Premium finance terms and definitions
Insurance and Premium Finance terms and definitions
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General
No insurance and
premium finance resource would be complete without a comprehensive glossary of terms.
Following is a list of terms and their definitions to better help navigate the sometimes
confusing world of insurance and premium finance.
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Account Current - The means by which an agent settles his accounts
with the insurance company each month, based upon a statement that includes all
debits and credits. Account current allows the agent to pay the net due, or request
a check if the net is a credit. Balances due are usually due at the end of the month
following the month in which the business was written.
Accounts Receivable - In premium finance, accounts receivable is an asset
account comprised of the total of debit balances owed the premium finance company,
whether current or not. Due to the short-term nature of premium finance contracts
(6 to 12 months), rapid pay-down of balances
holds accounts receivable to about one-third of production, assuming that most contracts
are the typical 9 month term. See Production.
Actuarial Earning
Actuarial earning
is a means of earning interest on a financed contract. It is much more complicated
than the Rule of 78 and requires sophisticated software to do it properly. In the
premium finance context, it requires that interest be determined on a daily rate
basis, much like a mortgage, then earned on the day that the next installment is
paid.
Add-on Rate – In finance, it is a means to determine the appropriate
finance charge for a given amount financed over a given term using rate tables.
If the rate is known and the term is known, a table (Regulation Z, Volume 1) can
be used to determine the dollar charge.
For example, using
the loan data found in Negotiated Rates:
$10,000 Policy
Premium $10,000.00
Total Premium
25% Down Payment ($2,500.00)
Down Payment (paid to agent)
12% APR $7,500.00 Amount Financed
$380.22
Finance Charge
$7,880.22
Total of Payments
9 Installments @ $875.58 each.
Using 12% APR
and 9 installments, Regulation Z can be used to determine that the appropriate add-on
rate is .0507 (the amount to be “added-on” to develop a 12% APR). Applying this
to the amount financed (.0507 x $7,500.00) = $380.2200.
(It might be necessary to round the pennies in the finance charge to work out even
over 9 installments.) Since most interest
calculations today are done by computer, add-on rate calculations and Regulation
Z are most useful for quickly validating that rates or finance charges are correct.
See Regulation Z.
Admitted Assets - Assets permitted by state law to be included in
an insurance company's annual statement. These assets are an important factor when
regulators measure insurance company solvency. They include mortgages, stocks, bonds,
and real estate.
Agency Bill - A type of billing system for insurance policies
in which the policy is purchased from an independent or captive agent, after which
the bill appears on the agent’s Account Current. The agent then contacts the insured
and either collects the premium in cash or obtains a down payment and a signed premium
finance agreement. The policy is subsequently paid on the following month’s Agent
Statement.
Agent - An individual appointed by an insurance company who
receives a commission on the policies sold and serviced.
Based upon compensation, agents work for insurance companies in one of two
classifications:
1. Independent
agents represents at lease one insurance company and (at least in theory) services
clients by searching the market for the most advantageous price for the most coverage.
The agent's commission is a percentage of each premium paid.
2. Captive agents
represent only one company and sells only its policies. This agent is paid on a
commission basis in much the same manner as the independent agent.
Agent Statement - A document
sent each month by an insurance company listing
all debits and credits for a given insurance agency.
If the business is agency billed, the agent will settle his account each
month based upon this statement. (See “Account Current”.) If the business is direct
billed, it informs the agent of debit and credit activity between his clients and
the company.
Aging – Or “Aging Report”, in premium finance, a report
that separates all contracts in a portfolio of receivables into those that are “current”,
“30 days past due”, “31-60 days past due”, “61 to 90 days past due”, “91 to 120
days past due”, “121 to 150 days past due” and “151 to 180 days past due”. Many
states require any balance 181 days or more past due to be marked-off.
The report is used to determine the effectiveness of the company’s collection
efforts. See
Past-Due Balances.
Amount Financed - In premium finance, the amount to be advanced by
the premium finance company to the insurance company after the down payment has
been deducted from the total premium.
Annual Percentage Rate (APR) – The cost of credit as computed as a percentage at
a yearly rate. The APR can be used to compare the costs of different kinds of credit
since it reduces interest rates to a common yearly rate, regardless of term.
