Businesses looking to finance their insurance premiums already are seeing higher rates from premium finance companies as a result of tightening credit markets, according to finance firms and observers.

Still, premium finance companies say they remain a cheaper alternative to bank loans and hope the liquidity crisis provides an opportunity to expand their business.

Premium finance companies pay a policyholder's premium essentially as a short-term loan, but they typically charge interest rates below what many banks offer on conventional lines of credit.

Home construction contractors, trucking companies as well as physicians, attorneys and others with professional liability coverage are among the relatively small percentage of policyholders--about 10% in the estimate of one industry official--who finance premiums.

"The neat thing about premium finance is companies can almost treat it as an additional line of credit that they don't have at their bank," said Jeff Larson, manager of premium finance at Itasca, Ill.-based broker Arthur J. Gallagher & Co. "And if they're getting squeezed at the bank, this is another way (to get financing) at a competitive rate."

Mr. Larson and others in the industry say most premium financiers have raised their rates over the past month or two. A company paying 6% interest on a premium finance note last year likely is looking at a minimum rate of 7.5% at this year's renewal, Mr. Larson said.

Alvin Jones, executive vp at Tallahassee, Fla.-based Premium Assignment Corp., estimated that most premium finance companies raised rates 1 to 1.5 percentage points since last year.

Typically, premium finance rates are pegged to the London Interbank Offered Rate, or LIBOR, which has fluctuated wildly since the credit crisis began; the three-month LIBOR spiked 200 basis points, or 2 percentage points, between mid-September and mid-October, although it has since declined to 40 basis points above its September level.

Some observers say the LIBOR increases and tightening credit markets make rate increases a necessity for some premium finance companies.

"If you don't (increase rates) and assume the LIBOR is going to come back down, you put out a bunch of low-yielding loans," said John Holsan, founder and president of Dallas-based premium finance firm AFS/IBEX Financial Services Inc.

In other cases, observers inside and outside the industry say rate increases indicate that premium finance companies see the current climate as an opportunity to improve their margins in a sector where intense competition often keeps pricing relatively soft. As a result, premium finance companies and brokers are aggressively courting new business.

"As a result of the credit crisis, many of our clients who in the past had no trouble borrowing money maybe can't today, and those who can are probably paying more now than they did before," said Ray Walsh, a managing director and head of the premium finance group at New York-based Marsh Inc.

Mr. Walsh, who said he has been pushing premium finance to his clients more since the economic crisis developed, and others say they have seen increased demand for premium financing and expect demand to increase further as the credit crisis continues.

Mark Henderson, executive vp at Kansas City, Mo.-based Lockton Cos. L.L.C., said the broker's premium finance activity in September and October increased 10% over the same period in 2007, though he pointed out there was no pronounced increase in October. He said about half of the 10% increase could be attributed to tightening credit markets.

"As capital becomes scarce, you tend to weigh the cost of capital more closely. So if the internal cost to create capital is running at 8% and you can finance premiums at 5% or 6%," premium financing might be a viable option, he said.

And if the insurance market hardens, premium financing may increase, said Mr. Henderson and others. Standard lines insurers frequently offer financing options, whereas policyholders make more use of premium financing firms when they use the excess and surplus lines markets, they say.

Some premium finance companies raise funds by borrowing from financial institutions or securitizing their receivables and selling them, while others are owned by larger financial institutions.

For example, Imperial A.I. Credit Cos. in Jersey City, N.J., is owned by New York-based American International Group Inc. Several other financiers are owned by banks: Premium Assignment Corp. is owned by Atlanta-based SunTrust Banks Inc.; AFCO Credit Corp. is owned by Winston-Salem, N.C.-based BB&T Corp; and Denver-based Flat Iron Capital is owned by Wells Fargo & Co. of San Francisco. Officials for all three firms say their parent banks are stable and report no increased difficulty in funding their operations.

Part of this may be because many view premium financing as a consistently profitable business, absent some kind of mismanagement. Typically, agreements allow the finance company to cancel the insurance coverage if the policyholder defaults on payment, with the unearned premiums serving as collateral.

"If banks are tightening up their offerings in other loan categories, it's very possible that they could be counting on premium finance to make up for volume lost in other areas," said Kathy Walker-Eich, a vp at the advisory and investment banking firm Hales & Co. and who previously worked in premium finance. "It's one of the best lending niches," she said.

Observers say premium finance companies are using current market conditions to aggressively court new business.

"If you're a company and you've got to pay $40,000 to $50,000 for your insurance program, even if you haven't borrowed before, now might be a good time to consider it, because you'd rather keep cash inside the business as long as you can," said Paul Zarookian, president of Imperial A.I. Credit.