High Deductible Insurance: How to Cure Collateral Sadness
High deductible insurance may seem like a painless way to lower your costs for liability or workers’ compensation 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 – Surety bond
A surety bond is a three-part contact between you, your insurer, and the surety. A bond is a promise that in exchange for the premium you pay, the bond will meet your financial obligations if you are unable to do so. If you cannot reimburse your insurer for payments that are within the deductible, the warranty 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 based on legal accounting standards. Bonds may require a guarantee on your part to post the bond, which will reduce some of the benefits of this approach.
Cure 2 – Trust Account
A trust account, which you finance with cash or high credit values, can substitute for letters of credit. The cost of maintaining a trust account is typically less than the cost charged by banks for LOCs, which means you can save money each year on collateral costs and not have to draw on lines of credit.
Approved securities for a trust account may not provide you with an attractive return. The money you save on administrative costs could be offset by a lower return on investment.
Cure 3 – Negotiate with your insurer
The amount of the guarantee 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. Your 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’ve been in a high-deductible insurance program for several years, you may be experiencing a “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 to your insurer.
A Loss Portfolio Transfer is a contract with an insurer or reinsurer to transfer your future claims obligations in exchange 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 not be suitable for LPT, as 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.