Assets - Assets refer to "all the available properties
of every kind or possession of an insurance company that may be used to pay its
debts." There are three classifications of assets: invested assets, all other
assets, and total admitted assets. Invested Assets refer to things such as bonds,
stocks, cash, and income-producing real estate. All other assets refer to non-income
producing possessions such as the building the company is in, office furniture,
and debts owed (usually in the form of deferred and unpaid premiums.) Total Admitted
Assets refer to everything a company owns. All other + invested assets = Total Admitted
Assets. Some states by law do not permit insurance companies to claim certain goods
and possessions, such as deferred and unpaid premiums, in the all other assets category,
declaring them "nonadmissable."
Assigned Risk Plan - One name
for state-sponsored “pools” of insurance companies found in 41 states wherein drivers
with poor driving records can obtain minimum coverages in order to comply with state
statutes. These pools are generally comprised
of every insurance company licensed in the state; each is required to accept a number
of drivers based upon the amount of voluntary business written in the state. Various
states have various names, i.e. New York Automobile Insurance Plan (NYAIP) or the
California Automobile Assigned Risk Plan (CAARP). See
Joint Underwriting Authority (JUA), Reinsurance Facilities, MAIF.
Authorized under Federal Products Liability Risk Retention
Act (Risk Retention Groups)
- Indicates companies operating under the Federal Products Liability Risk Retention
Act of 1981 and the Liability Risk Retention Act of 1986.
Best’s Ratings – A.M. Best is a benchmark financial service which
rates the financial strength of both property-casualty and life insurance companies.
Criteria are proprietary and delve into every aspect of company operations. Ratings range from A++ down to E. Other services
also rate insurance companies, including Standard & Poor, Duff & Phelps
and others.
Broker - Insurance salesperson who searches the marketplace
in the interest of clients, not insurance companies. Not appointed by an insurance
company and thus cannot bind coverage. Brokers are compensated through fees charged
to the policyholder.
Broker-Agent - Independent insurance salesperson who represents
particular insurers but may also function as a broker by searching the entire insurance
market to place an applicant's coverage to maximize protection and minimize cost.
This person is licensed as an agent and broker by different companies (but not the
same company).
Cancellation - The process of terminating coverage under a policy
of insurance. Cancellation may be requested by the insurer (in certain circumstances),
the insured or by a lender for non-payment of premium if the policy is premium financed.
See pro-rata and
short rate for determination of earned and unearned premium.
Capital - 1.The equity of shareholders of a stock insurance
company. The company's capital and surplus are measured by the difference between
its assets minus its liabilities. This value protects the interests of the company's
policyholders in the event it develops financial problems; the policyholders' benefits
are thus protected by the insurance company's capital. Shareholders' interest is
second to that of policyholders.
2. The amount
of equity plus subordinated debt in a premium finance company, used to determine
how much leveraged funding would be available under a line of credit.
Capitalization, or Leverage - 1. Measures the exposure of a company's surplus
to various operating and financial practices.
A highly leveraged, or poorly capitalized, company can show a high return on surplus,
but may be exposed to a high risk of instability.
2. Leverage: the ratio of capital plus subordinated debt to
bank funds available under a line of credit.
Captive Agent - Representative of a single insurer or fleet of insurers
who is obliged to submit business only to that company, or at the very minimum,
give that company first refusal rights on a sale. In exchange, that insurer usually
provides its captive agents with an allowance for office expenses as well as an
extensive list of employee benefits such as pensions, life insurance, health insurance,
and credit unions.
Casualty - Liability or loss resulting from an accident.
Casualty Insurance - That type of insurance that is primarily concerned
with losses caused by injuries to persons and legal liability imposed upon the insured
for such injury or for damage to property of others. It also includes such diverse
forms as Plate Glass, insurance against crime, such as robbery, burglary and forgery,
Boiler and Machinery insurance and Aviation insurance. Many casualty companies also
write surety business.
Change in Policyholders' Surplus - The annual change in a company's policyholders' surplus
derived from operating earnings, investment gains, net contributed capital and other
miscellaneous sources. Policyholders’ surplus is a good indicator of the ability
of the insurance company to continue to pay claims.
Claim - The demand for benefits as provided by the policy.
Collateral – What a lender accepts as security for a loan. In
premium finance, it is the unearned portion of the insurance policy.
Combined Ratio after Policyholder Dividends - The sum of the
Loss Ratio, Expense Ratio and the Policyholder Dividend Ratio. This ratio measures
the company's overall underwriting profitability. This ratio does not reflect investment
income or income taxes. A combined ratio of less than 100 indicates the company
has reported an underwriting profit.
Commercial Lines – Insurance coverages designed and marketed to business
and professional customers. They can be written
as monoline (one type of coverage) or multiline policies that combine property,
liability, inland marine and other coverages into one package.
