Credit Crunch Eases, But Tight Economy Putting Squeeze On Premium Financing

While premium finance companies last year cited the tight credit market as a critical factor inhibiting business growth, the longer-term effects of the ongoing recession and the stubbornly soft commercial insurance market have put independent agents and their clients in an even more challenging environment in 2010.

Experts in the premium financing field saw more insureds turning to premium financing in 2009, but the amount of premium being financed was lower due to softening rates and shrinking insurable exposures.

This battle between the increasing need for premium financing and the decimation of those businesses that need help in stretching out insurance payments has created a unique environment for firms in the field and the independent agents they serve.

“As we had anticipated, and frankly hoped for, at the end of 2008 the economic developments of that year [drove] up the need for a premium finance option in 2009,” recalled Eric Sepci, vice president and chief operating officer of Premium Payment Plan, based in New York. “That did indeed come to fruition.”

However, he added, “I believe to some extent we underestimated the net impact of the recession on industries where we write quite a bit of premium finance business.”

He said the result has been a sharp increase in the number of premium finance agreements written, but the increase in premium dollars financed was “a fraction of this unit increase,” as the borrowers scaled down their operations and thus required less insurance coverage.

“If you ask me to call a winner between the need for financing and the softening market, for us, it was clearly a draw,” he said.

Luther Grafe, senior executive vice president and chief operating officer of BankDirect Capital Finance–a premium finance company based in Lake Forest, Ill.–spoke similarly of the effect the economy is having on premium-per-risk, noting that an account his company financed last year generated $500,000 in premium, compared to just $240,000 for 2010.

But he also agreed with Mr. Sepci regarding the increasing number of risks. He noted that while generally in soft markets, lower premiums lead some insureds to forego financing and simply pay their premiums in cash, the challenging economy today is driving more insurance buyers to begin or continue financing.

“The bottom line,” he said, “is that cash flow will continue to be one of the primary reasons for insureds to choose premium financing.”

The business lost to the soft market and gained from the increased need to finance premium payments is “not a net-net at the end of the day,” according to Jerry Smith, president of Southern Premium Funding Inc., a North Port, Fla.-based brokerage that places agents with premium finance companies.

However, he said the need for financing has helped defray the losses from the soft market, adding that of those two forces, the soft market may be winning out a bit.

But the attractiveness of using premium finance facilities is there, he said, because it represents off-balance-sheet lending and does not appear on credit reports, “whereas, if you go to a bank, it does show up.”

While the economic environment is driving more clients to finance their premium payments, the recession is having negative effects beyond shrinking premium-per-risk. Delinquencies and cancellations are up, Mr. Smith noted, particularly in areas hit hardest by the economy.

“[A]s you can imagine, our accounts receivable team has been very busy this past year, and in all likelihood will be through the coming year due to the spike in defaulted agreements,” according to Mr. Sepci.

To address this reality, he said his firm “proactively implemented sweeping underwriting changes across all business lines in response to the stalled economy.”

“We made the conscious decision to automate quoting within tighter parameters to facilitate easier and faster quoting for our agents,” noted Mr. Sepci. “In the event a client requested something outside of the standard terms offered, we would take the time to underwrite the client at that point.”

Delinquencies, Mr. Sepci pointed out, have always been a reality for premium finance companies, and the rise during a struggling economy was not unexpected.

“The only way you can protect yourself from defaults and delinquency would be to not write any business,” he said.

Despite increasing delinquencies and cancellations, premium finance rates remain relatively low due to heavy competition among the existing players and low interest rates overall. And the cost of loans keeps falling, according to Mr. Smith.

He said margins are “probably as lean as they've ever been,” adding that rates are “absolutely more competitive now than a couple of years ago,” when the most recent soft market began.

“We're our own worst enemies,” said Mr. Grafe, contending that some deals today are being priced lower than they need be or should be. But he said those who want to play in the premium financing business have to be willing to compete on price–at least to a point.

