The Dichotomy of Insurance Premium Financing
Thank you for the overwhelming response to #AskTheActuary contest a few weeks back. If we were to go by the number of questions that poured in, it was a successful contest that engaged with the audience across the globe and helped us in increasing the understanding of insurance. In our quest to share nuances of insurance in an easy-to-understand fashion, we bring to you an interesting concept of Insurance Premium Financing.
Insurance Premium Financing, at a high level, is similar to taking out a loan for buying a house. When one buys a home, one typically takes out a loan from the bank, which is repaid over several years. The same idea applies to Insurance Premium Financing (IPF). While it is easy to appreciate the rationale to borrow for buying a house, it may not be immediately obvious why one would borrow for buying an insurance policy. Let’s figure this out!
Insurance premium financing — does it even make sense?
Before we delve deeper, it is important to reiterate that insurance is a necessity and not an option. Those who face “difficulty” in paying premiums, get it financed. This could apply to both the rich and the poor. The rich have the money and the assets but don’t prefer liquidating them to pay insurance premiums and hence get them financed. The poor find it difficult to pay the one-time annual premium (for non-life insurance) and hence get it financed. This is the dichotomy of insurance premium financing — both rich and poor get the insurance premium financed but for different reasons!
Insurance premium financing — how does it work?
Now that we know why it makes sense to get insurance premium financed, let’s investigate further to understand the dynamics starting with the life insurance premium financing.
Life Insurance: High Net worth Individuals generally ensure that their money works for them. While they understand the importance of life insurance policy, they also know their math! In the US, the borrowing cost for an insurance premium is typically about 1%-2% higher than the interbank lending rate i.e. LIBOR. In Singapore, while the corresponding benchmark for IPF is not abundantly clear, the current borrowing rate for insurance premium financing is around 3%. This is relatively cheap for an investor invested in other asset classes like equity which potentially offer significantly higher returns. Hence, such investors would prefer to get their insurance premium financed.
The option of insurance premium financing looks more lucrative if one also factors in the capital gain tax that would be attracted when one liquidates assets to buy insurance. While Singapore does not have capital gain tax. the insurance premium also earns investment returns making the deal sweeter!
From the lender’s perspective, the cash surrender values partially account for the collateral and the difference is compensated by other near liquid assets. Hence, it works for every party involved including the insurers who get their premiums on time and generate higher premiums by selling to an audience who would have been less willing to buy life insurance in absence of insurance premium financing.
In Singapore, however, the trend is to partially finance the insurance premium and is typically capped at 90% of the day-one surrender value. This makes Universal Life policies a good candidate for IPF as they have a non-zero day-one surrender value.
Non-Life Insurance: The story on non-life insurance premium financing is entirely different. To put things in perspective, non-life insurance contracts are generally one-year contracts and require insurance premiums to be paid upfront for the entire year. For those who are unable to cough up the lump sum amount can get it financed by paying a down payment of approximately 25% of the annual premium. In case the borrower is unable to pay the instalment for the outstanding loan amount, the insurance company cancels the policy and refunds the money to the lender after deducting charges.
In effect, the lender charges a slightly higher interest rate on loans to cover for the charges which insurance companies would deduct in case the policy is cancelled. The insurance companies gain by increasing the reach of insurance and the policyholders get an option to cover themselves against the financial risks even though they are unable to afford the lump sum premium.
Insurance premium financing — the future?
In this article, so far, we talked about the current shape and form of Insurance Premium Financing. With disruption becoming the norm, can technology change the way how traditional IPF works? Well, I am not very sure but at the same time do not deny the possibility that insurance premium financing can potentially get disrupted. In my opinion, P2P lending, by leveraging technology, can change the way how insurance premium financing would look like in the future. Given the fact that most P2P lending arrangement generally offers unsecured loans, would it make possible to finance insurance policies with zero surrender values on day-one? What do you think?
In a nutshell
Insurance premium financing, as a concept, works both for life and non-life insurance and is useful for rich and poor. However, the motivation of getting insurance premium financed for rich is diametrically opposite to that of the poor. Overall, it makes it easier for people to buy insurance, helps insurance company increase their reach and creates a business opportunity for the lender. In the future, the use of technology and with the advent of P2P lending, financing insurance premiums could become easier.
With the hope that you found the article useful, I wish to sign-off now and look forward to interacting with you on 25-February at 8 PM SGT over #AskTheActuary. Tweet us your questions on insurance premium financing or insurance in general and I would be happy to take them during the session. You could send your queries to hello@fidentiaX.com
Disclaimer: The article has been written with an aim to broadly explain an otherwise complicated and technical topic for readers with little or no insurance background. Hence, it doesn’t have finer details but is still broadly correct. The readers are recommended to take advise from their respective financial advisers before taking any financial decision.
About the writer: Mr Sumit Ramani is the Chief Actuary of fidentiaX. He is a qualified Life actuary and a computer science engineer with over a decade of experience in (re)insurance business with a focus on modelling of life and health products, peer review and business analysis.