Premium Financing: Benefits, Risks & When to Use It

Premium financing allows a company to borrow the cost required to pay an insurance premium. This typically only occurs when a specific company has a very high premium, making it necessary to borrow the sum, in whole or in part, to avoid reducing its liquidity. Premium financing is not carried out by traditional lenders; instead, businesses must seek specific premium financing companies to secure these loans, which can be risky for both parties.

Reasons to Use Premium Financing

When a company must make a large up-front payment of any sort, it will always consider whether those funds will be needed for the day-to-day operation or expansion of business. If so, the company will have to consider financing in order to avoid liquidating necessary assets or spending key funds. Most businesses rely on some type of debt model to sustain themselves. Premium financing is just another part of that debt cycle for companies with very high insurance costs. Multiple policies can be financed through one agreement, allowing a company to make only one insurance premium payment each month. In fact, insurance companies are well adjusted to premium financing, and they will accept payment directly from the finance company. The business is then billed by the premium finance company rather than the insurer from that point forward. 

Reasons to Avoid Premium Financing

• Most premium financing arrangements are made with a variable interest rate. This can make the cost of insurance very unpredictable if the market index used to set the rate climbs substantially. Unpredictability could be entirely eliminated if the insurance premium was paid directly.

• The lender can require payment in full when the insurance term expires. This can create a highly stressful situation at the time the policy is set to renew. The business must pay off the old policy, secure a new quality insurance policy and obtain financing for the new policy within a narrow window of time. Not all premium finance companies will call the loan in its entirety when renewal periods arise, but most will do so if they have any reason to doubt an insured's ability to pay.

• The financing company may choose to stop paying an insurance carrier if that carrier has a large drop in financial ratings. The financing company does not want to pay premiums only to discover the insurer cannot pay claims. If the financing company chooses to do this, the insured must quickly locate a new insurance policy to replace the existing policy. The financing company must agree to the change, and this can create a very unstable situation for the insured.

• Defaulting on the loan results not only in financial repercussions from the lender, but also with the termination of the insurance policy. This presents a systemic risk to an organization that is experiencing a slow business cycle. Insurance requirements set at the state level must be met without interruption. If a business defaults on a loan, and its insurance is taken away as a result, it may be forced out of business.