Premium Finance Industry Overview
rev June 14 2016
Premium finance industry origins
This premium finance overview, according to our information, Credit Club in Pennsylvania was the very first premium finance company that began around 1933. However, the premium finance industry in the United States got rolling in the 1950’s with the establishment of AFCO, originally the “America Four” company, owned by four insurance companies. Over the years, three of the companies sold their shares to the remaining owner, the Continental Insurance Company. Many years later, Continental agreed to sell and AFCO was acquired by Mellon Bank. Although there may have been other companies established earlier, AFCO has always been one of the first and one of the largest. In its infancy, the financing of property-casualty insurance premiums was a response to the increasing size of premiums and the realization that the insurance companies’ practice of allowing policyholders to pay for the policies with three or four equal payments and no additional charge ignored the time value of money.
When finance specialists focused on the insurance industry, it became apparent that insurance premiums could be safely financed if the terms and conditions were favorable. A property-casualty insurance policy has a finite life, usually twelve months, and a predictable earning curve, usually 1/365 per day (called pro-rata earning) or 1/365 per day x .9 (short-rate earning). Knowing that, and the cancellation provisions of the policy, a down payment and a payment plan can be established that will insure that the unearned premium remaining at any given time will be sufficient to pay off the balance of the loan, thus fully-collateralizing what amounts to an asset-based loan. And so the mechanics were established.
Industry Commodity
The insurance agents are the point of sale, producing premium finance agreements by financing the insurance policies that they sell. Although a few agents have been able to fund their own policies, the lenders generally supply the funding needed for the agents’ insurance policies. Agents use financing as another closing tool which benefits the policyholder who is strapped for cash, or who simply wishes to spread their insurance expense throughout the year.
Industry Development
Once the concept of financing insurance policies was accepted, it began to gather momentum through the Fifties and Sixties. The insurance agents could now offer another product to the consumer which enabled the purchaser to put up a relatively small sum of money (usually 20% of the policy premium) and spread the balance over the next 9 months for some nominal cost.
The terms of premium finance contracts (commonly called Premium Finance Agreements or PFA) always call for a down payment plus no more than nine or ten installments. This is done for two reasons: first, by making the financing term a little shorter than the policy term, a small “cushion” of collected funds is developed that helps insure that the balance due is paid off in case of cancellation, and second, it gives the insured a two-month break before he has to start paying for the renewal policy. This is a good sales tool for the insurance agent.
Upon execution, the finance company would advance the amount financed to the insurance company and send the insured a payment book. The result of all this was that the agent sold more policies, the insurance company received its premium up front (offering the opportunity for more investment income), the premium finance company earned a finance charge for performing the service and the insured got to pay for the policy over time. In return for advancing the premium, the finance company got a limited power of attorney allowing cancellation of the policy if an installment was not paid. Little has changed over the past fifty years as policies are financed today in much the same way. Many companies offer several billing options in addition to the payment book, including monthly invoice, ACH transfer, check by FAX and payment over the internet.
If the policy was to be cancelled, and the insurance company cancels on a pro-rata basis, the policy earns 8.33% of the premium per month. While the policyholder makes payments, a nine-month term collects about 8.8% (see below) of the premium each month in addition to the down payment. If cancellation is requested because the insured missed an installment, it will take another month to cancel the policy. If the insured made two payments then defaulted, the company will have collected 38.9% of the premium while only 32.9% had been earned. If the insured had defaulted on the first payment and it took 30 days to cancel, the 20% down payment would more than cover the 16.66% earned by the insurance company. (These examples ignore earned finance charges.)