“We've walked away from deals over rate,” he said, when the competition offered rates far below what BankDirect believes is warranted or acceptable.

Competition also continues to come from standard carriers that have their own direct billing programs. As these carriers push into more and more sectors in the ongoing soft market, the risk of losing more business to them increases.

“For a long time, carrier direct plans and direct bill options have been the bane of premium finance companies,” Mr. Sepci explained. “Recently, the softened market has somewhat amplified this competition in that premium amounts are down to a point where a pre-pay discount may not outweigh the finance charges we need to charge, so more clients are electing to go direct bill.”

The way to compete, Mr. Sepci and Mr. Grafe advised, is on the service side.

“Some insurance companies don't do a great job managing direct bill,” according to Mr. Grafe, adding that agents sometimes do not like the commission streams associated with direct billing.

Mr. Sepci said that “strategically, you cannot compete with the cost associated with direct bill plans as carriers charge so little. The only place we can compete and add value is on the service side–simply being easier to deal with and offering more flexibility than a carrier plan.”

Noting the challenges of the economy, though, he added: “That said, the economy has placed a premium on low cost, so either way it's an uphill battle.”

One area of competition that was in play two years ago during the soft market that has disappeared today because of the poor economy is favorable terms for clients.

In 2008, Mr. Smith told National Underwriter that in a typical market, premium finance companies will generally want 20-to-25 percent down, and a term of about nine months of equal payments.

In the competitive market back then, he recalled, premium finance companies were offering 10, 11 or even 12 months of equal installments.

“As the market's gotten more competitive,” Mr. Smith explained at the time, “the need for us to be more aggressive on term and rate has become a big factor.”

Now, however, Mr. Smith said fewer premium finance companies are willing to take on the exposure of 12 months of equal installments.

The credit market has made premium finance companies wary, he said, and if they are pushed to lower rates, and are taking slimmer margins on a deal, “then taking exposure makes a little less sense.”

Mr. Grafe confirmed that premium finance companies have become more conservative with terms and less willing to offer lower down payments and/or more installments. Competitive deals in this environment, he said, are often differentiated by rate.

With conditions expected to remain difficult for quite some time, premium finance companies are finding ways to ride out the recession and credit crunch.

One strategy has been to look for acquisition opportunities. Mr. Smith and Mr. Sepci pointed to increased consolidation in the industry in 2009, with finance companies being purchased by banks and other financing firms.

For Mr. Grafe, who said he expects 2010 to be similar to 2009, the strategy is essentially business as usual. “Our model has proven to be successful and has not changed,” he said.

He explained that even in a challenging environment, clients are not willing to go without insurance, and so they will find a way to make their payments.

He said Bank Direct Capital is encouraging existing agency customers to talk-up premium financing as a strategy to bring in new clients. Competitors, he noted, are doing the same.

Mr. Sepci said his company began preparing for the current economic conditions in 2008.

“With the economy clearly headed into disarray in late 2008, Premium Payment Plan made a calculated decision at that time and prepared for a long credit slump…by implementing a very disciplined underwriting protocol for all businesses we write in, but particularly focused on industries we projected to be decimated by the recession,” according to Mr. Sepci.

Although he said this strategy was met with skepticism at first, it is now becoming the norm among premium finance companies.

“Admittedly, it was met with quite a bit of pushback from the field, and cost us some short-term opportunity as we were perceived as too conservative,” he recalled. “Fast-forward to today, almost every 'aggressive' finance company has fallen back to a position similar to ours.”

Looking forward, he said Premium Payment Plan will continue to focus on the basics.

“Can it get much worse?” he wondered. “Hopefully not, but we don't expect it to improve much, if at all. Recognizing this, we expect to keep things pretty tight throughout 2010, really making due with what we have and investing only where we really need to incur the expense. As with 2009, we'll keep projects and nonessentials to a minimum.”

Regarding possible improvement in 2010, Mr. Smith said, “I think the market wants to harden. But the economy is preventing the market from doing what it needs and wants to do.”