Contract – A legally binding agreement between two or more
parties. In premium finance it is commonly
called a “premium finance agreement” or PFA. See also
Premium Finance Agreement.
County Mutual Insurance Company – One of a group of companies exclusive to
Coverage - Protection under an insurance policy. In property
insurance, coverage lists perils insured against, properties covered, locations
covered, individuals insured, and the limits of indemnification. In life insurance,
living and death benefits.
Direct Bill - A type of billing system for insurance policies
in which the policy is purchased from an independent or captive agent, after which
the insured receives monthly invoices directly from the insurance company (hence
the name), and all remittances are made directly to the insurance company.
Premiums are collected as they are earned.
See Agency Bill for the alternative.
Disbursement – Rendering payment.
Disclosure Statement – The section of the premium finance agreement which
illustrates the total premium, fees, amount financed, finance charge, annual percentage
rate, total of payments and amount of each payment.
Federal regulations require minimum type face size, bold letters and boxes
to highlight this area for personal lines contracts
only.
Dividend - In a mutual or participating company, it is the
return to the policyholder out of the earnings of the company. In a stock or nonparticipating
insurance company it is the division of the profits among the stockholders of the
company. Also, a refund of part of the premium on a participating life insurance
policy. It is a share of the surplus earned apportioned for distribution and reflects
the difference between the premium charged and the actual experience.
Down Payment - That portion of a policy collected by the agent
to bind coverage and create a premium finance agreement.
An adequate down payment will collect sufficient premium to cover the earned
portion from inception date to the first payment due date plus enough time to cancel
the policy.
Earned Premium - That portion of a premium for which the policy protection
has already been given during the now-expired portion of the policy term. Premium
is earned on a daily basis, usually on a 12-month term except for automobile coverage
which is typically written for a 6-month term.
Effective Date – The date shown on the policy or binder when insurance
coverage begins. This is also the date that
interest begins to earn under the premium finance agreement, regardless of when
funds are actually disbursed to the insurance company.
Encumbrance - Any outside interest in or right to property founded
on legal grounds, such as a mortgage, lien for work and materials, or a right of
dower. it diminishes the interest of the person owning the property.
Excess and Surplus Lines - The excess and surplus lines market acts as an industry
safety valve when coverage is no longer available through standard insurance carriers.
E&S insurance companies are non-admitted, meaning that they are licensed in
their state or country of domicile but not in the state in which they are doing
business, and are not subject to restrictions on rates and forms. If a broker or
agent no longer has a standard market for a given risk, he can approach the E&S
market through a licensed E&S broker and request a quote. Since rates and forms
are not restricted, it allows the E&S insurance company to determine a rate
for the exposure and generate custom forms to cover it.
A risk placed in the E&S market is usually priced much higher than it
was, or would have been, in the standard market.
Since E&S companies do not participate in state guaranty funds, they
are somewhat more risky than standard companies. They are rated by Best’s Insurance
Rating Guide, however, giving premium finance companies and lenders some insight
into their financial condition.
Expense Ratio - The ratio of underwriting expenses (including commissions)
to net premiums written, expressed as a percent. This ratio measures the company's
operational efficiency in underwriting its book of business.
Finance Charge - In premium finance, the amount charged by the premium
finance company for advancing the amount financed to the insurance company on behalf
of the insured.
Flat Cancellation – Cancellation of an insurance policy as of the effective
date without charge. Commonly used to refer
to rescinded premium finance agreements as well.
General Agent (GA) - The line
between an agent and a General Agent is becoming more blurred, but a General Agent
usually “holds the pen” for an insurance company, meaning the GA has underwriting
and policy-writing authority. After that, the agency may or may not collect premiums,
service the policy or settle claims.
Guaranty Funds - Pools of funds organized in each state for the purpose
of settling claims and debts of insolvent insurance companies.
Guaranty funds are not paid for with appropriated funds, but rather by the
insurance companies licensed in each particular state.
Hard Market - A “hard market” occurs cyclically, seen from 1985-1990, and again from 1999-2005, is characterized by a decline in the availability of insurance combined with rising prices. The so-called “standard” insurance companies gradually pull away from portions of the market to be replaced by excess-surplus insurance companies. Premium finance companies will finance more policies at higher prices.
Hazard - Circumstance that increases the likelihood or probable
severity of a loss. For example, the storing of explosives in a home basement is
a hazard that increases the probability of an explosion.
Impaired Insurance Company – Refers to an insurance company operating in a financially
hazardous manner.
