Does premium finance need fixing?

The noise around the FCA seeking to take action on premium finance has been circulating around the industry for years now. But in recent months, that noise has intensified and rumours about premium finance being next on the regulator’s list of targets have grown.

Speaking to the House of Commons’ Finance Treasury Committee in April 2024, the FCA’s director of general insurance and conduct specialists, Matt Brewis, described premium finance as an “essential product” that allows those who would otherwise be unable to afford cover to make monthly payments.

But, Brewis added that he was “very concerned about the additional cost” for consumers that opted to use this model.

He said: “My concern is around the credit risk that is charged. There is very limited credit risk when it comes to these products.”

Under the new regulatory regime brought in alongside Consumer Duty, which came into effect from July 2023, all firms that sell premium finance need to create a fair value assessment of the product – Brewis confirmed to the government committee that this is one of the areas the FCA “will be looking at” more closely.

So, what is next for premium finance? Is this a broken product that needs fixing? Or is it an essential product that makes insurance more affordable for the poorest in society?

Pros and cons

Fairer Finance managing director James Daley told Insurance Times that premium finance in its current form is not working. He argued that it “piles pain on customers who are the least financially resilient”.

But in a statement sent to Insurance Times defending the product, premium finance firm Premium Credit reiterated the importance of premium finance in offering choice to customers when paying for their policies.

“Premium finance is an important payment option helping customers to purchase their insurance, competing with cash, overdrafts and credit cards,” it said.

“Premium Credit completes a thorough annual fair value assessment for our premium finance product, in line with the FCA’s regulation, and [we] work with our partners to ensure the cost charged for the service provided to customers is appropriate and is attractive in price when compared to other sources of credit available to the customer.”

Daley, meanwhile, fell short of calling for the product to be banned – recognising that the option to pay for insurance monthly was “invaluable” for many – but he noted that changes do need to be made to the way in which the market approached premium finance.

He explained: “Banning premium finance doesn’t work. All it would do is leave millions of people unable to pay their car insurance – and they’d probably just end up borrowing [money] by other means.

“We need to look at whether it’s possible to force insurers to allow some or all of their customers to pay in instalments at no extra cost.

“There would inevitably be some cost to this, which would be added to all insurance premiums, but if it’s less than the cost of premium finance, then it might be worth considering.”

Daley pointing to the example of pet insurance as one market where this approach is already working.

But Premium Credit said that improvements have already been made to the way the market operates thanks to the FCA’s recent regulation updates and it urged patience while these are allowed to bed in.

“There have already been a range of positive changes as a consequence of evolving regulatory requirements that improve the way in which the product is offered and managed,” it said.

“These include actions to promote transparency of pricing and other key components, leveraging technology to ensure that affordability of financing is taken into account and ensuring [that] all providers consider premium finance as a separate product with all the regulatory protections that implies.

“The market is making progress on embedding all of this, but there is still work to be done by some players. We welcome regulation that ensures all customers have access to the essential insurance products they need and are treated fairly.”

The poverty premium

One of the criticisms fired at premium finance is that it acts as a ‘poverty premium’, with those least able to pay for cover facing a higher expense as a result of the interest charged in order to pay monthly.

Daley agreed with this sentiment, although he acknowledged that premium finance was unlikely to have been originally designed in this way. But he added that in today’s market, this issue has become much more important.

“When [premium finance] was first introduced, premiums were much lower and so the additional cost in pounds and pence wouldn’t have been so much,” he explained. “Today, it can add hundreds on to a customer’s cost of insurance.”

Premium Credit, however, argued that the ability to pay monthly “increases accessibility to vital insurance products”. Without such an option, the level of underinsurance in the market would increase, it added.

“Our research, as part of our annual Insurance Index, shows that some consumers select the level of cover they can afford to pay for in a single lump sum, rather than the appropriate cover required, resulting in underinsurance,” it said.

“Premium finance can help prevent underinsurance by spreading the lump sum cost of insurance into more convenient and manageable monthly payments.”

And when it comes to the cost of credit, Premium Credit’s stance is equally clear.

“Premium finance rates will vary depending on a number of elements including the services provided, the size of the premium, the number of instalments, the expected cancellation rate, the predicted bad debt and the cost of lending,” it said.

“All elements are reviewed as part of the annual fair value assessment to ensure that the cost charged delivers fair value to the customer.

“The cost of premium finance is clearly disclosed to customers in line with regulatory requirements and typically aligns well with other forms of credit available, such as credit cards or overdrafts.”

For Daley, however, premium finance in its current form is not working to the benefit of customers, and he has called on the FCA to look for alternative options.

“First, [the regulator] needs to do a thorough cost-benefit analysis of the different policy solutions,” he said.

“Social tariffs, interest rate caps [and] Insurance Premium Tax waivers could all be possible solutions or part of the solution. But we’re still at the stage where no one has the evidence to make the case for these policies one way or another.”

Furthermore, Daley believes “a new government will be the catalyst for action in this space”.