Analysing the Underlying

From solar farms to streaming royalties, the underlying assets being offered to securitisation investors is broad ranging. The variety appeals to those seeking diversification away from the home, credit card, auto or equipment loans that likely form the core of traditional books. With this breadth, comes a call for a fresh look at the scope of diligence on the underlying assets, operating landscape and sponsors participating in these industries. It also invites consideration of the legal foundation for the relevant debt transaction that generates the receivables.

In 2009, Matt Taibi called out lax underwriting standards in his oft cited article which scathingly blasted issuers, investors and their regulators, for allowing vast swamps of crap to be bundled up and sold on to people who did not know what they were buying. Against a backdrop of increased regulation and prosecution, and an increasingly diverse range of receivables being used to originate transactions, resources are stretched and deal teams need to use a laser focus to prioritise diligence expectations as part of the wider credit assessment in these newer asset classes. Those who were around to witness the institutional reaction to being branded a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money may be especially sensitive to the call for diligence.

Analysing the Underlying is a series which we will use to look at one issue, in detail. Our due diligence checklists, notes for the transaction documents or asset opinion and comments on the law, policy and credit perspectives are shared in the SFS toolkit. These might help debt teams with asset diligence and in briefing advisers retained to address relevant risks and to develop features to mitigate against relevant risks. Customise them to reflect you credit perspectives, apply your jurisdictional layer, and share your comments and action items with your deal teams. Some of the materials reviewed in preparing this note are shared in the discord channel, where you're invited to share your views.

Asset overview

Insurance premium finance is a form of funding, provided to borrowers, for the purpose of purchasing insurance. While it can be provided for a range of purposes and on varying structures, in this note, our focus is on loans made to SME borrowers, for the purpose of purchasing property or casualty cover. Typically it's secured, on a limited recourse basis, over the policy purchased with the funding.

Input1 assesses the global premium finance market size to be ~US$55bn in annual originations. Colonnade estimates ~US$45bn is attributable to commercial lines.

By using debt, the annual premium costs of a policy (or group of policies) can be repaid by monthly instalments over the course of the year. For many policy-holders, insurance is not a discretionary expense, given it can be a regulatory requirement for operating a business, and it may otherwise be required to satisfy internal governance controls. A borrower's incentive to maintain it, should be strong. There may be added convenience where a borrower takes out multiple personal or business policies using this credit-line. The looming cycle of economic distress and increasing cost of coverage suggests that borrowers might increasingly look to use this debt, as a means by which to improve working capital management.

The key credit protection is the security over the right to cancel the policy (or policies) and direct the insurer to refund the premium attributable to the unexpired term. This security shores up the credit quality of the outstanding payment obligation by converting it from from one owed by the SME borrower, to obligation directly owed by the insurer. To achieve this, the finance agreement includes terms on which the borrower assigns its rights to all unearned premiums on the policy to the premium finance company and appoints the premium finance company as its attorney, allowing the financier to act in the name of the borrower to enforce the collateral. Specifically, the power of attorney signed by the borrower gives the premium finance company the right act in the name of the borrower, by exercising rights contained in a policy, which allow the insured to cancel the insurance policy. Alternatively, where the policy has been assigned by the borrower to the funder, the credit agreement envisages that, upon default, the funder could act in its own name in cancelling the policy and directing the insurer to refund all unearned premiums.

A credit cushion is built into the structure, by having the borrower pay a deposit which is the equivalent to at least one monthly repayment instalment. In that context, financing for annual policies should be repaid over the following 9, 10 or 11 months, which should buffer against any period between the date of non-payment default, and the date on which the policy is cancelled.

If the financier (or its servicer) has control of the levers to promptly effect a cancellation, and direct that the refund be paid directly by the insurer, the loss exposure should be contained. At least that's how the rating agencies approach the assessment. Provided a portfolio has adequate diversification across brokers, insurers and borrower industries and exposures, and insurers maintain an acceptable credit rating, it's off to the races - or is it?