Insolvent Insurance Company - The company’s
assets are insufficient to pay policy claims.
Insurance Policy – The contract between insurer and insured containing
information regarding the risk, policy holder, contractual conditions and rate assessed.
Joint Underwriting Associations (JUA) – State-sponsored
pooling mechanism through which all companies doing business in the state share
premiums, profits, losses and expenses incurred for high-risk drivers or companies. Generally, each agent is assigned to an insurance
company which is one of several that have agreed to issue and service JUA policies.
Losses may be recouped by surcharging policyholders.
See Assigned Risk Plans, Reinsurance
Facility, MAIF.
Late Charge – Also known as a Late Fee, it is an amount payable
to the premium finance company, permitted by state statute, for any installment
received more than 5 or 10 days after the due date (state statutes vary). Personal
lines fees are usually limited to some nominal amount such as $5.00. Commercial
lines usually consist of 5% of the installment amount.
Late fees are posted as debits to the balance due from insured but are not
earned as income until paid.
Late Notice – Usually the same notice as the Notice of Intent
to Cancel, but can be a separate notice encouraging the policyholder to bring his
premium finance agreement current. See Notice
of Intent to Cancel.
Lender – A financial institution that loans money such as
a bank, premium finance company or insurance company.
Leverage, or Capitalization - measures the exposure of a company's surplus to
various operating and financial practices. A highly leveraged, or poorly capitalized,
company can show a high return on surplus, but may be exposed to a high risk of
instability.
Liability - Broadly, any legally enforceable obligation. The
term is most commonly used in a pecuniary sense.
Liability Insurance - That insurance that pays and renders service on
behalf of an insured for loss arising out of his responsibility, due to negligence,
to others imposed by law or assumed by contract.
Licensed - Indicates the insurance company is incorporated
(or chartered) in another state but is a licensed (admitted) insurer for this state
to write specific lines of business for which it qualifies.
Premium finance companies are required to be licensed in most states. Many
states regulate the financing of personal lines insurance policies but not commercial
lines insurance policies.
Liquidation – The process through which an insolvent insurance
company’s assets are used to pay claims.
All policyholders are notified of the cancellation of policies on a stated date
and given directions how to make a claim against the estate. They are also informed
that a guaranty association may handle the processing of future claims.
Liquidity - Liquidity is defined as "the ability of an
individual or business to quickly convert assets into cash without incurring a considerable
loss." There are two kinds of Liquidity: quick and current . Quick liquidity
refers to funds, cash, short-term investments, and government bonds - possessions
which can immediately be converted into cash in the case of an emergency. Current
liquidity refers to current liquidity plus possessions such as real estate which
cannot be immediately liquidated, but can be sold and converted into cash eventually.
Quick liquidity is a subset of Current Liquidity. Again, the importance of Liquidity
has to do with how fast and how much cash an insurance company can get their hands
on in case there is a disaster and they need to pay off claims. This reflects the
financial stability of a company and thus their rating.
Lloyd's - Generally refers to
Lloyds Organizations – Organizations in the United States that are voluntary
unincorporated associations of individuals patterned after the well-known Lloyds
of London. Each individual assumes a specified portion of the liability under each
policy issued. The underwriters operate through a common attorney-in-fact appointed
for this purpose by the underwriters. The laws of most states contain some provisions
governing the formation and operation of such organizations, but these laws do not
generally provide supervision and control as strict as the laws dealing with incorporated
stock and mutual insurance companies. See Lloyds.
Loan – A sum of money which is lent for a specific period
of time, repayable with interest and fees.
Loss Control - All methods of reducing the frequency and/or severity
of losses including exposure avoidance, loss prevention, loss reduction, segregation
of exposure units and non-insurance transfer of risk. A combination of risk control
techniques with risk financing techniques forms the nucleus of a risk management
program. The use of appropriate insurance, avoidance of risk, loss control, risk
retention, self-insuring, and other techniques that minimize the risks of a business,
individual, or organization.
Loss Ratio - The ratio of incurred losses and loss adjustment
expenses to net premiums earned, expressed as a percent. This ratio measures the
company's underlying profitability, or loss experience, on its total book of business.
MAIF - Acronym for
the Maryland Automobile Insurance Fund,
a state agency created in 1972 for the purpose of providing automobile insurance
to those
Managing General Agent (MGA)
– These are agents appointed by an insurance company who carry out all of the functions
of an insurance company. They market the product, write the policies, collect the
premium, service the policy and settle claims. Although not usually owned by the
insurance company, they function as a de facto branch office of the insurance company
or companies.
