Large Deductible Insurance – How to Cure the Collateral Blues

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A large deductible can seem like a painless way to lower your workers' compensation or liability insurance costs. But appearances can be deceiving. The collateral your insurer needs to protect their credit risk can weigh on your lines of credit or your credit rating. Here are three remedies for this common problem.

Cure 1 – Surety

A surety bond is a tripartite 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 the payments included in the deductible, the surety will refund those payments.

Not all insurers will accept a bond in lieu of cash collateral or letters of credit. They may not get full credit for the bond under statutory accounting rules. Sureties may require a guarantee from you to issue the surety, which will reduce some of the benefits of this approach.

Cure 2 – Trust account

A trust account, which you fund with cash or high credit securities, can be replaced with letters of credit. The cost of maintaining a trust account is usually lower than the cost charged by banks for LOCs, meaning you can save money each year on warranty fees and not have to use lines of credit.

Securities approved for a trust account may not offer you an attractive return. The money you save on administrative costs could be offset by lower returns on your investment.

Cure 3 – Negotiate with your insurer

The amount of coverage set by your insurer is calculated using several factors: the frequency and severity of your historical claims; the credit rating of your business; social and economic inflation factors. Their actuaries use these factors to predict future amounts and when to pay for claims in 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. Discuss these changes with your insurer. 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 participating in an extensive franchise insurance program for several years, you may be suffering from a "stacking" of guarantees. This is the accumulation of guarantees over a number of years to such an extent that you have significant amounts of assets or credit tied to your insurer.

A claims portfolio transfer is a contract with an insurer or reinsurer to transfer your future claims in exchange for paying a premium. The LPT contract premium is determined by the expected timing and amount of your future claim payments, as well as the time value of money.

Many people think that a low interest rate environment would not be suitable for LPTs since the discount factor will be so small. But releasing letters of credit frees up your lines of credit for other uses, and that alone can be worth buying.


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