The asset pipeline

Typically, loans are intermediated by brokers who sit between the insurer, borrower and lender, and act as the agent of the borrower in facilitating the loans and of the insured(s) in arranging insurance policies. The lending process is designed to be light touch, so that the digital processing of applications, and entry into legal agreements is optimised to reduce the need for engagement with the borrower, by either the broker or the financier. Renewal rates are reported to be high.

The ability for premium funders and their intermediaries to maintain a light-touch approach, depends on regulatory status in the jurisdictions in which a product is sold. Most marketing collateral for this sort of product promotes "instant authorisation, subject to anti-money laundering or credit checks" only. They support or require online execution and have renewal terms that maximise continuation of the debt-funded, insurance coverage. To achieve this speed and simplicity, they may be automating identity verification and credit assessments and making use of an exemption from licensing regulations to avoid the consumer credit compliance burdens that may otherwise apply. Exemption status should be verified and compliance with any conditions on which an exemption may have been issued should be considered as part of the initial credit assessment and ongoing periodic reviews. If title perfection occurs, exemption status might also need to be conferred on the trustee.

The refund

Given cancellations are vital to maximising the refund of unearned premiums on defaulted loans, the basis for exercising the rights to get that refund might be verified in the diligence process and confirmed in the asset opinion. A valid assignment of the policy, and a valid right to direct the insurer to cancel the policy and give directions for the payment of the refund are cancellation requirements expressed as conditions to many of the policies reviewed in preparing this note.

Ratings agencies may be willing to rate a transaction on the credit quality of the insurer, so apart from a potential missed coupon (attributable to timing delays between the default triggering enforcement, and the expiration of the notice period which may be required to be given to the insured), the loan is either repaid by the borrower, or recovered by directing the insurer to cancel the policy and to pay the refund in to the funder. Without the refund, the lender (or trust) is left with exposure to to borrowers on an effectively unsecured basis. This profile may not be eligible to maintain the ratings issued against an expectation that in the default scenario, an insurer would make that payment. Default rates are historically low in this asset class, so tests of the integrity of this structure may not have escalated to the point where they have attracted the notice of those structuring transactions (or policy conditions).

Where the borrower has granted security elsewhere (such as a general security agreement that may have been granted to a bank as security for working capital facilities), in the absence of a priority agreement between secured parties, no contractual regulation of priorities will have been made. The fallback is that security takes priority in the order it was granted. The scope of diligence performed by brokers or funders in making these loans may not be concerned with competing security interests.

In many of the template credit agreements we reviewed, rights of cancellation and refund are expressed to arise by a security assignment of the rights to the policy, and are supported by a power of attorney which may be required to facilitate steps being taken in the name of the borrower, when it comes to engaging with the insurer.

For the purposes of this review, we've used the following terms and conditions as examples to test what might be required to obtain a refund in the event of a borrower's default under a loan agreement used to finance the policy premium:

• a premium finance agreement used by AICCO Inc., a subsidiary of American International Group Inc. (USA - 2008 was the most recent we found)

• a sample credit agreement used by Close Brothers Premium Finance(UK)

• Hunter Premium Funding's commercial terms (Australia)

Check our annotated copies of those agreements in discord to see our comments on these contracts. These template terms may not be broadly reflective of terms currently used across the key jurisdictions, and may be dated (it's especially difficult to find templates used by financiers who issue finance contracts after policies have been entered into, using membership apps that generate agreements). Against these caveats, key points to note are that:

• Most of US states regulate premium finance by customised statute. This is not a feature of legislation in Australia or the UK, where codes or rules of practice are used.

• US courts have held that:

  • a premium funder's security interest in the unearned premium arises at inception of the financing;

  • the lien as a core protection on which the transaction depends; and

  • the security interest does not need to be filed.

• Cases contested before the US courts, have left open the potential to challenge the priority interests that competing secured creditors may bring, so a valid security interest over a refund may still fail against a prior ranking security granted elsewhere. Perhaps the size of these loans is sufficiently low so as to avoid such competition, but should it arrive, neither statute nor precedent protects the funder.