Mutual Insurance Companies - Companies with no capital stock, owned by policyholders.
The earnings of the company over and above the payments of the losses and operating
expenses and reserves are the property of the policyholders. There are two types
of mutual insurance companies, the nonassessable companies charge a fixed premium
and the policyholders cannot be assessed. Legal reserves and surplus are maintained
to provide payment of all claims. Assessable mutual companies are those companies
that charge an initial fixed premium, and if that is not sufficient may assess the
policyholders to meet losses in excess of the premiums that have been charged as
well as provide statistical services.
Negotiated Rates – The premium finance industry has one absolutely
unique characteristic in that interest is charged
on funds that usually have not yet been disbursed. All state statutes specify
that the interest clock begins to run on the inception date of the policy, but the
premium finance agreement often arrives days or weeks later. In many cases, disbursement
may not occur for 30 to 60 days. If no agreement is in place, the premium finance
company gains an increased return because it is earning interest on money that has
not been disbursed. Quite often, the delay in funding is used by the agent or general
agent to negotiate a lower rate for the customer. It can be proven mathematically
that a 30 day delay results in a 3.15% increase in the yield (in theory, at least)
because the disbursement is made as the first installment is received.
For example:
$10,000 Policy
Premium $10,000.00
Total Premium
25% Down Payment ($2,500.00)
Down Payment (paid to agent)
12% APR $7,500.00 Amount Financed
$380.22
Finance Charge
$7,880.22
Total of Payments
9 Installments @ $875.58 each.
If disbursement
is not carried out until Day 30 and the first installment is received, the same
$380.22 is earned on $6,624.42 ($7500.00 - $875.58).
The add-on rate for $380.22/$6,624.42 = .0574 over 8 remaining payments or
15.125% APR, a gain of 3.15%.
Net Income - The total after-tax earnings generated from operations
and realized capital gains as reported in the company's NAIC annual statement page
4, line 16.
Net Investment Income - This item represents Investment Income earned during
the year less investment expenses and depreciation on real estate. Investment expenses
are the expenses related to generating investment income and capital gains but excluding
income taxes.
Net Premium - is the portion of the premium for which the insurance
company is responsible. It does not include the part of the premium that covers
expenses, contingencies (commissions paid to agents) or profits. Why not profit?
Because net premium is only potential profit at this point. The insurance company
does not yet know whether or not it will be paid with this money.
Net Premiums Earned - This item represents the adjustment of the net premiums
written for the increase or decrease during the year of the liability of the company
for unearned premiums. When an insurance company's business is increasing in amount
from year to year, the earned premiums will usually be less than the written premiums.
With the increased volume, the premiums are considered fully paid at the inception
of the policy so that at the end of a calendar period, the company must set up premiums
representing the unexpired terms of the policies. On a decreasing volume, the reverse
is true.
Net Premiums Written - This item represents gross premium written, direct
and reinsurance assumed, less reinsurance ceded.
Net Underwriting Income - Net premiums earned less incurred losses, loss adjustment
expenses, underwriting expenses incurred, and dividends to policyholders.
Non-payment – In premium finance, the failure to pay an installment
or down payment when due. Either is grounds for cancellation of the policy for non-payment.
Non-standard Auto – Also
known as high risk auto or sub-standard auto, it is Insurance for motorists who
have poor driving records or have been cancelled or refused insurance. The premium
price is much higher than standard auto due to the additional risks.
See also Preferred Auto and Standard Auto.
Notice of Cancellation – A legal notice advising the policyholder that coverage
is cancelled as of a certain date. It must
be preceded by a Notice of Intent to Cancel for the cancellation to be legal. It
can be sent by the insurance company for underwriting reasons. It can be sent by
a premium finance company only for non-payment.
Notice of Intent to Cancel – A legal notice sent by a premium finance company
(or insurance company) alerting the policyholder that the coverage will cease in
ten to thirteen days (some states requires ten days plus mailing). Commonly called
a “Late Notice” because most premium finance companies will wait for five or ten
days (depending on state statutes) after the payment due date in order to charge
a late fee.
Notice of Reinstatement – A form used when an insurance policy has been cancelled
for non-payment by a premium finance company then brought current by the policyholder.
This notice advises the policyholder that a request has been sent to the insurance
company to reinstate the insurance policy. Only the insurance company can reinstate
a cancelled insurance policy. The premium finance company cannot do so.
