How does insurance premium financing work?

QUESTION: WHAT are the pros and cons of premium financing? Our insurance agent recommended that we use it to pay the premium for our pharmacy.

- S.K.L., St. Ann's Bay P.O., St. Ann.

ANSWER: Banks and finance companies lend money to consumers to pay their insurance premiums. It is big business. If 20 percent of the non-life premiums were funded by these companies, the total amount involved, excluding interest, would add up to nearly $2 billion each year. Insurers and brokers also provide this type of service through companies they own and operate.

Insurance premium financing is similar to hire purchase. Retailers and car dealers, for example, use various financing plans to sell their products. These plans make the products more affordable to consumers. They do not have to find the purchase price all at once. The price of the product, including interest, is spread over a period of say 24 months. The consumer may make a deposit when the loan begins. He, or she, signs a contract agreeing to make equal payments of pre-agreed amounts at pre-arranged dates. The payments are made until the loan has been repaid. The finance company pays the retailer. The goods are delivered to the consumer. Where the consumer is delinquent the goods are seized and resold to cover the unpaid debt. Insurance premium financing operates in much the same way.

Despite the similarities, premium financing is different from hire purchase. In the case of the latter, there is property to secure the loan. Banks and finance companies are always seizing assets. They sell them to recover debts gone sour. In premium financing, there are no assets to flog. Security for these loans is not tangible. However, it is just as valuable as assets that are subject to seizure. It represents a part of the annual premium paid to insurers. Policies that run normally for 12 months are very seldom financed for periods longer than 10 months. This means that if the deal is properly structured the finance company should never have a bad loan on its books.

Interest rates for premium financing loans are calculated on an "add on" basis. These rates are actually much higher than they seem since interest is not computed on the basis of the reducing balance. The following table compares a few examples of add-on rates with equivalent 12-month rates computed on a reducing balance:

Most persons who enter into insurance premium financing contracts make at least one big mistake. They omit to read the fine print. This means that they often overlook important details and get into serious trouble. Here are a few features of a typical agreement:

• There are several parties to the contract. These are the insured, the finance company, the broker, the insurance company and the lien holder or mortgagee. The finance company is the first among equals.
• The finance company has the right to cancel the insurance and collect any return premium that is due.
• The insured is legally obliged to pay default and other charges if the policy is cancelled.
• The finance company is entitled to be paid any claims payment made by insurers under the policy.

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