• Instances of state advocacy against premium funders for early cancellation of policies illustrate a diligence point that could be addressed by reviewing servicing policies to examine the protocols to be used where there is payment delinquency.

Diligence categories

There are legal, factual and policy considerations involved in this assessment, including:

• form requirements:

  • At law, some contracts, in some jurisdictions, need to take a particular form to be valid. For example:

    • the granting of security and the appointment of attorneys are steps that may need to be documented as deeds, and/or executed in the presence of a witness; and

    • the granting of security over a policy may require that the security agreement is executed by the insureds whose rights are being assigned by way of security and may also require registration in order to be effective against third parties who may also have security interests in the refund. Similarly, the appointment of an attorney might need to be made by the appointor (as opposed to another person acting as its agent).

    • The template agreements we reviewed include samples that fall short of legal requirements for the effective grant of security or appointment of attorneys. In some of our sample, the agreements propose that the borrower signing the agreement (or the broker on behalf of that borrower) could grant these rights or make the appointment, on behalf of the insured. Legal precedent for this agency has not been established in the jurisdictions we reviewed, and directly offends statutory requirements in some of them. While some templates did contemplate that the funder may have successors in title to the loan, the language appointing the funder as attorney, did not extend that appointment to those successors. On title perfection, the servicer may need to use the power of attorney to satisfy the insurer's conditions for cancellation.

  • Other commercial dealings (such as entry into loan agreements) may need to be tested against agency principles (ostensible authority) arising at general law. These tests, both in relation to the scope of agency and the execution formalities, may not be satisfied by click through screens provided in a broker portal, especially where the party on the other side of that digital interface is not a party to loan agreement.

  • Legal opinions on the asset may be provided against the form of template agreement, and be issued on terms that assume that it will be validly executed. This assumption may not be aligned with the processes adopted by lenders and brokers in making these contracts.

  • An assignee can only assign the rights they hold. To the extent that the borrower is not the insured, or not the only insured, covered by a policy, then the assignment of the borrower's rights under that policy is something less than all of the rights of the insureds under the policy (absent and effective appointment by the other insureds of the borrower, to act as agent in assigning those rights). If a policy requires all insureds to give an effective cancellation notice (which some of the sample policies reviewed require), then a security agreement that is not made by each of those insureds would appear to fall short of this requirement.

  • Some of the credit agreements we reviewed include representations and undertakings given by brokers, in favour of premium funders. Where the credit agreement includes a signature block for the broker to give these covenants, and depending on the jurisdiction, there may be a question as to whether a good consideration has been paid by the funder to the broker in consideration for these covenants; and further invite consideration as to whether the broker is capable of giving these undertakings, absent the fully informed consent of the borrower(s)/insured(s).

  • As with many other asset classes, diligence on the credit agreement should confirm that the agreements (both the debt and the security) are assignable, free from set-off, permit disclosures to securitisation vehicles and investors seeking to receive reporting in relation to them, and do not fall foul of consumer protection laws. The sample agreements we reviewed included instances where these requirements have not been met.

• contract formation:

  • Digital efficacy is promoted as a feature on most premium funding broker sites we visited. The law is generally a laggard. Legal form requirements still exist in many parts of the world and they must be satisfied for valid contractual rights to form.

  • Many broker websites initiate contact with an insured, by inviting them to seek a quote. Offers for financing may be made as part of that invitation. If an insured is interested in taking a loan, it is invited to apply for finance. That application (an offer to make a contract), if accepted by a lender, becomes a loan agreement with effect, subject to any conditions that may be specified in the loan (such as completion of anti-money laundering checks, or the payment of a deposit). Whilst most premium funders advertise some for of 'immediate' approval, there can be delays of several weeks where there is a question mark over something raised in the AML or credit assessment process, such that it may be unclear as to when a contract has formed, and how that acceptance is communicated to the borrower. Any change in a borrowers capacity to contract in the period between offer and acceptance may threaten the validity of the contract. Diligence on the contract formation protocol could help to get a view as to how many loans are actually formed with 'instant' effect.

