Premium financing is an underused source of cash flow for many companies
Here is the kind of business story everyone loves: Neighbours jettison unwanted but reusable clothing and household items for a good cause. Charities that seek item donations but can’t complete their resale are paid cash for the collections by a third-party business. The items are sorted, priced, tagged and sold in thrift stores where clients find needed items at good value and the business generates its revenue stream. The majority of unsold items are shipped to developing nations through philanthropic and wholesaler efforts, helping the needy in those nations and also helping the planet by reducing the huge strain on landfills.
The interesting question is, why would a thriving business like this–whose business model brings to mind the Brothers Grimm fable of Rumpelstiltskin spinning straw into gold–choose to finance its insurance premiums?
The answer lies in the cash flow benefits of insurance premium financing. As loans go, premium financing is a relatively straightforward process, with simple loan documentation and collateral tied to the unearned portion of the premium. Where else can you get a loan that involves a two-page contract and provides funding within 24 hours of acceptance? Pricing quotes and repayment plans are shaped both by the economic environment and the financial health of the borrower and, for the most part, loans are paid back in under a year. If firms are looking for a loan, it doesn’t get much simpler than that. What’s more, a premium finance loan doesn’t deplete bank lines of credit, there can be positive tax implications, and, depending on accounting opinion, the disclosure is different on financial statements.
But, what happens when complexity arises based on the cash flow needs of the insured? Bob Willis, national sales manager for CAFO Inc., a large Canadian premium finance company, says that brokers don’t have to become expert in premium finance to advise their clients. But they do need to understand their client’s business.
“The better a broker understands the client’s capital needs, cash position, expansion plans, and cash management sophistication, the better a premium finance company can tailor the financing to support those needs,” he says.
That might seem an unusual request of advisors who are expected to help clients manage risk. However, lack of access to capital can itself be a business risk. By offering premium financing, brokers can expand their value proposition to their clients. Willis explains that some of this information becomes apparent when brokers analyze their client needs for other insurance products such as Business Interruption Insurance. Competent premium finance personnel can help brokers craft questions for more rigorous analysis, and even visit large clients with a producer to uncover business, insurance and financing needs (see “The Talk” sidebar).
CAFO was started in Canada in 1955, a year after sister company AFCO was founded in the United States. In those early years, premium “budgeting” was used by businesses having a difficult time paying their insurance bills, but it also mirrored the post-war growth of instalment credit in North America.
By offering premium financing, brokers can expand their value proposition to their clients.
That’s a far cry from today where successful business firms involve premium financing to manage their cash flow with acuity. Alternatively, a large conglomerate conducting business across the border in both Canada and United States that requires premium financing for several entities involving numerous policies through more than one broker can turn to a premium finance company to find a solution. That solution could involve security interest or cross-collateral cross-default provisions but it is still much simpler than getting a loan of a similar size from a different financial source, says Willis.
Challenges and solutions
Willis says he recently quoted an account that required a Letter of Credit for partial support of the loan. He also tackled an unusual situation with a multinational Canadian-based manufacturer that wanted to finance its benefits program not covered by traditional premium financing.
CAFO is currently working with a large borrower that has lending restrictions within its covenants so that, with the correct approvals in place and after consultation with other lenders, it will be able to borrow to finance its insurance premiums.
Some premium finance companies offer customized seasonal repayment plans that reflect the cash flows of businesses such as ski resorts, agricultural ventures or landscape architects. Whether the client wants to maximize cash flow or minimize debt service costs, premium financing can offer multiple plans, plans by policy, or delayed cheque-release opportunities. Payments can be quarterly, monthly or a mix of down payment amounts and repayment schedules that best suit the unique situation of the business.
While the benefit of premium financing may not be quite a transformation of straw into gold, it does unlock the intrinsic value of business insurance premiums and can provide substantial and underutilized cash flow benefits.
Reina Teeger is senior vice president and manager of marketing communications at CAFO in Canada and sister company AFCO in the United States. She has a Master of Arts in Journalism and has been involved with AFCO CAFO for close to three decades.
The Right Fit
What brokers should look for in a premium finance provider
Premium financing may be a simple transaction, but when it’s not, you need to have trust in and a close working relationship with your provider. For example, where a pricing quote does not meet your client’s situation, you should feel comfortable approaching the provider to structure a different proposal.
Your trust should extend to asking questions — even if they appear basic — to help you avoid the contingent liability that could occur if you wrongfully assert information that you didn’t fully understand.
Choose a provider that does good-quality underwriting, which can protect you, the broker.
Frequently, private corporations are reluctant to share financial information. Experienced premium finance companies are able to arrange credit interviews and information-gathering techniques that these corporations find acceptable and that can result in the financing being approved.
If you have clients with cross-border businesses, use a provider with appropriate capabilities. The cross-border implications of the Companies Creditors Arrangement Act (CCAA) in Canada, along with Chapter 11 regulations in the United States, require a premium finance company that has the experience and local expertise to deal with the companies and the trustees to find a solution for financing.
Conversation starters for brokers to broach the subject of premium financing with clients
- Have you specifically planned the insurance premium expenditure for this year at the level that we are discussing?
- Are there fluctuations in your cash flow seasonally or related to specific projects that you are dealing with in your business? Can you explain those to me?
- Do you currently have lines of credit that you use for the operation of your business? What are you currently paying for that credit? Would it be helpful to have additional credit at competitive pricing?
- Are you expecting any unusual cash flows this year that may impact your business and if so, would paying your premiums by instalment help you deal with that?
- How have you traditionally paid your premiums? Have you ever found that paying the premium presented any problems for you?
- If you were able to flow the cost of the insurance over the year rather than paying in advance, would you be in a position to consider purchasing some of the alternative coverage improvements and options that I have presented to you?
Copyright 2010 Rogers Publishing Ltd. This article first appeared in the October 2010 edition of Canadian Insurance Top Broker magazine.