Collateral for Insurance liabilities resurfacing as an Issue:
The period of low interest rates has allowed insurers, insureds, captive members, and the like to relax their concerns about collateral costs for insurance liabilities.
Interest rates rising has the costs of collateral for insurance liabilities rising…
Hence a concern…
Why Collateral is an issue?
Each year, insurers require insureds to collateralize their obligations under their insurance contracts. These insureds are those who decide to retain a certain amount of their risk through large deductibles or SIR’s.
Although the “SIR” term applies whether the company is utilizing an insured high deductible, captive or legally self-insured workers compensation program: the requirement to pay losses and loss obligation can shift to different parties through a SIR vs. deductible in the event of bankruptcy, since these claims below the chosen level of retention are “retained” (paid for) by the company, not the insurer this was not contemplated in the pricing and can pose credit risk for the insurer.
Hence the need for collateral to protect insurers and to draw down in the event of an insured default/bankruptcy.
Despite slight improvements in economic conditions, insurers still continue to aggressively manage the credit risk they take on from policyholders.
Collateral costs for Insurance liabilities
The shift in credit markets has raised collateral costs, these costs are not expected to ease in 2017, and are likely to continue to rise. Since July 2016 the 10 Year Treasury rate has risen 100 bps.
Economists are projecting the continued dollar strengthening and inflation.
The Fed is expected to raise the short term rate 2x-3x in 2017, this will have an impact on collateral for insurance liabilities.
As can be seen at the following interactive chart, the 10 year treasury is rising and is predicted to continue to rise. 10 Year Treasury Rate – 54 Year Historical Chart
Forms of Collateral
Risk managers and small business owners are under pressure from upper management to reduce collateral costs and limit their LOC use to keep scarce capital available for other corporate needs. LOCs have been the most widely used instruments for posting collateral that insurers require to guarantee payment of commercial auto, general liability and workers compensation claims falling within large deductibles.
Insiders note that costs for bank-issued LOCs are higher than a year ago, prompting risk managers to turn to other strategies, such as new trust accounts arranged by insurers, surety bonds and loss-portfolio transfers.
Also, some are aggressively seeking structured solutions to free up old collateral insurers hold for past policy years.
Based upon these changes in collateral costs as well as the prediction of increases in the future, insureds are looking at structured solutions to limit their exposure, this includes LPT, novations, alternative financing, etc.
Will insureds transition away from loss sensitive to guaranteed cost products?
Often, there is little incentive for insurers to release the collateral on “runoff accounts,” But recently, some insurers have done so in cases where the losses are winding down and they hope to improve their relationship with a broker or win back an old client.
Work with a skilled broker and adviser. If you are in this space, negotiating collateral needs and forms of security will have to be done with your carrier. A skilled professional can review existing collateral held by your insurer and help negotiate its release.
Even before turning to a trust or other alternative to LOCs, however, companies should demand a full accounting of how their insurer will calculate their collateral requirements.
Another strategy requires negotiating with insurers to release past-year policy collateral held for accounts they no longer insure.
Also, request quotes and consider converting to a guaranteed cost program. This will eliminate headaches related to insurance collateral and allow businesses to utilize LOCs or revolving credit lines for their businesses operations directly (for growth). Will allow you to leverage competing quotes over time as your collateral runs off.
Finally, consider structured solutions to alleviate these concerns.