  • As an operational matter, premium funders have little direct contact with borrowers and rely on the information provided either by the broker or the borrower, for the efficacy of their own direct lending agreements. In order to satisfy the eligibility criteria that may be specified in order to sell receivables to the trust (such as a requirement that only borrowers who have duly executed funding agreements, are insureds for the purposes of the policies funded with the proceeds of the loan), the accuracy or truthfulness of such matters would depend on factual status which seems unlikely to have been tested within the scope of the identity and credit diligence performed as part of the loan application process. A sample review of the back book could form part of a diligence review.

• policy conditions:

  • Some policies specify terms which may interfere with the financier's expectation that a refund of unearned premium will be made. For example, policies issued on terms that require the insurer to receive a minimum return or which, which if unearned at the time of cancellation, may represent an unanticipated reduction in the amount of the refund. Others may be issued on non-cancellable terms. Insureds may also nominate other parties as named insureds whose consent to deal with the policy may be required, in the default scenario.

  • Insurers specify cancellation terms and conditions to the right to assign policies in the product disclosure statements or terms and conditions attaching to the policies they issue. Of the 50 such policy disclosure statements we reviewed in the course of this analysis, we found a variety of terms which conflict with the basis on which the security agreements have been expressed (examples of relevant clauses are shared in the discord). The key terms of the policy that should be considered are:

    • the definition of who is insured (because that is the entity, person or group whose rights will be cancelled and who may need to be party to a cancellation instruction);

    • the requirements for giving a cancellation instruction;

    • what the insurer says it will do when it receives the cancellation instruction; and

    • consent controls that the insurer may reserve to itself, when it comes to purported assignments of the policies, by the insureds.

  • Some policies will deal specifically with how the insurer can take instructions where there is more than one insured. Some require all insureds to give cancellation instructions, others allow a broker to do so as agent of the insureds, and others specify that any single insured can give the instruction which will be acted upon withe effect against all of the insureds.

  • Where policies specify conditions dealing with policies funded with premium financing, many require a power of attorney to have been granted by the insured(s) and/or a legal right over the policy (this would be the assignment) to effect the cancellation and claim the refund. This requirement puts the need to test the legal validity of the power of attorney and the security agreement in focus. As a matter of ordinary course, we understand that premium financiers, do not perform diligence to check whether the borrower named on a loan is the (only) insured named on a policy.

  • Market practice may involve reliance on brokers to effect cancellation in the default scenario. The legal foundation for the premium funder to direct the broker to arrange this cancellation does not appear to be established by the terms of the credit agreements we reviewed.

• operational factors:

  • For banks, with low cost of funds and large balance sheets, there exists a strategic advantage to acquiring premium finance companies. At the other end of the spectrum, technology providers are offering PFaaS to enable anyone to start a premium financing business. The extent to which a funder relies on third party technology or to perform critical steps, should be considered.

  • The risk of fraud should be considered at formation, and throughout the term of the relationship with the intermediary, particularly given reliance on brokers to introduce borrowers (and vet them against credit criteria), to remit proceeds of loans to insurers, and then to manage the cancellation and refund process, exposes premium funders to reliance on brokers to take material steps in the management of this credit.

  • In determining appropriate broker diversification parameters, consideration might be given to the basis on which brokers are owned or operated.

  • Diligence could be extended to sample reviews of broker protocols.

• regulatory factors:

  • In the US, most states:

    • regulate insurance premium finance companies through the Insurance Departments or Offices of Insurance Regulation in which they operate. Each state has specific laws regulating items such as interest rates, late charges, loan terms, forms, audit provisions, cancelation requirements, the form of the agreement, relief from registering the security agreement an a prohibition on exercise of certain rights (eg: Massachusetts).

    • have the ability to audit each finance company and require annual reports to be submitted.

