Large deductible insurance may seem like an easy way to reduce the costs of workers’ compensation or liability insurance. But appearances can be deceiving. The collateral your insurer needs to protect your credit risk can put a strain on your lines of credit or credit rating. Here are three cures for this common problem.
Cure 1 – Bail
A bond is a three-way contact between you, your insurer, and the bond. A surety bond is a promise that, in exchange for the premium you pay, the surety will meet your financial obligations if you are unable to do so. If you cannot compensate your insurer for payments that fall within the deductible, the guarantee will cover those payments.
Not all insurers will accept a surety bond as a substitute for cash collateral or letters of credit. They may not get full credit for the bond under legal accounting standards. Warranties may require you to issue the bond, which will reduce some of the benefits of this approach.
Cura 2 – Trust Account
A trust account, which you finance with cash or high credit securities, can be substituted for letters of credit. The cost of maintaining a trust account is typically less than the cost banks charge for LOCs, which means you can save money each year in escrow costs and not have to draw on lines of credit.
Securities approved for a trust account may not provide you with an attractive return. The money you save on administrative costs could be offset by lower investment returns.
Cura 3 – Negotiate with your insurer
The guarantee amount set by your insurer is calculated using several factors: the frequency and severity of your historical claims; your company’s credit rating; social and economic inflation factors. Their actuaries use these factors to predict future amounts and timing of payments for claims that fall 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 in your favor. Talk to your insurer about these changes. Hire your own actuary to analyze your losses. Don’t assume your insurer’s warranty calculations are set 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 “stacking” of warranties. This is the accumulation of collateral over several years to the 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 liabilities for future claims in exchange for the payment of a premium. The LPT contract premium 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 not be suitable for LPT, since the discount factor will be very small. But releasing letters of credit frees up your lines of credit for other uses, and that alone may be worth buying.