Are You Getting The Most From Premium Financing?

Key Insurance obliges the carrier and the insureds by financing the premium through Bay Budget Corporation, a wholly owned agency subsidiary that currently charges about 16 percent simple interest, plus up to $20 as a set-up fee, with as little as 10 percent down. The interest and fees don't add to much to the monthly amount the customers will pay, O'Neil says, and besides: 'The selling point is service. The customer usually just says, 'Where do I sign?'

O'Neil has been operating Bay Budget for 11 years, drawing on bank debt and internal funds for capital. Today the subsidiary earns a return that O'Neil will only say is in six figures. And while he knows not everyone wants to do this much premium financing, his rationale is convincing: 'You can easily make $50,000 or $60,000 with this.'

Key Insurance is unusual among agencies for its volume and the type of close-to-home premium financing it employs. Most agencies that engage in the business arrange financing only for Commercial policies, and most use an outside company to assume the risk and administer the program. But even then, premium financing isn't widely used. While there are no independent statistics, industry leaders estimate that just $12 billion, or less than 10 percent, of Commercial P/C premiums are financed.

It's not that agents don't know about premium financing: a PIA poll taken a few years ago found that nine out of 10 agents set up financing for some Commercial clients. Now, though, more agents are apparently following in Dick O'Neil's footsteps and going into business for themselves. As they seek ways to manage their cash flow more effectively, these agencies are trying to imitate on a small scale what the giants of the industry do as multi-billion-dollar businesses: borrow against receivables and lend against the unearned portion of the premium.

It's high finance that promises new profits, but there are risks beyond the obvious of lending to a customer. That's why agents must ask a few tough questions before they take the plunge:

• Is there a large enough untapped demand that I can fill?
• Do I have the skills to run a finance company that generally must be licensed, incorporated, located, and staffed separately from the agency?
• Am I prepared to assume the requisite financial risk?

Most agencies play it on the safe side. Julie Sizemore, Commercial Lines supervisor at the Murray M. White agency in High Point, NC, says her company has been arranging premium financing for Commercial accounts for more than 10 years. But they don't market the service aggressively: 'It's mainly a service to the customer,' she says, offered when the carrier or broker doesn't provide a payment plan. The agency, which uses Imperial Premium Finance for all its financing, normally doesn't guarantee the insured will pay the loan. For the most part, she says, 'There is really no risk for us at all.'

That's music to the ears of Imperial, the fourth-largest company in the industry. The California-based company handles premium financing for many PIA members' E&O coverage. Like O'Neil. Imperial's President and CEO Robert Cycon urges you to be more aggressive in selling premium financing. 'We tell the agent to prepare the financing agreement and present it along with every policy quote.'

Rex Hughes, vice president and partner with the Messer-Bowers Company, a $13-million agency in Enid, OK, is that aggressive. He'd rather strike a gusher than watch a slow dribble of commissions checks come in as installments are paid to the carrier. 'We try to finance everything and get our money upfront,' Hughes says.

Messer-Bowers draws on several premium finance companies to arrange deals for multimillion-dollar premiums, but the agency also does its own financing by borrowing from a local bank. 'We shop for the best rate just like we shop for the best price for coverage,' he adds.

When the agency obtains the financing from the bank, though, it must agree to full recourse if the insured fails to pay. Even so, there haven't been many problems. Says Hughes, 'We rarely have to make up any difference.'

Five years ago, the Insurance Systems agency of Brecksville, OH (now Commerce Insurance Systems) entered the premium business when it opened its own company, Priority Premium Finance. Today, $1 million of the agency's $7 million in Commercial premiums is financed either with premium finance companies or through the subsidiary's own line of credit at an Illinois bank. 'It provides profit to the agency and helps the balance sheet,' says Greg Hostelly, Priority's vice president of finance. 'Financing converts receivables into cash or a more collectible note.'

O'Neil is willing to admit that premium financing isn't for everyone. 'This isn't a business for people who aren't good managers. You have to follow the rules, monitor the accounts and collect the receivables.'

But if an agency is ready to enter the ring, there are many companies eager to lace up their gloves. O'Neil's Bay Budget Corp. was equipped with a premium finance software system developed by Streetwise Systems of Boca Raton, Florida. EASYSTREET generates contracts and bills, tracks payments, and issues overdue and cancellation notices. Written for PCs and Novell networks, the program is offered in three increasingly sophisticated versions for agents getting started, independent finance companies and multi-state operations. Prices start at $5,000, plus a monthly maintenance charge of about $150, and the company says more than 300 copies have been installed. 'We provide training, maintenance, and ongoing communications about market conditions and changes in laws and regulations,' says Joseph Hartly, a Streetwise vice president. 'We try to eliminate the pitfalls and ways to lose money.'

In the last year, for example, Streetwise opened a management company to operate finance companies for agencies that don't have the confidence, staff, or inclination to operate it themselves.