  • in Australia:

    • a Code of Practice for Insurance Premium Funding was introduced with effect from 1 October 2022 and places emphasis on the discontinuation of 'conflicted remuneration' (kick-backs) which have been used by lenders to encourage brokers to refer borrowers. A notable change between the draft discussion paper and the final form of the code, is the light touch approach taken to managing the conflict of interests that brokers may have when it comes to commitments they have to insureds, whose policies a funder may wish to cancel, in the event of a payment default. Since coming into effect, 2 Australian premium funders are compliant with this code. Non-compliant issuers may need to disclose the extent of non-compliance to their investors and seek waivers from requirements to comply with the industry code.

    • premium funders may seek regulatory exemptions from compliance with consumer credit laws, and may also fall within an exclusion to the requirement to formally register the security interest created by the assignment clause in the loan (on the basis that it might be characterised as an insurance payment or indemnity. Legal opinions could address these points.

  • in the UK:

    • new FCA rules were introduced with effect from from 1 October 2021 (for governance) and 1 January 2022 (for pricing). Among other things, they require insurers and intermediaries to demonstrate to consumers, how a premium finance product offers value for money. Exemptions from consumer credit law may be available to financiers in this market. Legal opinions could address these points.

    • while financiers might claim that the margins depend upon automation, the General Insurance Pricing Practices Market Study, issued by Financial Conduct Authority in the UK in 2019 and updated in 2020, found that premium finance was a material component of non-core revenue, and identified a number of practices relating to premium financing, that are newly regulated or prohibited.

The role of the broker

The bulk of premium loans are originated through intermediaries who refer borrowers to lenders. They play an important role in explaining contracts, entering into and renewing them, and dealing with borrowers should they experience financial difficulty.

The kick-backs for these referrals can take many forms and appear to be continuing from the initial loan, and through each annual renewal. Standard Premium Finance Holdings, Inc generalises that the commissions paid to the brokers that recommend its premium financing loans, is ~25% of the gross revenue earned on the loan. Brokers also receive points in a rewards program, which can be redeemed for travel and accommodation benefits.

In giving cancellation instructions to an insurer, brokers are acting as the agent of the insured. This insurance-agency relationship is the subject of specific legislation in many jurisdictions. The scope of that legislation is formed around a brokers agency in its dealings with insurance policies (as opposed to other commercial arrangements, such as arranging financing to pay for insurance).

Where a broker is instructed to cancel a policy by a premium funder, the broker might need to consider whether its fiduciary duties to the insured(s) (who may or may not be the borrower) are discharged. In distress, an insured (who may be legally required to hold insurance in order to operate a business) may prefer to allow a loan to remain in default, and retain the insurance, in order to trade through those difficulties. In such circumstances, a broker might be obliged, as fiduciary of the insured, to prioritise that commitment.

Some of the sample contracts reviewed include 'irrevocable directions' which are given by the borrower, to the broker (who is not party to that agreement and does not have any standing on which to rely on them) and direct the broker to comply with instructions given by the funder to cancel a policy. Contrast against the lure of revenue stream that may flow from ongoing referral fees or other incentives that a funder may provide to a broker, there is potential for a conflict of interest that does not appear to be explicitly addressed by the regulations that operate to prohibit conflicts of interest, in some parts of the world.

Aside from the potential for issues in effecting cancellation, another broker-level process that should be considered is that premium loans, once drawn, are remitted to brokers, who will hold those funds, and then send them to the insurer on a periodic basis, sometimes as infrequently as quarterly. Whilst portfolios may specify parameters which cap exposure to any single broker, consideration should be given to the potential for competing claims for the funds that are sitting in a broker's trust or operating account. A variety of actors may have grounds to make claims against this pot of money.

A further payment consideration arises where the insured has made a partial payment for the insurance to the insurer (or broker) directly, and reimbursement is proposed as part of the funding terms. Protocols for managing these payments could be reviewed as part of a diligence process, to verify where payments have been made and at what point reimbursements are made.

Insights

A lot of law gets made on the basis of insurance claims. The stakes can be high, the product is regulated, and risks and interests are varied. Across the world, this is a subject in respect of which precedents are set and legislation is passed. Precedents set centuries or decades ago, still apply today. By contrast, the premium finance product may have 30-50 years of history (some date its beginnings back to 1933, but generally, participants have a maximum of 3-4 decades of operating history). It is a relatively new product. It seems that attempts are being made to expand the boundaries of insurance law, into the practice of secured lending to optimise its investment appeal.