Order of Liquidation – A court order appointing a Regulator as Liquidator
of an insurance company. The Liquidator then appoints a Receiver to dissolve the
company and pay off all claims.
Order of Rehabilitation – A court order issued against an insurance company
wherein a Regulator is empowered to manage the insurance company until the problems
are corrected. The Regulator will take possession
of the company’s books, records and assets and assumes all powers of the company’s
directors, officers and managers.
Order of Supervision - A court order that empowers a Regulator to require
an insurance company to take specific corrective steps or obtain approval before
it undertakes certain transactions.
Order of Suspension – A court order that empowers a Regulator to order
an insurance company to stop all or a portion of its business in the state.
Originator – As used in
the premium finance industry, a licensed Property & Casualty insurance agent
who writes policies that are then financed.
In broad terms, it can also be a premium finance company that has contracts with
agents that guarantee a flow of premium finance
agreements that can be sold.
Payment Options Disclosure Form – A written statement required of the agent or broker
that informs the insured of his right to be given information on all the options
available for the payment of the premium.
The statement must be signed by the insured indicating that the insured has been
given enough information to make an informed choice.
Past-Due Balances – In premium finance, past-due balances are treated
somewhat differently due to the underlying security of the financed insurance policies.
When a scheduled installment is not paid, the premium finance company can, based
upon the Power of Attorney granted by the insured, send a Notice of Cancellation
to the insurance company and effectively cancel the insurance policy, once all statutory,
regulatory and policy conditions are satisfied. The insurance company will eventually
cancel the policy and return the unearned portion to the finance company. This may
take anywhere from 30 to 150 days depending on the type of coverage and the state
in which it was written. The critical difference
is this: cancelled receivables are good receivables until all of the money has been
received from the insurance company or companies.
Being in a cancelled status does not impair the receivable unless and until
it has been determined that the unearned premium has been fully earned or will not
be returned for some other reason. Each day, premium finance software will run an
“Aging “ report to determine which account require Notices of Intent to Cancel (Late
Notices) or Notices of Cancellation.
Peril – The cause of a possible loss.
Personal Lines - Insurance coverages designed and marketed to individuals.
Personal lines of coverage include automobile, homeowner, dwelling fire, boat, inland
marine and others.
Policy - The written contract effecting insurance, or the
certificate thereof, by whatever name called, and including all clause, riders,
endorsements, and papers attached thereto and made a part thereof.
Policyholders' Surplus - This item is the sum of paid in capital, paid in
and contributed surplus, and net earned surplus, including voluntary contingency
reserves. It is the difference between total admitted assets and total liabilities
and is a key denominator of many financial ratios measuring the financial strength
of an insurance company.
Preferred Auto - Also known
as “family auto”, provides the widest coverage for the least cost to drivers with
good driving records. Depending on the company,
accidents and tickets can make drivers ineligible for preferred rates. See
Standard Auto and Non-standard Auto.
Premium - Is the cost of insurance coverage assessed by the
insurer to the insured for coverage for a specified period. Also, the payment or
one of the regular periodical payments a policyholder is required to make for an
insurance policy.
Premium Finance Agreement - The contract that establishes the relationship between
an insured (the purchaser), the agent intermediary) and the insurance company (insurer).
It pledges the unearned portion of the insurance policy to secure the money advanced
by the premium finance company on behalf of the purchaser, and grants a limited
power of attorney to the premium finance company to cancel the policy in the event
of non-payment of premium.
Premium Finance – A process wherein a lender pays an insurance premium
to an insurer on behalf of an insured. The
policyholder repays the lender for the amount of the loan (amount financed) plus
interest and any assessable fees and charges. The process is initiated at the agent/broker’s
office when the coverage is originally applied for and the down payment is made.
Premium, unearned - That part of the premium applicable to the unexpired
part of the policy period. See Unearned Premium.
Production - In premium finance, the total of the amount financed
of all contracts for a given time period.
Due to the short-term nature of premium finance agreements (6 to 12 months), production
is not equal to accounts receivable. Because
of the rapid pay-down of the agreements, production is typically three times receivables;
the converse ratio is that accounts receivable are equal to one-third of production.
See Accounts Receivable.
Private Passenger Auto Insurance Policyholder Risk
Profile
- This refers to the risk profile of auto insurance policyholders (you and I) and
can be divided into three categories: standard, non-standard, and preferred. In
the eyes of an insurance company, it is the type of business (or the quality of
driver) that the company has chosen to taken on.
See also Preferred Auto,
Standard Auto and Non-standard Auto.
