Large deductible insurance may look like a painless way to reduce your workers compensation or liability insurance costs. But appearances can be deceiving. The collateral your insurer needs to protect their credit risk can put a burden on your credit lines or credit rating. Here are three cures for this common problem.
Cure 1 – Surety Bond
A surety bond is a three party contact between you, your insurer and the surety. A surety bond is a promise that in return for the premium you pay, the surety will honor your financial obligations if you cannot. If you are unable to reimburse your insurer for payments falling within the deductible, the surety will make good on those payments.
Not all insurers will accept a surety bond as a substitute for either cash collateral or Letters of Credit. They may not get full credit for the bond under statutory accounting rules. Sureties may require collateral from you to issue the bond which will reduce some of the benefit of this approach.
Cure 2 – Trust Account
A trust account, which you fund with cash or high credit securities, can be substituted for Letters of Credit. The cost to maintain a trust account is usually less than the cost banks charge for LOC’s, which means you can save money each year on collateral costs, and not have to tap lines of credit.
The securities approved for a trust account may not provide an attractive return to you. The money you save on administrative costs could be offset by lower investment returns.
Cure 3 – Negotiate With Your Insurer
The collateral amount set by your insurer is calculated using several factors: your historical claims frequency and severity; your business credit rating; social and economic inflation factors. Their actuaries use these factors to predict the future amounts and timing of payments for claims falling within your deductible.
An improvement in your credit rating, a change in business activity, long term expectations for future business opportunities in your industry can all work to your advantage. Talk to your insurer about these changes. Hire your own actuary to analyze your losses. Do not assume your insurer’s collateral calculations are fixed in stone.
Bonus Cure – Loss Portfolio Transfer
If you have been in a large deductible insurance program for several years, you may be suffering from collateral “stacking”. This is the build up of collateral over a number of years to a point where you have substantial amounts of assets or credit tied up with your insurer.
A Loss Portfolio Transfer is a contract with an insurer or reinsurer to transfer your future claim liabilities in return for the payment of a premium. The premium for the LPT contract is determined by the anticipated timing and amount of your future claim payments, as well as the time value of money.
Many people think that a low interest environment would be unsuitable for LPT’s since the discount factor will be so small. But the release of letters of credit frees up your credit lines for other uses, and that alone may be worth buying it.