Some boundaries still exist to divide the banking and insurance sectors. The terms of a policy, including cancellation and refund terms, are governed by insurance laws. This financing product serves to blend the two regimes so as to extend the protections recognised at law for the insurer or broker, to financiers making loans and taking collateral over policies. Context for why insurance protections are made in law, do not seem to be considered in making this leap. The assumption that the debt used to buy a policy, will be treated with same legal brush, as policies issued by insurers has been not been universally validated by the courts or regulators, and may not withstand the sort of legal scrutiny that a challenger may bring. Some of the template contracts go further, so as to exclude the insurance obligations, leaving financiers room to assert that the benefits should be conferred on the credit agreement, whilst also asserting that the liabilities are not applicable.

Insolvency practitioners might be the likely intervenor to play the role of agitator. Where one is appointed to deal with a distressed insured (or its assets), whose creditors may wish to claim the refund due on a cancelled policy being returned for distribution, or an administrator wishing to resist cancellation to allow it to trade through distress, an attack on the validity of the security agreement or power of attorney, or the broker's authority to act as agent of the insured might be made. Where challenges have been brought in US courts, the resolution has depended upon a codified recognition that the financiers security over the refund under the policy as the cornerstone to the commercial transaction. Other parts of the world have not codified this protection. It will be left to the contract to establish it. In any event, the US cases do not address the formation weaknesses, or practical deployment of the product where the insured is not the grantor of the security interest. They also leave open the potential for competition for priority over assets where security has been granted to third parties, by the borrower.

The issues with the validity of the grant of that security (by reason of the digital contract formation and renewal process, sometimes being executed by a broker, in its capacity as agent), the entitlement to exercise rights under the policy (given the cancellation terms specified in the policies) are among the factors which a financier might need to overcome, in order to have confidence in the security being enforceable, with the effect that it allows recovery against the unearned premium.

Whilst market conventions, commercial practices and industry group commentary suggest a pattern of expectation that a borrower in default under the loan agreement, would expect to lose a right to maintain status as an insured, there is work to be done to create legally enforceable protections to enable a financier to bring about this result.

Reliance on brokers and borrowers to make sure that financing provided is used in a way that is consistent with the funder's expectation of security over the unearned premium, has several touch points.

The first is the through-line from the credit agreement (which contains the security terms) to the rights of cancellation under the policy. The trigger depends on an assumption (or in the case of some of the sample agreements reviewed, representations in the contract made by either the broker or the borrower) that the borrower is the policy holder, and has rights all rights of cancellation.

Secondly, the terms of the policies funded with these loans are not reviewed. Where they contain definitions of who is an insured, which might be a group that includes entities that are not party to the loan agreement as a borrower and security provider, then the security granted to the funder may be insufficient. The funder would be left with an unsecured debt claim against an SME borrower. Alternatively, the funder may seek a soft intervention by the broker, who could intermediate the cancellation of the policy and to direct the refund of the unearned premium. That intervention might be incentivised by the broker's pursuit of ongoing referral commissions that it can expect to receive from the lender's continuing business. For an investor, the point at which it takes title perfection, may mean that the lender is no longer writing new debt and trustee's may not find brokers as cooperative as they are in their dealings with lenders who operate as a going concern. A quick google search produces a variety of sample broker agreements, pursuant to which agents offer services to various forms of product issuers, such as premium funders. Those agreements tend to recognise that the provision of the services offered to the funder, is subject to on overriding fiduciary obligation, owed to the principal that appointed the broker to act as agent.

