The CFO of a $4 billion cleaning company that had $175 million tied up as collateral for its insurance coverage recently found himself across the table from the chief credit officer and chief actuarial officer of his company's carrier. His goal: Get the insurer to agree to reduce that collateral requirement, which ate up 75% of the company's credit revolver. Marcia Linton, national practice leader for Wells Fargo Insurance Services USA, who was helping this company negotiate its policy renewal, says that by conducting a "thorough review" of the company's financials as well as its third-party actuarial calculations and vetted loss projections, the CFO was able to convince the carrier to reduce its collateral requirement by $20 million in the first year and another $17 million in the second year.
Insurers require collateral to guard against the risk the insured company might fail to pay future premiums or retained losses, particularly in the event of a bankruptcy. But increasingly, companies confronting the need to conserve cash and maximize access to credit and facing a relatively soft insurance market are challenging carriers' collateral demands. In many cases, they can win significantly better terms.
The key is dealing with a company's insurance needs strategically, says Jim Fay, a managing director at Corporate Risk Solutions in Atlanta. "This is not something you should start thinking about 90 days before your renewal date," Fay explains, suggesting companies start to prepare six months in advance.
"You should do your own actuarial analysis," he says, "and get a sense of what the carrier is going to ask for. Push the carrier to disclose its own analysis. Often they don't want to, because often it's not very defensible."
Companies also need to present their own, independent credit analysis, Fay says.
Letters of credit (LCs), the most common form of collateral, have become more costly since the financial crisis in 2008. Another approach some companies are taking is to substitute other forms of collateral for LCs.
Tim DeSett, executive vice president for financial solutions at insurance brokerage Lockton, says insurers are often willing to accept bonds instead of LCs. He cites the case of a company Lockton advised that was able to replace one-third of its LC collateral with surety bonds. "That is an off-balance-sheet transaction," DeSett says, noting that LCs drain from the credit available under a company's revolver while being roughly the same price as surety bonds.
Another approach, especially for captive insurers or risk retention groups, is to use trust funds as collateral, says Wells Fargo's Linton.