How does Premium Funding work and is it worthwhile?
For many businesses, maintaining adequate cash flow can be key to survival amid volatile market conditions. In fact, a recent report by ScotPac shows 72.5% of SMEs reported cash flow problems in the 2021 financial year. Premium funding may provide a solution to this pain point by alleviating pressure on cashflow arising from up-front and lump sum insurance premium payments.
Premium funding allows for payment of premiums to be spread across monthly instalments, rather than an annual lump sum. The premium funding contract is between you (our client) and the premium funding company and is separate to the insurance contract. The insurance broker acts as an intermediary to facilitate the premium funding contract.
If an application for premium funding is approved, the premium funder will pay insurance premiums on your behalf by the due date to the nominated insurer(s). Subsequent payments are then made by you to the premium funder in instalments. Instalment plans are commonly monthly and range from six to twelve month periods. When premium funding is placed through a broker, multiple policies with various insurers can be included in the one arrangement, which means all policies are captured within one monthly instalment.
In November, 2020 the Australian Financial Industry Association (AFIA) commenced a consultation on a Code of Practice for Insurance Premium Funders (IPF Code). As stated by AFIA:
“The IPF Code of Practice strengthens disclosure obligations and makes it easier for customers to compare prices and other aspects of these funding products.”
Historically, the flat interest rate has commonly only been disclosed on premium funding applications. However, in an effort to display greater transparency, some premium funders are now also disclosing the annual percentage rate (APR) on funding applications alongside of the flat interest rate, which will provide comparable financial information to clients.
The key difference between a flat rate and an APR is that the flat rate interest is paid consistently on the amount of money that was borrowed at the beginning of the loan throughout its lifetime. However the APR takes into account any instalments that have been repaid.
Whilst the disclosure of the APR is intended to provide greater transparency and comparability of the cost of borrowing, the disclosure of multiple interest rates may cause confusion. Importantly, the disclosure of the two rates does not result in you paying a greater amount of interest. A comparison of the two rate disclosures is explained using the following scenario (excluding any application fees):
Loan amount: $1,000
Loan term (months): 10
Flat interest rate: 4%
Annual percentage rate (APR): 8.63%
Total repayment amount (1.04 x $1,000): $1,040
Monthly installments (divided by 10): $104
Total interest paid: $40
|Month||APR||Monthly APR (divided by 12)||Interest||Principal||Monthly instalment||Principal remaining|
|1||8.63%||0.72%||$ 7.20||$ 96.81||$ 104||$ 903.20|
|2||8.63%||0.72%||$ 6.50||$ 97.50||$ 104||$ 805.69|
|3||8.63%||0.72%||$ 5.80||$ 98.20||$ 104||$ 707.49|
|4||8.63%||0.72%||$ 5.09||$ 98.91||$ 104||$ 608.58|
|5||8.63%||0.72%||$ 4.38||$ 99.62||$ 104||$ 508.96|
|6||8.63%||0.72%||$ 3.66||$ 100.34||$ 104||$ 408.62|
|7||8.63%||0.72%||$ 2.94||$ 101.06||$ 104||$ 307.56|
|8||8.63%||0.72%||$ 2.21||$ 101.79||$ 104||$ 205.77|
|9||8.63%||0.72%||$ 1.48||$ 102.52||$ 104||$ 103.26|
|10||8.63%||0.72%||$ 0.74||$ 103.26||$ 104||$ –|
|Total||$ 40||$ 1,000||$ 1,040|
As shown above, an APR of 8.63% may initially appear to be greater than the flat interest rate of 4%, however once calculated over the life of the premium funding agreement it is apparent the total interest paid is identical.
Is Premium Funding worthwhile?
The answer to this question is dependent on the unique circumstances of each business, but primarily relates to cash flow. At a time when the current official cash rate as determined by the Reserve Bank of Australia, is almost at zero (0.10% as of 3 August, 2021), premium funding can offer a number of benefits to our clients.
These benefits include, but are not limited to:
- Flexible instalment options
- Access to multiple payment methods, such as direct debit, credit card or BPay®
- Interest payments may be tax deductible
- Freeing up capital for other purposes
- No additional security costs as the insurance premium itself acts as security
- Fixed interest rates which protect clients from interest rate fluctuations.
Whilst there are many benefits to premium funding, it is important for our clients to consider the cost of premium funding and their cashflow requirements. If premium funding enables our clients to effectively use the capital elsewhere in the business, the benefits may outweigh the cost. However, if our clients have surplus idle cash that is not creating returns for the business due to low savings interest rates, the cost of premium funding is greater than the benefit of paying premiums with cash upfront.
Our role in arranging premium funding for our clients
Our brokers have access to a network of premium funders which can offer competitive rates for our clients should they wish to obtain premium funding. Whilst the premium funding contract is between the premium funder and you, our client, our brokers will provide the terms and conditions associated with a premium funding contract and provide assistance should you require further explanation or information on their premium funding options and/or contract.
Furthermore, if you are experiencing financial hardship, we can assist in seeking alternative arrangements with premium funders should they be available.
For more information on premium funding or to obtain a quote, contact us via the form below.