9 pay with 20% down
|
Month |
Collateral/Debt Ratio |
|
1 |
110.56% |
|
2 |
112.55% |
|
3 |
115.28% |
|
4 |
119.10% |
|
5 |
124.67% |
|
6 |
133.29% |
|
7 |
148.02% |
|
8 |
178.01% |
|
9 |
269.00% |
|
10 |
0.00% |
|
11 |
0.00% |
|
12 |
0.00% |
10 pay with 20% down
|
Month |
Collateral/Debt Ratio |
|
1 |
110.54% |
|
2 |
111.14% |
|
3 |
112.05% |
|
4 |
113.39% |
|
5 |
115.39% |
|
6 |
118.43% |
|
7 |
123.29% |
|
8 |
131.79% |
|
9 |
149.35% |
|
10 |
203.18% |
|
11 |
0.00% |
|
12 |
0.00% |
It is easy to see that properly-structured PFA should always be fully-collateralized.
The loan structure was sound, but the insurance statutes of the time only required the insurance company to cancel at the request of the insured, not a finance company, and required return of the unearned premium to the insured, not the finance company. The statutory protection that premium finance companies enjoy today did not exist. The temporary answer was a series of negotiated side agreements between AFCO and hundreds of insurance companies in which the insurance companies agreed to cancel the policies if AFCO requested it and to return the money to AFCO. Thus financing was made available to hundreds of insurance companies without each having to establish its own premium finance company. As time passed, legislation filled the loopholes so that the unearned premium is now sent directly to the finance company and these agreements were found to no longer be necessary.
Production vs. Accounts Receivable
A note of explanation is probably required here. Premium finance companies are usually compared based upon the amount of accounts receivable that they own. However, due to the short-term nature of the loans, “receivables” do not equal “production”. Since most contracts are 9-month or 10-month contracts, the ongoing mechanics of the equation “current receivables = previous receivables + new business – payments received +/- adjustments “translates into: Receivables = 40% of Production or the converse, Receivables x 2.2 = Production.
For example, if a premium finance company books $3 Million per month in new receivables (amount financed + finance charges), production at the end of twelve months will be $36 Million, but receivables will be in the vicinity of $14.4 Million.) Variations occur due to the type of business, the frequency of cancellations and the particular market in which the agent operates.
Legislation
Since the Fifties, legislation providing statutory lending authority to licensed premium finance companies has been passed in 48 of the 50 states. Only Arkansas and Nebraska do not have premium finance statutes, although the existence of a statute does not necessarily mean the industry is fully regulated or tracked. These statutes set down requirements for licensing, capitalization, maximum rates that can be charged, cancellation requirements, administrative requirements, and, in some states, what kinds of forms must be used. Just as important, the statutes pertaining to the insurance industry were changed to instruct the insurance companies operating in that particular state that they would recognize the legal rights of premium finance companies and how, when and to whom money should be returned in the event that policies were cancelled. Insurance companies that do not comply can be subjected to regulatory or even criminal sanctions.
With the banks chartered lending powers, they can engage in direct and indirect premium finance lending without separate licensing under the various state premium finance laws, although there may be certain state qualification and/or filing requirements under general state corporate laws or premium finance laws.
Early Bank Involvement
Large money center banks such as Chase, Bank Boston and J.P. Morgan became involved in the industry almost from the beginning, typically providing lines of credit. This was mostly because large insurance companies dealt with large banks, and it was the large insurance companies that led the way.
Although the large property-casualty companies were predominant, others also got involved. Imperial Bank engaged directly for many years and finally sold off Imperial Premium Finance in the early Eighties. Imperial Premium Finance eventually merged with AICCO. Borg-Warner was a leasing and factoring company that wrote premium finance contracts directly for a number of years before closing the subsidiary.
Premium Finance Today
The landscape today is changing. There are approximately 1,400 licensed premium finance companies in the country. There are still at least six large premium finance companies financing over a billion dollars of premium, including AFCO, Imperial/A.I.Credit, Cananwill, Premium Financing Specialists, First Insurance Funding and Premium Acceptance Corp. But the number of small companies financing $5, $10 or $20 million has increased over the past two decades due primarily to the easy availability of professional software designed to manage premium finance receivables and cheap computers on which to run it.
