Premium financing is used in place of inflexible carrier installment plans or if the only option is payment of the annual premium in full. The latter is typically the case with the E&S market. By signing a finance agreement, the insured is agreeing to have the premium finance company advance the annual premium to the insurance company on their behalf. The insured is then given a payment plan from the finance company that includes premium and interest payments. If the insured fails to pay one more installments when due, the premium finance company has the right to request cancellation of the policy from the insurance company.
A finance company generates income by borrowing money at a certain interest rate from one source (i.e. a bank, private investors, etc.) and lending that money at a higher rate to policyholders that request financing. Profits from premium financing also include late fees and other incidental charges. The costs of forming and running a premium finance company include interest expense (i.e. cost to borrow the money), day-to-day administration and overhead, licensing and accounting expenses. With proper financial modelling and the commitment to promote the financing transaction, the income generated by a portfolio of premium financing loans can yield a considerable return on investment. Past experience shows that at a minimum, a captive commercial premium finance operation with average size premiums of $3,000 could realize anywhere from $20,000-$30,000 in income per year for each million dollars of financing. This number will vary depending on a variety of factors including the difference between the rate charged for funds and the rate paid for funds (i.e. the “spread”), the late fee income and how one chooses to administer the book of business.
Why captive financing?
The most obvious reason for captive financing is this: You (the agent) paid 100 percent of the cost to bring a deal in the door but failed to retain 100 percent of the potential income from that deal. In other words, you’ve left money on the table. Secondly, as covered above, the recent growth in premiums comes with the downside realization that insureds are strapped for cash to pay for their insurance and if they can’t pay for it, they may choose not to purchase it or purchase less of it—not a good outcome for the insured or the agent. Empowered with the ability to make decisions about your own finance company (as opposed to have terms dictated to you), your agency can solve a very important developing problem in a hard market.
How do you get started?
Every business has its minimums and premium financing is no different. The total amount of premiums that could be financed needs to be at a certain level to meet the start-up and minimum ongoing costs of owning a premium finance company. What that minimum is also depends on the total number of loans that would be financed in a given year and the interest rates that will be charged for each premium range are very important.
These factors can help make the financial forecast much clearer in terms of understanding the return one can expect. Companies can run a financial pro-forma for you for free to help you in this process.
Once a decision has been made to proceed, the first task to consider should be the acquisition of capital. Agents might be able to work with their local bank or lending institution or even have a servicing/software vendor introduce them to lending relationships that specialize in this niche market.