Similarly, Stewart Rosenberg, an agent and president of Premium Finance Associates of Baltimore, offers to set up agents in premium finance with a software package that he is continually customizing to meet emerging needs. Rosenberg claims 61 current clients, including agencies, managing general agents, insurers and several independent investors who provide capital for premium capital for premium finance.

Rosenberg has also lined up a major reinsurance company to act as a guarantor so that agents can borrow at close to the prime rate, like major corporations, and increase their leverage. He finds that agencies best suited for premium financing are those with strong niche markets where the policies are similar and a high percentage require financing. The volume threshold for entering into the business, he believes, should be about $100,000 for receivables, or $400,000 of premium to be financed. 'Our independent premium finance company has $22 million in receivables,' he says, 'and the late fees cover the payroll of almost $400,000.'

At Commerce Insurance Systems in Ohio, the premium finance subsidiary is structured to minimize its administrative burden on the agency. St. Louis-based Cost Financial Services does the bookkeeping, invoicing and collecting, and charges a fee based on the number of transactions and dollar volume. 'They came to us, having already arranged the financing, and said, 'All we need is you,' he recalls.

Yet, long-time industry players view agencies' premium finance subsidiaries skeptically. Paul Zarookian, senior vice president of A1 Credit, points out his company can borrow by selling commercial paper at the lowest market cost. The company-a New York subsidiary of AIG that is among the largest in the business-has recently offered rates from 4 to 13 percent, usually with 20 percent down and nine monthly payments. Deals for less than $75,000 are handled over the phone.

A1 Credit avoids asking the agent to assume financial risk. In fact, the company's standard contract is non-recourse to the agency. 'If there's a shortfall in payments, I don't want to come after the agent to collect,' says Zarookian, 'because that's who we're trying to sell our services to.'

Even when using a premium finance company, though, there is the risk having to return unearned commissions if there's a cancellation. And Zarookian identifies another risk: 'Short-term interest rates are low now, but we anticipate they're going to rise,' he projects. 'There is a rate risk in doing these loans, and you need the size and capital base to work with it. Most agencies don't have enough capital to do it, and they have to go to a bank, where their cost of borrowing is far higher.'

Which brings up his third objection: 'What else could you do with that capital?' he asks. 'Looking at the return for the risk, most agents would probably do better hiring another producer than going into a business they may not completely understand.'

At CIGNA's INAC premium finance subsidiary in Philadelphia, president Richard Skilton agrees. 'Agents should do what they do best, which is sell,' he says. 'We believe it's best for them to arrange premium financing and then step out of the picture.' With about $270 million of premium currently financed, INAC tries to win agents' business with competitive rates and responsive service. 'We offer quick turnarounds, electronic funds transfers, and direct access for account status information,' he says. The company is also putting software in agencies so agents can obtain quotes by computer. Agencies can also call the company for a quote.

Agent who are profiting from their premium finance ventures also recognize other market risks. 'The greatest fear is of the failure of a carrier for whom you financed a premium,' says Dick O'Neil. When that happens, he explains, 'The carrier has your money and the insured, on getting the notice of insolvency, stops paying off the loan.'

Still, some of those losses may eventually be made up by the state guaranty fund, says an optimistic O'Neil. 'Even with all the troubles we've had in Florida [in hurricane-related insolvencies], we've lost less than $1,000,' he says, 'and I expect to get half of that back.' But to minimize such exposures, O'Neil won't finance premiums for non-admitted or for excess and surplus lines carriers. He also steers clear of audited premium policies, since the insured may be handed a bill for more premium to pay for past coverage. If that happens, the bill could land in O'Neil's lap.

Strict procedures and attention to detail can greatly minimize the E&O risk from arising from an incorrect billing or cancellation, says Imperial's Cycon. 'If you make a mistake like that, it can cause a lot of grief,' he warns. Cycon also believes it's best not to spread your business among several finance companies. 'You might not want to put all you eggs in one basket, but if you bring more volume to one company, you can get better terms.'

Whatever level of risk agents accept in premium financing, there remains the question of whether it's a promising area to pursue. INAC's Skilton expects it to grow only with the market as a whole. Others, like Imperial's Cycon, believe several factors point to more financing. 'Insurance rates are soft now, and with low interest rates, the carriers aren't making as much on their investments, so we're beginning to see premiums go up,' he says. Furthermore, he predicts, carriers are likely to eliminate their own low-cost or no-cost premium financing programs in a hardening market.

Forecasts aside, though, the possibilities bear serious consideration. Agents with a clear eye for risk, a growing need to offer their customers financing, and a desire to fill that need (either through the established premium finance companies or by establishing their own) can accomplish a host of goals through premium financing. Like Messer-Bowers' Rex Hughes, they can build new businesses, earn more on their existing book, and get their money sooner.