Pro-Rata - A means of determining what portion of a policy
has been earned (or unearned), usually for the purpose of cancellation or computation
of endorsements. Pro-rata is determined by
dividing the number of days the policy was in effect by the number of days in the
policy period (typically 365 days). Thus
a $1,000 policy in effect for 163 days would have earned 163/365 (44.6%) or $446.
The insured would receive the reciprocal of that number, 55.4%, or $554 as unearned
premium. Pro rata is normally used when the insurance company has cancelled the
policy, or, in some states, when the premium finance company has cancelled the policy
for non-payment. These calculations are simplified
by the use of a circular slide rule called the
Ronoco Six and Twelve Calculator (copyright 1970) or software written for
this purpose. See Earned
Premium and Unearned Premium.
Profit - A measure of the competence and ability of management
to provide viable insurance products at competitive prices and maintain a financially
strong company for both policyholders and stockholders. Virtually the same definition
for premium finance except that the product is money and the revenue stream is made
up of earned finance charges and fees.
U
Reciprocal Exchanges - These organizations are composed of a group of persons,
firms or corporations commonly termed "Subscribers" who exchange contracts
of insurance on the Reciprocal or Inter-Insurance plan through the medium of an
attorney-in-fact. Under this plan, each Subscriber executes an agreement identical
with that executed by every other Subscriber, empowering the attorney-in-fact to
assume on his behalf an underwriting liability on policies issued by the Exchange
covering the risks of the other Subscribers. The attorney-in-fact assumes no liability
as an underwriter. The Subscribers' Liability is several and not joint and is limited
by the terms of the Subscribers' Agreement.
Regulation Z, Volume 1 – Published by the Board of Governors of the Federal
Reserve System, this publication consists of Annual Percentage Rate Tables. Any finance charge can be converted to an
add-on rate by dividing the finance charge by the amount financed. The add-on rate
can then be converted to an APR by simply finding the number of installments on
the left and reading across until the add-on rate is found. (Add-on rates that fall
between published rates are easily interpolated.)
The APR is then read at the top of the column.
Reinsurance - An agreement between two or more insurance companies
by which the risk of loss is proportioned. Thus the risk of loss is spread and a
disproportionately large loss under a single policy does not fall on one company.
Acceptance by an insurer, called a reinsurer, of all or part of the risk of loss
of another insurer. A fire insurance company which issues a large policy generally
reinsures a portion of the risk with one or several other companies.
Reinsurance Ceded - Premiums ceded to other affiliated and nonaffiliated
insurance companies as payment for risk assumed under a reinsurance contract.
Reinsurance Facility - Found in
Rescind – Cancellation of a contract as of the effective date. When a premium finance agreement is rescinded,
the contract is cancelled and all money returned. This may occur if the insurance
company is unacceptable to the premium finance company, or the insured changes his
mind and pays cash for the insurance policy. It is commonly called a “flat cancellation”
(cancelled with no charge) in both insurance and premium finance.
Risk – Risk is defined as the possibility of loss. There
are at least five types of risk: market risk, currency risk, credit risk, interest
rate risk and industry risk. Premium finance is concerned mostly with the last three,
since only a few premium finance companies operate across international borders
and the only markets that the industry deals with are the funds markets. Credit
risk concerns the ability of the borrower to repay the loan. Interest rate risk
is concerned with the rapid rise or fall of interest rates and their effect on the
company. Industry risk includes the stability of insurance companies whose collateral
is accepted and the banks that generally provide funding.
Risk Management - Management of the pure risks to which a company
might be subject. It involves analyzing all exposures to the possibility of loss
and determining how to handle these exposures through such practices as avoiding
the risk, retaining the risk, reducing the risk, or transferring the risk, usually
by insurance.
Risk Retention Groups - These entities, formed under the Liability Risk
Retention Act of 1986, enable businesses or professionals with similar exposures
to band together to provide needed liability overages for each other. Under statute,
Risk Retention Groups are precluded from writing certain coverages; most notably
property lines. These Groups predominately
write medical malpractice, general liability, professional liability, products liability
and excess liability coverages within a particular industry. They can be formed
as a mutual or stock company, or a reciprocal and are usually heavily reinsured.
