Cashing in on the Credit Crunch

The first quarter of 2009 has proved to be tumultuous, to say the least. A credit crunch and a deep recession have left virtually no sector of the economy unscathed — with the oil and gas, construction and manufacturing sectors taking the biggest hits. If that wasn’t bad enough, experts predict the commercial property and casualty market in Canada will likely harden over the next 12 months.

As companies plan for the bumpy ride ahead, the management of cash flow becomes top of mind. As a result, third-party premium finance companies in the Canadian market are reporting an increasing demand for their services.

Therein lies the rub: in the midst of increasing demand for the financing services during a credit crunch, one of the biggest players — if not the biggest player — in the Canadian premium financing market, AIG Credit Corp. Canada, made an abrupt announcement in February that they are winding down their Canadian premium financing business.

Within 24 hours of its announcement, AIG no longer originated loans in Canada and began to scale down to a one-office operation in order to honour existing contracts before permanently closing its doors in a year.

Brokers say the impact of AIG’s withdrawal from the premium financing market will likely not be felt for another nine or 12 months, when it’s time to renew the business currently placed with AIG Credit. They say the void left by AIG’s exit will likely be filled by existing players in the premium finance market; several of these players told Canadian Underwriter they are confident they will be able to pick up the slack despite the increased cost of credit. And now, an increasing number of brokers are giving consideration to getting in on the game themselves.

BROKER REACTION

Brenda Rose, vice president of Firstbrook, Cassie and Anderson Ltd., says two things are currently occurring in the Canadian marketplace.

“The first is that AIG Credit is out of the picture, so the other providers — and there are several in the Canadian marketplace — are likely seeing an increase in business,” she says. “The second thing is that, with tightened credit, premium finance rates are generally going upwards just because of the cost of funding is increasing overall. Credit is tight in the entire market, not just in the insurance market.”

Dan Danyluk, CEO of the Insurance Brokers Association of Canada, says he has not heard of brokers having any major problems finding a home for clients that opt to finance their premium payments. “But one of the challenges is that when a finance company withdraws from the marketplace, there isn’t an immediate reaction because there are loans in force, so it actually takes about 12 months before the total impact is felt.”

Premium financing has been “a good bit of business” in Canada for many years, Danyluk says. But where we will see a problem in the future, he adds, “is if there is a sudden hardening of the marketplace, and we haven’t seen that yet.”

BOWING OUT AND STEPPING UP

Paul Zarookian, president of AIG Credit Corp., says the company made the decision to stop originating new business and wind down Canadian operations because premium financing is not considered core to AIG. At a time when the organization is “totally focused on paying the U. S. government back for its loans, it has identified working on its major lines of business as its singular focus,” he says.

Zarookian did not comment on AIG’s market share in the premium financing area, saying only that AIG Credit financed any carrier with a financial strength rating of B+ or better.

Bob Willis, vice president and national sales manager at CAFO, estimates roughly between 15% and 20% of the commercial property and casualty marketplace (excluding the large cap accounts) is financed in Canada. Roughly half of those are mid-market size accounts, he continues, or “just above the mom-and-pop sized accounts but below the risk management accounts.”

Ben Sillem, vice president of operations at Broker Builder Corp., estimates that between a quarter and a third of the supply of third-party premium financing in Canada came through AIG Credit Corp.

Given the credit crunch that’s bearing down on the economy, Sillem says, other third party financing companies may be struggling to maintain the capacity needed to supply the market should the banks decide to withdraw credit facilities. “Banks will re-evaluate the type of lending and arrangements that businesses are getting and that’s the case for insurance companies and finance companies,” he says. “It’s a basic limitation in this environment that we’re in.”

On the other hand, Darrell Blenus, president of IFS Premium Finance Services Inc., remains confident third-party premium financing market will maintain an adequate amount of supply to meet demand. “As long as the banks are satisfied that we are going to be able to lend the money out at a reasonable rate of return,” business should continue as usual, he says.

Wes Franklin, director of operations at PenCross Financing Inc., agrees, adding that at the same time, he predicts players that have merely been dabbling in the market over the past three or four years will likely withdraw.

Franklin further observes that during the height of the soft market, a lot of specialty business, such as premium financing was being pushed through the regular markets, where it became available to the “regular market financing, such as whatever the bank was extending to them as credit or the insurance company was passing onto its customers.”

“Let’s face it, [premium financing of specialty lines] was not [the banks’ or insurers’] business to begin with,” he continues. “The market is going through a rough time. There’s more focus on writing these classes of business properly so that the underwriter at the end of the day isn’t expecting huge losses. As a result, a lot of stuff that was going to regular market was being undersold, with losses piling up, and insurers are saying:’We’re not doing that anymore,’ and so it goes back over to the specialty market.”

PICKING UP THE SLACK

Even prior to AIG Credit’s withdrawal from the marketplace, third party financers were seeing an uptick in demand, Willis says. “Commercial clients are having difficulty getting credit through their traditional lending facilities. As a result, they are much more interested in looking for alternatives. The premium financing loan is an easier one for them to get, and it doesn’t impair their other facilities.”

The demand is being seen across all account sizes, he continues, though the demand is greater in some industries than others. “In Southwestern Ontario, companies that have been relatively stable over the years and maybe haven’t been using premium financing are now having difficulties accessing credit themselves, and they are having difficulties managing cash flow because of the changes in the auto sector.”

Contractors servicing the pulp and paper industry, as well as organizations in the oil and gas sectors, are other examples of industries exploring their premium financing options.

Basic economic principles suggest this is good news for those in the premium financing business. In fact, Sillem has noticed an increasing number of brokers wanting to get a piece of the pie.

As the economy really started to “head south” in late 2008, the number of brokers interested in starting a financing business slowed dramatically, despite the increasing demand from their clients for the service. “They got scared and they didn’t want to do anything,” he says. “Now, in the past month, they seem to be saying that doing nothing is not an option; with AIG Credit being gone, that’s the real kick-off to get them to explore the option themselves.”

Ontario is the only jurisdiction with a regulation for the start-up of a premium financing operation, he says. RIBO (Registered Insurance Brokers of Ontario) states that brokers will need a secondary business exemption, and they need to set up a separate entity through which to do the financing. In other words, the financing operation can be owned by the brokerage, but it can’t run through the brokerage.

In terms of the capital needed to start such an operation, Sillem says a brokerage will need to multiply the anticipated volume of business by 1/3 to determine the capital/credit facility required to support the premium finance efforts.

In times of tight credit, the transparency and simplicity of brokerages will be attractive to lenders.

“Banks are rather friendly towards lending to a broker because a brokerage is a known, conservatively-run business,” he says. “The banks know when they’re lending to them what a brokerage has or doesn’t have. There aren’t a bunch of funky things going on in the background. A brokerage is what a brokerage is.”