Large deductible insurance may seem a painless way to reduce workers’ compensation or liability costs. But appearances can be deceiving. The collateral your insurer needs to protect credit risk can put your credit lines or credit rating at risk. Here are three cures for this common problem.
Treatment 1 – Guaranty
A security is a three-party contact between you, your insurer and the surety bond. A security is a promise that in exchange for the premium paid, the surety will honor your financial obligations if you can’t. If you are unable to repay the insurance payments to the insurer, the surety will proceed to pay these payments.
Not all insurers accept a deposit to replace cash guarantees or letters of credit. They may not obtain full credit for the obligation under statutory accounting rules. Surety bonds may require collateral from you to issue a bond that will reduce some of the benefits of this approach.
Treatment 2 – Trust account
A trust account, financed with cash or high debt securities, can be replaced with letters of credit. The cost of maintaining a trust account is usually less than the cost charged by the banks for the LOCs, which means that you can save money every year on the costs of collateral and not having to resort to credit lines.
Securities approved for a trust account may not provide you with an attractive return. The money saved on administrative costs could be offset by lower investment returns.
Treatment 3 – Negotiate with your insurer
The amount of the guarantee established by the insurer is calculated using various factors: frequency and seriousness of the historical claims; your corporate credit rating; social and economic inflation factors. Their actuaries use these factors to predict future amounts and timing of payments for claims that fall under the deductible.
An improvement in your credit rating, a change in business, long-term expectations for future business opportunities in your industry can work to your advantage. Talk to the insurer about these changes. Hire your actuary to analyze your losses. Do not assume that the insurer’s collateral calculations are set in stone.
Bonus Cure – Transfer of the loss portfolio
If you have been in a large deductible insurance program for several years, you may suffer from “stacking” the guarantees. This is the accumulation of collateral for a number of years at a point where you have substantial amounts of assets or credit linked to your insurer.
A loss portfolio transfer is a contract with an insurer or reinsurer to transfer future liabilities in the event of a claim in exchange for the payment of a premium. The premium for the LPT contract is determined by the timing and amount expected for future claims payments, as well as the time value of the money.
Many people think that a low interest environment would not be suitable for LPT as the discount factor will be so small. But releasing letters of credit frees up your credit lines for other uses, and this alone might be worth buying.
by Paul Dzielinski