For many businesses already challenged by the financial pressures of the COVID-19 pandemic, the collateral required by insurers writing long-tail lines of coverage such as workers’ compensation can be an additional source of stress.
Workers’ compensation claims make up a large portion of many organizations’ total cost of risk. The collateral required by workers’ compensation insurers generally takes the form of bank letters of credit, a form of debt that can limit businesses’ borrowing options. For businesses that lack financial strength, the challenge is multiplied by higher costs they’re charged on letters of credit, as well as potential duplication of collateral required to receive letters of credit.
What’s more, insurers can change collateral requirements as conditions change, making it difficult for insurance buyers to keep pace. Existing collateral can also tie a business to a particular workers’ compensation insurer, making it hard to move the business to a new insurer. What businesses need, then, are ways to unlock their collateral and create value for their organization at the same time.
The Real Cost of Collateral
The cost of collateral — typically bank letters of credit — required by workers’ compensation insurers is based on the financial strength of the insurance buyer. As a debt instrument, collateral can limit the borrowing capacity of the business. As such, the costs of collateral should be viewed not only as nominal costs, but also the opportunity costs.
Leaders, of course, would much rather use debt to advance the organization through research and development, capital investment or new technology — not to buy insurance. And the COVID-19 pandemic’s impact on businesses and economies has made the issue of insurer collateral requirements even more significant for many businesses, muddying waters even more. Businesses, therefore, need to find ways to reduce those insurer collateral requirements. As they look to do so, the company’s broker can be a valuable advocate in addressing collateral issues.
Three Steps to a Comprehensive Approach to Collateral
It’s helpful to take an integrated approach to collateral considerations and understand how those various considerations work together by:
1. Closing claims
Workers’ compensation claims can sit on a company’s books for years, often up to two decades, because of collateral requirements from insurers. One way to reduce those requirements is to close claims quickly.
The more quickly claims close, the less collateral the insurer will require. But businesses often miss opportunities to close legacy claims because they’re focused on finding creative ways to settle them. A broker can play an important advocacy role, helping a business find ways to settle those workers’ compensation claims quickly so they don’t linger as unresolved obligations.
Actuarial advocacy is another important step in convincing the insurers to reduce collateral. Without credentialed actuarial analysis, closing claims earlier can provide an impression that claims payments are higher than typical client trends. Insurer actuaries may inadvertently interpret this increase in payments to indicate that the value of the portfolio is increasing rather than decreasing. Demonstrating the corresponding impact on outstanding loss valuations is a critical step to prove the impact of claims closure on reducing outstanding actuarial valuations.
2. Making the financial case
A broker can also serve as a credit-risk advocate for the insured, making sure the insurer has a true understanding of the insurance buyer’s financials and its business plans. This can help the buyer gain more favorable collateral treatment, and cascade that message to appropriate levels within the insurer’s organization. In discussions with credit officers, alternative forms of collateral may also be addressed including surety bonds, insurance trusts, or hybrid collateral with a captive insurer.
In addition to actuarial and credit advocacy, a knowledgeable professional can help provide access to program alternatives that may mitigate or reduce collateral requirements. These include, for example:
- Alternative program structures such as self-insurance, non-subscription, or guaranteed cost may make sense depending upon the states of operation.
- Loss portfolio transactions either directly with an insurer or with a captive into a reinsurance vehicle. These complex negotiations to transfer the outstanding legacy claims to an insurance company, in exchange for a premium cost, can eliminate the collateral requirement for past claims.
3. Putting the pieces together
Ultimately, the ideal approach to unlocking collateral is to engage with insurers across these various areas with a multilevel strategy. For businesses, it’s important that the effort is ongoing rather than a one-time effort. To effectively address collateral requirements, an organization should aim to show insurers continuous year-over-year improvement in reducing legacy claims exposures as well as proactive strategies in claims management and risk control to reduce the level of new cases coming in.
The Risk Manager’s Role in Collateral
To effectively help the organization reduce its collateral requirements, the risk manager should be well connected with operations to limit losses by addressing safety issues. The risk manager can also help reinforce best practices in managing and settling claims when losses do occur. A risk manager who understands the way workers’ compensation claims touch various aspects of the business can help an organization’s leadership better understand the adverse impact of workers’ compensation claims across the organization.
Data and the ability to analyze relevant metrics is essential in gauging an organization’s progress in addressing legacy claims and improving collateral terms. As in managing other areas of risk, effective performance tracking can play a significant role in reducing collateral requirements.
Beyond assisting with collateral requirements, reducing workers’ compensation losses can also benefit organizations in other ways. Employees who are working in healthy, safe environments have higher levels of engagement, are more productive and ultimately have less injuries—which means fewer absences—which can improve operations.
The pandemic environment has created a variety of challenges for businesses. For many, finances are strained, with insurer collateral requirements for legacy claims pressuring them further.
However, there are potential solutions to the collateral issue. A business that takes a comprehensive, continuous approach to reducing, understanding and addressing workers’ compensation claims can find ways to successfully unlock collateral, driving value for stakeholders.