For organizations with loss-sensitive casualty programs, posting collateral has become an increasingly burdensome and expensive requirement due to volatile economic conditions.
“Over the past few years, the costs and risks around collateral have gone up considerably,” says Michael Gruetzmacher, director of Collateral Advisory Services, Aon Risk Solutions. “The impact of rising collateral costs can be a severely deteriorating factor to a company’s total cost of risk.”
Fortunately, an innovative casualty product requiring zero-collateral is available in addition to several opportunities to improve a company’s current collateral situation.
Smart Business spoke with Gruetzmacher and Ralph W. Sloan, senior vice president, brokerage, Aon Risk Solutions, about how companies can manage collateral issues and how some companies may be able to avoid them.
Why is collateral required in a large deductible casualty insurance program?
Insurance companies require collateral to manage the inherent credit risks associated with high-deductible casualty insurance programs that come from the client’s obligation to reimburse the insurer for obligations within its deductible.
While the high-deductible program creates many benefits for clients by minimizing costs and improving cash flow, these benefits can be offset by rising collateral costs. These rising costs manifest via rising letter of credit (LOC) fees, as well as the opportunity costs of tying up capital, limiting borrowing capacity and the ability to invest in strategic growth opportunities.
What factors influence insurers when determining what a collateral obligation might be?
Insurers are influenced by how they view the loss experience of the client, the go-forward structure of the program and how that structure may include retained losses, and how the insurer perceives the client’s credit risk.
How do companies address the collateral challenge while optimizing their insurance spending?
Traditionally, there are three ways to attack collateral issues:
? Aggressively manage claims pre and post loss
? Restructure the program to best balance collateral costs with other corporate needs
? Strategically negotiate the amount of collateral held by the insurers to reflect the true underlying credit risk
The first opportunity is finding ways to improve the loss experience. Risk management professionals should review their risk control programs to minimize losses, aggressively manage open claims to ensure reserves are appropriate and close losses faster.
Second, insurance brokers and insurance companies need to work with clients to determine the right program structure. This includes a financial review to determine if retaining less or more risk, in favor of paying lower premiums, makes the most financial sense. Modeling needs to be a highly individualized process based on the client’s financial situation. Considerations include the cost of capital, cost of collateral and the overall objectives of a company’s risk management program.
The third part is helping clients with credit risk advocacy as the risk management professional negotiates collateral. The expert should make sure the insurance company understands what’s going on with the client from a credit risk standpoint, and understands its true credit picture. Then, the expert uses that information with robust benchmarking analytics to negotiate the best possible collateral outcomes.
How can companies reduce collateral obligations through minimizing losses?
Insurance brokers must understand how their clients prevent claims and also manage those claims that do happen throughout their full lifecycle. Working with their client to implement the right safety programs and preventing losses from happening in the first place will have the clearest benefit from a collateral standpoint. Not only will preventing losses have a direct cost-savings benefit, collateral is not needed to secure losses if losses don’t happen in the first place. Furthermore, from a post-claim standpoint, it is important to stay on top of third-party administrators and work with them to close out claims as fast as possible. There is a lot of money left on the table in this area.
What other advice can you provide to companies struggling with collateral obligations?
As companies think about collateral, they should develop an exit strategy. Working with a professional can help companies perform transactions such as a program close-out and loss portfolio transfers as a way to eliminate collateral obligations. These transactions can make a lot of sense for companies that have a high collateral cost and place a lot of value on getting that collateral back.
Is there a zero collateral solution?
It’s very apparent that companies don’t like to post collateral, but they enjoy the benefits they get from high-deductible programs. The Aon Zero-Collateral Deductible Program is a high-deductible casualty program structured in a way that companies wouldn’t need to provide collateral. Instead, they pay a one-time, upfront fee based upon their creditworthiness, which eliminates the collateral obligation for the life of the program. The company saves substantial money over time and frees up capital while removing all risks associated with traditional collateral. The program eliminates risks that companies typically face with collateral, such as untimely adjustments from the insurance company. The program is best suited for those with expected annual losses of up to $5 million and a credit rating of BB or above. Even if a company is not rated or is private, it may be acceptable for the program.
Michael Gruetzmacher is director of Collateral Advisory Services with Aon Risk Solutions. Reach him at (312) 381-4472 or firstname.lastname@example.org. Ralph W. Sloan is senior vice president, brokerage, Aon Risk Solutions. Reach him at (314) 854-0807 or email@example.com.