It is not uncommon for a company to finance the premiums for its property and liability insurance policies through a premium finance company. To secure these loans, such specialty lenders generally take an assignment of the unearned premium payable upon early termination of the insurance policies. To maintain sufficient collateral throughout the loan, premium finance companies usually require the borrower to make an initial down payment on the premium so that the premium rebate, taking into account debt amortization, will always be larger than the loan balance.
During our due diligence on behalf of a lender in the origination of a secured loan, we uncovered a more aggressive premium financing arrangement. The proposed borrower had obtained 100% financing from the premium finance company. To improve its collateral position the finance company also took an assignment of "all loss payments which will reduce the unearned premium which become payable under the insurance policies".
Under its loan facility, our client would have a perfected security interest under the UCC in both the borrower's personal property and the insurance proceeds payable by reason of loss to such goods. However, we could not assure our client that its security interest would have priority over the premium finance company's lien. The lien of a premium finance company is generally governed by state law other than the UCC.
If you are a secured lender, we recommend the following: First, ask your borrower whether it independently finances its insurance premiums and, if it does, review the documentation signed by your borrower. Second, if the premium finance company claims a security interest in insurance claim proceeds, require the finance company to subordinate the priority of its lien on insurance loss payments payable with respect to your collateral.