if the client fails to make repayments on time, they leave themselves open to having the policy cover terminated.
One of the factors that differentiate premium finance providers is the issue of recourse. Recourse is a guarantee made by the broker that they will make good any losses resulting from non-payment by their clients. This originated and is mostly associated with personal lines policies where it should be easier for the broker to secure a return premium in the event of a client defaulting.
With recourse, the finance company will not seek repayment from the client or return premium through the broker, but will require the broker to pay off the balance of the loan. It will then be up to the broker to seek restitution from the client or more often the insurer if there is a return premium. This clearly involves a significant amount of extra work. So brokers need to consider carefully the trade-off between the generally better terms for recourse and the extra responsibilities assumed.
Every significant premium finance company in the UK has an electronic system for submitting business. These are generally live on-line systems. For personal lines, information is usually required for skip tracing (tracking down clients if they miss payments and do not respond). Integrated online systems streamline the process - saving time and eliminating errors - and provide a more efficient system for receiving approval and feedback.
The UK may have one of the most mature insurance markets in the world, but the provision of premium finances is still a relatively young initiative. Research suggests that only around 18% of premiums are currently funded by specialist premium finance companies, but the number is rising steadily and expected to rise more steeply in future. IT
Ian Jerrum is managing director of Searchlight Solutions