Insurance is an essential purchase for businesses in all industries to help cover the costs of property damage and liability claims. General liability insurance, commercial auto insurance, workers’ compensation insurance and other types of insurance policies for small businesses ensure that business owners do not face financial ruin in the event of a lawsuit or catastrophic event.
Although the value of business insurance is undisputable, the cost of these policies can often be overwhelming for small business owners. When companies are unable to pay their premiums, they could experience a lapse in coverage. To avoid this risk, many businesses rely on insurance premium financing.
What Is an Insurance Premium?
The first step is to gain a clear understanding of what an insurance premium is and how it is calculated.
In basic terms, an insurance premium is a payment that a policyholder agrees to pay a company for insurance. The policyholder enters into a contract with the insurance company and the insurance company guarantees payment in the case of a covered loss or damage. In return, the policyholder pays the insurance company premium payments.
An insurance company will take many factors into consideration when determining the price of a premium, such as how likely an accident or disaster is, the likelihood of a claim being filed and how much the insurance company is likely to pay out if a claim should manifest. Policyholders also have the option to choose from varying amounts of coverage based on their needs and budget.
Commercial insurance, depending on the types and amounts of coverage, can become expensive. For small or start up businesses, these amounts may create a cash flow problem. Insurance premium financing can be a beneficial solution to alleviate this issue for some businesses.
How Does Insurance Premium Financing Work?
Insurance premium financing entails taking a loan to pay for an insurance policy’s premiums. Similar to other types of loans, the lender charges the borrower interest and the borrower must repay the loan in installments based on the agreed contract until the debt is paid in full or the insured party passes away.
The goal of insurance premium financing is to help alleviate the financial burden that many business owners experience when acquiring insurance policies.
When a business engages in insurance premium financing, the business owner makes payments to a premium finance company instead of directly to the insurance carrier. The premium finance company is then responsible for paying the premium payments to the insurance carrier.
With a well-structured premium financing program, business owners pay as little out-of-pocket as possible for insurance policies. There are several types of premium financing arrangements that business owners can enter into based on their needs.
- Premium-Only Financing — This arrangement occurs when an individual only borrows funding for premiums and pays the interest out-of-pocket.
- Premium and Interest Financing — This arrangement occurs when an individual borrows both the premiums and interest on a loan and does not have an annual outlay.
- Partial Premium and Interest Financing — This arrangement occurs when an individual borrows some premiums and/or interest for a specified period of time.
Benefits of Insurance Premium Financing
The cost of insurance for a business can be significant, especially if a large amount of coverage is needed. A company may have the option to liquidate assets to pay for the premiums upfront, but this is not always the most cost-effective choice. Businesses may want to use these funds for other investments that will lead to higher gains over time. Liquidating large assets can also create complicated tax issues for certain businesses.
Insurance premium financing is an effective option for businesses that want to finance their insurance premiums instead of paying with cash. This solution is often a suitable strategy for companies that own multiple insurance policies from different carriers. When multiple policies are involved, insurance premium financing allows businesses to consolidate their payments for added convenience.
Drawbacks of Insurance Premium Financing
Although there are many benefits of insurance premium finance, there are also some downsides to consider. Insurance premium finance is considered a type of loan, similar to real estate mortgages, auto loans and other types of loans in which the borrower is expected to pay interest.
In addition to repaying the loan itself, the borrower will be responsible for added interest based on the interest rate provided in the contract. Similar to other types of loans, the borrower may be required to provide collateral to acquire financing.
If the borrower is unable to continue making payments, they may default on the loan and the collateral against the loan will be forfeited. The collateral may include the insurance policy itself, meaning non-payment could result in the cancellation of the policy which puts the business at a higher risk for financial damages.
Who Should Consider Insurance Premium Financing?
Insurance premium financing can be a useful tool for some businesses but it is not right for all companies. If good interest rates are available, then using insurance premium financing may make financial sense in the long term. However, if the interest rates are high, then using financing to pay for insurance premiums may result in a major financial loss.
When deciding whether insurance premium financing is the right solution, consider factors such as insurance rate, the cash value of the policy and possible tax implications.
Take time to research the insurance carrier and financing company and weigh the risks versus the rewards. Scrutinize the economics of the arrangement to ensure that the plan outlined is able to help the business reach its desired goals at an acceptable cost.
There are many variables when it comes to insurance premium financing and a business owner should never make a decision without first speaking with an insurance professional.
The experienced business benefits consultants at the Business Benefits Group can provide guidance and advice when selecting insurance policies and acquiring financing to pay for policy premiums. To learn more about insurance premium financing or what it entails, reach out to the Business Benefits Group today.