Insurance coverage is a smart purchase. Sometimes it’s even a necessary expense. When cash flow is low, however, paying for premiums up front can present a problem. For some businesses, premium financing might be the solution.
What Is the Insurance Premium?
Before learning about insurance premium financing, it’s important to understand how insurance policies work. When you purchase a policy, you need to pay the premium. This is different from other costs, such as the deductible, which is the portion you pay out of pocket when you file a claim. The insurance premium is paid whether or not you ever file a claim. Essentially, it is the cost of owning the policy.
How Does Insurance Premium Finance Work?
Insurance premium financing is similar to other types of loans. Instead of making payments directly to the insurance carrier, the insured will work with a premium finance company. The premium finance company will take care of the premium payment due to the insurance carrier. The borrower, or insured, in turn makes payments to the premium financing company.
Who Is Insurance Premium Finance Suitable For?
Premium financing may be used for many types of insurance, but it is typically seen in commercial insurance. This doesn’t mean that premium financing should be used for every business purchasing these types of policies. There are both advantages and disadvantages, and it’s important to consider the risk before deciding to pursue this strategy.
Premium Finance for Businesses
Solid insurance coverage is essential for any business. At the same time, commercial insurance policies can be expensive, potentially adding to a company’s already significant overhead costs. This can be especially problematic for businesses that need to reinvest profits and have limited cash flow.
This is why financing can be an attractive strategy for business owners. With premium financing, a business can get the coverage it needs without the extreme upfront costs associated with the policy.
Right now, premium financing can be especially attractive to many business owners. This is because commercial property and casualty insurance rates have been rising. At the same time, many businesses are experiencing reduced revenue. As the premium cost goes up and cash flow goes down, obtaining the cash needed for a policy becomes more of an obstacle. As a result, more business owners might be interested in financing their premiums.
What Are the Disadvantages of Premium Finance?
Premium financing is basically a type of loan. It can be compared to mortgages for real estate, auto loans, business loans and other types of loans. You will need to repay the loan, and you will be expected to pay interest. This means that premium financing will increase the total cost of the premium based on the interest rate.
If good interest rates are available, this might not be a significant deterrent. However, if the interest rates are high, financing the insurance premiums may not make financial sense in the long run.
Additionally, as with other loans, collateral may be required, and the loan will need to be repaid. If you are unable to continue making payments, you will be forced to default, and the collateral you put up may be forfeited. Because the collateral may include the policy itself, it is also possible that non-payment will lead to the cancellation of the insurance policy, although a similar risk occurs when paying the insurance carrier directly, as well.
What Are the Advantages of Premium Finance?
Although a company may be able to liquidate assets in order to pay for the premium upfront, this is not always the best course of action. For one thing, the funds may be better spent in other investments. A business owner may need to invest the money in ways that will help the business grow, for example. Furthermore, liquidating the significant assets needed could result in a complicated tax situation.
Premium financing provides another option. Just as many people might want to finance a building or other large purchase instead of paying with cash, some people may decide it’s in their best interest to use premium financing.
This strategy may also be suitable for businesses with multiple policies from different carriers. In this case, financing may allow the business to consolidate payments.
Is Premium Financing Right for You?
Premium financing is a complex issue. There are many considerations, including the interest rates, the tax implications, the cash value of the policy, the carrier, the financing company and the terms of the agreement. There are advantages to the strategy, but there are also disadvantages, and there is some risk involved, as well.
Whether the advantages outweigh the disadvantages and risks or vice versa will depend on your unique situation and needs. Before deciding whether premium finance is the right strategy for you, it’s important to understand the terms and potential risk. Talk to one of our brokers if you have more questions regarding a premium financing strategy.