Third, in the event that an insolvency practitioner intervenes in the process by instructing an insurer to cancel a policy and direct a refund be paid to the borrower's estate, the insurer's compliance may result in institutional level policy changes that better protect the insurer in terms of its right to rely on cancellation instructions - affecting all policies, with further potential that the approach becomes an industry standard. The bias for which such a change may be made may reflect the insurer's self-interest in selling more policies (which it could be said is achieved by cooperating with brokers), or concern to avoid the wrath of regulators (who may be inclined toward protecting the rights of the insured), or a preference to avoid becoming involved in claims brought by insolvency practitioners (who are astute at using litigious techniques to achieve quick recoveries). A wholesale change of this kind would not be visible to the funder, absent diligence as to which policies its loans are used to fund.

Depending on the jurisdiction in which an investment transaction is structured, there may be an assumption that the asset opinion will address the legal risks inherent in the receivables terms. For an industry that expects standard form contracts (originally, real property contracts of sale and mortgages), the legal sign-off on the asset opinion could be generated by a mechanical turk. It should be possible for cheap lawyers to produce them, on the basis that the agreements are widely used and not generally negotiated. Those involved in structuring the investment transaction may have little regard for its scope or qualifications and may assume that the underlying risks have been fully reflected in the eligibility criteria and portfolio parameters that have been commercially negotiated. For receivables in newer asset classes, it might be time to reconsider this approach.

Some of the diligence points flagged in this note might be contained on the basis the loans are typically small, they have a short tenor, are structured to include the deposit as a cushion to buffer against default, and then portfolio parameters can be used to diversify exposures to loans made to borrowers in particular sectors, the brokers that arrange them, and the insurers that issue the policies. Default rates being historically low may provide commercial comfort. The material risk that is not contained by these features is that arising where an insurer is threatened with action by or on behalf of a borrower that does not wish to have its policy cancelled and refund paid to the premium funder. A reaction to that threat might be an industry wide clarification of the policy terms, so as to put more certainty around the conditions on which insurers will cancel a policy, where those clarifications may be inconsistent with the receivables terms.

For those products issued outside the jurisdictions where insurance premium funding is specifically regulated, then it might be worth considering whether the volume of the market and precedent for investment in this asset class has been generated on the basis of that regulatory framework.

Innovation

Technology enthusiasts like to say things happen slowly, until they happen quickly. They mean that it can take a while for the groundswell to build, and then just moments for it to reach escape velocity. The insurance landscape is slowly evolving and increasingly regulated. New market entrants are redefining aspects the industry. Similarly, the models used to financialise the premium funding loans used to pay for insurance are ripe for review. The technology exists to enable seamless underwriting and ongoing monitoring against a filtered set of parameters and criteria, which could identify compliance with credit, legal and governance criteria. Tagging funded policies, with security interests that have been granted (and upon which the transaction relies) is within reach, if the processes were better enabled by plugging into existing technology.

To demonstrate what's possible, the SFS sandpit includes a blockchain demo of a product that scrapes key terms of policy terms and conditions, and tags them against the security terms we found in the sample of contracts we reviewed and a mock up of what that would look like if it were represented against security registers (that would show any conflict between the negative pledges we saw in our sample review, and the security registered in favour of third parties). The demo is built on Moralis, and will not be activated outside the sandbox (the data collection process we used has not been scrubbed for superseded policies or for the other exclusions we've flagged) or refreshed on a regular basis. Our demo build was developed in a few hours. Check it out and get in touch if you'd like to workshop the potential applications.

Next steps

We've written private letters to some of the funders, insurers, investors, industry groups and brokers who are active in this market and invited them to comment on the thoughts we've shared in this newsletter. We'll keep these interactions private, to allow an opportunity for these market participants to consider whether their products and practices address the thoughts shared in this note.

Our practice will be to share the results of that interaction either with the consent of those participants, or, if we haven't reached an outcome that satisfies our curiosity, then we will summarise the position on the anniversary of this newsletter and open it up to wider discussion. You're welcome to join that conversation.

Next month

Next month, our deep dive is getting into the extent of directors duties in managing climate risk diligence and disclosures. We will follow that with a look at the legal intricacies of partial assignments, and the underlying structure of novated car leases. Let us know if you'd like to co-author with us, or drop a note in the discord if you'd like to share a note related to any of these topics.

You can also make a suggestion for a topic you'd like to see covered in this series.