-Partners in Practice -
INSURANCE MARKET UPDATE	APRIL 1997

Even in today's relatively soft market, the cost of professional liability insurance is a major line item in your overhead budget. The full annual premium is due on renewal, and the amount can be intimidating. Simply writing a check could do serious damage to your cash flow. Enter the premium finance company.

Premium financing is a reasonably cost effective means for spreading the burden of payment over time. Premium finance companies lend money (for the payment of premium) against security (the right to cancel the policy for non-payment), just as banks do. The value they add is a thorough knowledge of the insurance industry and a streamlined system for processing loans. They do not require extensive credit information (owing to the security they have in the policy).

 The financing agreement is a relatively straightforward loan document printed on two sides of a single page. It is prepared by your insurance broker after securing terms and receiving your instructions to effect the loan. The agreement is normally forwarded for your review and signature, along with a request that it be returned with the down payment. Once returned, it is sent to the finance company for payment of the premium on your behalf and issuance of payment instructions to you.

It is all fairly simple and straightforward, but in every financial transaction, there are terms for some and there are terms for others. They are worth knowing about.

Premium financing involves many of the same variables you would encounter with any other loan. Most are subject to negotiation, a process which usually takes place between the premium finance company and your insurance broker. Here are the issues of primary concern to you:

As a general rule, premium finance companies require down payments ranging from 20% to 30% of the premium financed. Competition can help drive this amount down. So, too, can a favorable perception of credit risk (but competitive margins are thin, so the tolerance for risk tends to be low).

Architects and engineers are good credit risks, and brokers who specialize in serving them are in a position to demonstrate this. They are also in a position to generate a large volume of loans to these good credit risks year in and year out. The result is a happy one: They are generally able to secure favorable terms, including a down payment requirement which is less than the company would need to fully secure the loan from the outset. It could be as low as 10%.

Even under the best of circumstances, a premium finance company is eventually going to want to control at least as much of your unearned premium as the outstanding balance on your loan. The unearned premium is the amount the finance company would receive from your insurer in the event it became necessary to cancel your policy for non-payment. Thus, payment terms for an annual policy are rarely, if ever, extended to a down payment and eleven monthly installments. Most often premiums are financed with payments due over a seven month period. For architects who have access to favorable terms, the loan can usually be satisfied in ten equal payments.

Rates quoted for premium financing vary widely. They depend on the amount financed, who the insurer is, how quickly the premium must be released, the credit risk, and the nature and quality of the relationship between the premium finance company and your broker. In today's interest rate environment, rates range from as low as 3% below prime for special programs to as high as 6% over prime. Under standard programs offered by most premium finance companies, large firms financing large premiums enjoy favorable rates; small firms often take it on the chin.

There is a solution to this problem. Brokers who specialize in professional liability insurance for architects and engineers typically negotiate blanket rates for firms of all sizes at the favorable rates available to larger firms. They are able to do so because the premium finance company is willing to look to the overall profitability of a high volume of relatively homogenous business, rather than apply a sliding scale, based on average profitability, on an account by account basis. Interest rates under these circumstances are more likely to range from 3% below prime for special programs, to prime plus 1 to 2%. Rates for the very largest firms are almost always negotiated on a case by case basis. 

How would you qualify for a rate 3% below prime? This requires a programmatic approach negotiated with individual insurers willing to assist their insureds with the payment of premium. By way of example, such an approach has been developed by a/e ProNet for ProNet members whose clients are insured in the CNA/Schinnerer program. 

It is not unheard of for brokers to charge a fee for arranging and administering the financing of premiums. Those who do so feel that the added effort justifies the additional compensation. Those who do not believe that to charge a separate fee for so modest a service would trivialize the value of the substantive services they offer. Most states require disclosure where a fee is charged. If you are not certain which path your broker is taking, you may want to ask.

The financial health of premium finance companies depends upon the promptness of the payments they receive on outstanding loans. Late payments are usually subject to a late payment fee. Under extenuating circumstances, brokers can secure a waiver of this fee on your behalf.

 Assume, for a moment, that your premium is $15,000, that the prime rate is 7.25% and that your broker has negotiated favorable terms for premium financing. Then go to Figure 1. It is a breakdown of the key elements of a typical premium financing proposal. A quick review will reveal how it works.

Premium financing is not for everyone, but it does serve a useful purpose. There is also a side benefit: It is a source of operating capital which is separate and distinct from your line of credit. Your premium can be financed without reducing the amount of credit available from your bank, and the rate may well be more favorable than the rate applicable to your line. It can be an option worth considering.