Evolution Inc.(since 1979) led the way and created the first commercially available software for personal computers. When Evolution switched from DOS to Windows in 1993 it made it easy for anyone to process loans, including the agent. Most recently, the internet has become another marketing venue for many companies. Originally used only as a means for agents and insureds to look up payments and policy status, it is now becoming another way of selling premium finance agreements, reviewing accounts and making installment payments as state statutes become friendlier to internet commerce. Over the past several years it appears that most states have made the legal changes necessary to allow premium financing to be carried out over the internet.
The aggregate size of the premium finance market is a very difficult determination to make because there is no industry trade group or other organization that compiles nationwide statistics. Industry insiders state that the market is about $40 Billion in property-casualty insurance premiums that are financed each year or about $158 Million every business day.
Current Bank Involvement
Today, banks are more likely to be lending directly to the consumer than to be providing traditional revolving lines of credit but they typically do so through a wholly-owned subsidiary. Examples abound:
Premium Assignment Corp (PAC) is owned by SunTrust Bank.
UPAC was purchased by First Banks, Inc. of St. Louis.
Atlantic Bank of New York owns Standard Funding.
Westchester PF, part of Flatiron Credit, was purchased by Hudson United Bankcorp.
2009 AFCO buys Cananwill
BB&T, a North Carolina domiciled bank with a large investment in the property-casualty insurance business, owns and operates AFCO, CAFO and Prime Rate.
Wintrust, a group of 10 or more banks in Illinois has for years owned and operated First Insurance Funding; FIF exceeded $1 Billion in new business in 2003, all through the purchase of premium finance contracts. It is believed that they have started implementing purchase agreements with small premium finance companies which mimic a bank line of credit.
Wintrust also purchased Broadway Premium Funding and operates it independently.
Webster Bank owns the asset-based lending firm Webster Business Credit Corporation, the insurance premium finance company Budget Installment Corporation,
The daily purchase of premium finance agreements is, incidentally, how Flatiron Credit has managed the lines of credit it has provided to smaller premium finance companies.
Wells Fargo is connected to Flat Iron
BankDirect Capital Finance, a division of Texas Capital Bank, N.A. around 2005
Meta Financial Group, Inc. (NASDAQ: CASH), announces that on December 2, 2014, its bank subsidiary, MetaBank, completed the acquisition of substantially all of the commercial loan portfolio of AFS/IBEX Financial Services, Inc. read more...
Banks have several avenues of approach to the industry:
- Organize a premium finance company (or purchase one) and engage directly with the producing agents or managing general agents.
- Provide traditional revolving lines of credit to startup or existing premium finance companies.
- Purchase premium finance contracts from premium finance companies either in “blocks” (a one-time purchase in which the premium finance company receives a fee for servicing) or on a daily basis (similar to ‘b’ above, but the asset becomes the bank’s property, still serviced by the seller).
- Engage a third party such as Evolution Inc. who can help you structure a direct relationship between your bank and insurance agents.
Summary and Conclusion
Although the market is consolidating at the top, with mergers and liquidations reducing the number of super-large companies, it is fragmenting on the bottom, where better, less expensive software and computers are enabling new players to enter the market. And it isn't necessarily a zero-sum game for several reasons:
First, the insurance market follows its own cycle which does not necessarily move with the national economy. Despite a significant slowdown in the national economy since 2000, aggregate property-casualty insurance premiums rose 11.2% or $36.5 Billion from 2000 to 2001 and another $51.5 Billion (14.2%) from 2001 to 2002. No slowdown here!
Second, direct-bill policies can be converted to agency-bill policies so they can then be premium-financed.
Third, new products such as automobile warranty financing become part of the market as specialists figure out secure ways to finance them. We can help with this as well.
Fourth, governmental actions sometimes create new markets. A good example is the State of South Carolina who rescinded their state auto-insurance (assigned risk) pool several years ago thereby creating a brand-new nonstandard auto market in that state.
And finally, innovative businessmen can create new markets. Evolution Inc. enables any bank to quickly and easily establish new premium finance business relationships with agents, a truly revolutionary win - win development creating bank premium finance on a local scale.
There is still a great deal of opportunity. Find out how fast and easy this can be.