Rule of 78
The “Rule of 78”,
also known as the “Sum of the Digits” method of earning interest and apportioning
it according to how much of the balance due remains unpaid. 78 is the sum of the
digits 1 through 12. As an example, interest
on a 12-month loan would be apportioned as follows:
in Month One, 12/78 or .1538 of the finance charge becomes earned interest
and is taken into income. In Month Two, 11/78 or .1410 of the finance charge becomes
earned interest and is taken into income. In Month Three, 10/78 or .1282, and so
forth. In the premium finance context, most contracts are written on a 9-month basis,
so this becomes the “Rule of 45” if you will, and the interest is earned as follows
on a $100 finance charge:
Month One 9/45 .2000 $20.00
Month Two 8/45 .1778 $17.78
Month Three 7/45 .1556 $15.56
Month Four 6/45 .1333 $13.33
Month Five 5/45 .1111 $11.11
Month Six 4/45 .0889 $8.89
Month Seven 3/45 .0667 $6.67
Month Eight 2/45 .0444 $4.44
Month Nine 1/45 .0222
$2.22
1.000
$100.00
Similar calculations
will be made, usually by the software, for any other term that might be written. Depending on the state, the software and the
disposition of the manager or owner, the software may or may not continue to earn
interest once a policy is cancelled and the premium finance contract is placed in
a “cancelled” status. Technically, all loans earn interest until paid, so the finance
company is within its rights to do one of two things: a) it can just continue to
earn interest under the Rule of 78 until funds are received to pay off the contract
or (more technically correct) b) it can stop earning under Rule of 78 and process
a credit for the unearned interest as of the cancellation date. Then, on the day
following, it can legally charge level interest at the contract rate on the unpaid
balance until the return premium is received.
Short Rate - Is a means of determining what portion of a policy
has been earned (or unearned), usually for the purpose of cancellation or computation
of endorsements. There are several ways of determining a short rate calculation,
but typically is determined by dividing the number of days the policy was in effect
by the number of days in the policy period (typically 365 days)
and adding an additional 10% penalty.
Thus a $1,000 policy in effect for 163 days would have earned 163/365 (44.6% plus
10% = 54.6%) or $546. The insured would receive the reciprocal of that number, 45.4%,
or $454. Short rate is normally used when
the insured has cancelled the policy, or in many states, when the premium finance
company has cancelled the policy for non-payment.
Many states construe cancellation for non-payment a voluntary cancellation
by the insured and thus eligible for short rate.
Standard Auto – Coverage for drivers with one or two accidents or
tickets. Most insurance companies would be
willing to provide coverage but at higher premiums than those of a preferred driver.
See Preferred Auto and
Non-standard Auto.
State of
Stock insurance company - A company owned and controlled by stockholders and
conducted for profit. It sets a premium charge for insurance, assuming all liabilities
on a corporate basis. The owners of the business are paid the profits.
Subrogation - The right of the insurance company to recover the
amount paid under the policy from a third party. For example, if damage is done
to your automobile, protected by a collision insurance policy, the insurance company
may collect the amount of damages which were paid to you from the party whose automobile
ran into your car, by the process of subrogation.
Total Loss - A loss of sufficient size so that it can be said
there is nothing left of value, or the complete destruction of the property. The
term is also used to mean a loss requiring the maximum amount a policy will pay. Many insurance policies specify that the premium
is fully earned in case of a total loss, especially in marine and aircraft hull
coverage. If this is known to the premium
finance company, it can either refuse the financing or have itself named as a loss
payee on the policy. As such, the claim payment
check will be made out to the insured and the premium finance company, gaining some
leverage in obtaining the balance due on the account.
Total of Payments - In premium finance, the total amount payable to
the premium finance company by the insured. It consists of the amount financed plus
the finance charge.
Total Premium - In premium finance, the total amount of all policies
financed on one premium finance agreement.
Underwriter - The individual whose duty it is to determine the
acceptability of insurance risks or premium finance agreements. A person whose duty
it is to select risks for insurance and to determine in what amounts and on what
terms the insurance company or premium finance company will accept the risk or contract. Also, an insurer.
Underwriting - To determine whether or not a particular risk is
insurable under the policy for which it has applied and at what premium rate. In premium
finance, the selection of new finance agreements at prices, terms and conditions
acceptable to the finance company.
Underwriting Guide – The underwriting guide, also called the underwriting
manual, underwriting guidelines, or manual of underwriting policy. Regardless of
its name, the guide details the underwriting practices of the insurance company
or premium finance company and provides specific guidance as to how underwriters
should analyze all of the various types of applicants they might encounter.
Unearned Premium - For an individual policy, that portion of the premium
not yet earned by the insurance company. If cancelled, that part of the premium
that would be returned to the insured. The unearned portion can be computed on a
pro-rata or short-rate basis. See
Pro-Rata and Short-Rate.
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