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Insurance Premium Finance Terms and Definitions
Back to noteworthy information--Insurance and Insurance Premium Finance Terms and Definitions
A B C D E F G H I J K L M N O P Q U R S T U V W X Y Z
General
No insurance and premium finance resource would be complete without a comprehensive glossary of terms. The following is a list of terms and their definitions to better help navigate the sometimes confusing world of insurance and premium finance.
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 Texas formed in the 1940’s for the purpose of creating insurance availability to the rural areas of Texas . They are exempt from rate controls exercised by the Texas Insurance Department. County Mutuals are today used primarily in the non-standard automobile market. They have small equity contributions and typically reinsure every risk 100% with reinsurance companies, collecting a fee for the service. Most county mutuals today are owned by large insurance groups such as State Farm.
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 Lloyd's of London , England , an institution specializing in excess & surplus coverages within which individual underwriters accept or reject the risks offered to them. The Lloyd's Corporation provides the support facility for their activities. See Lloyds Organizations.
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 Maryland residents that can not obtain it through the usual markets. It acts in the same capacity as the Assigned Risk Plan or Joint Underwriting Authority in other states. It receives no state funding, operating entirely on the premiums received from policyholders. If the fund suffers losses, they can be recouped through surcharging all drivers in the state. Unique in that it is the only one of its kind in the United States . See also Assigned Risk Plans, Joint Underwriting Authority and Reinsurance Facility.
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.
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 North Carolina , New Hampshire and Massachusetts and serves the same purpose as Assigned Risk Plans, Joint Underwriting Authorities and MAIF in that it is a mechanism for pooling high risk drivers and businesses. Insurers issue the policy then decide if they want to cede (transfer) the risk to the reinsurance facility. Premiums are sent to the pool and the pool is billed for claims payments and expenses. Profits or losses are shared by all automobile insurers in the sttate. See also Assigned Risk Plans, Joint Underwriting Authority and MAIF.
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 Domicile
The state in which the company is incorporated or chartered. The company is also licensed (admitted) under the state's insurance statutes for those lines of business for which it qualifies.
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.