Premiums for many corporate insurance programs are on the rise, and with that, collateral requirements and liquidity challenges.
That’s not a good trajectory at this moment of economic uncertainty, argues Stephen Roseman, founder and CEO of 1970 Group, a New York City-based company focused on helping companies unlock liquidity. He spoke with StrategicCFO360 about how finance chiefs can meet their organization’s insurance collateral obligations while maintaining liquidity, what kinds of insurance costs are rising most and the opportunities in a soft economy.
Why are insurance collateral requirements an issue for companies?
While loss-sensitive and captive insurance programs have been attractive to corporate insureds for many years due to their ability to lower premiums and increase cash flow, the limitations of the letters of credit and other products used to collateralize these programs have become increasingly evident. Specifically, LOCs and other instruments are considered drawn capital, and continue to constrain balance sheets and reduce the liquidity needed to run and grow a business.
Workers’ compensation, general liability and commercial auto insurance are all examples of programs that have become more expensive in terms of both premium prices and the opportunity costs associated with inaccessible, collateralized balance sheet capital.
How will recent economic events and forecasts impact insurance collateral requirements and corporate balance sheets?
In response to rising claims costs, carriers have already announced significant insurance premium price increases for 2022, and collateral requirements in loss-sensitive programs are also likely to rise due to these same claim trends. Corporate balance sheets are likely to be further tested in the anticipated event of an economic slowdown and the potential for recession, characterized by tighter lending requirements and financial performance volatility. The combination of these factors creates the expectation that companies will increasingly seek incremental liquidity to support corporate health and equity valuations.
Soft economic cycles can provide a competitive advantage to companies that have stronger balance sheets—they can capitalize by acquiring and investing when their competitors cannot. However, these same firms may find their plans constrained due to these higher insurance-related collateral demands. And of course, companies more concerned with weathering the economic storm have a more basic need for liquidity for ongoing business operations. The need to optimize their balance sheet and release trapped collateral will be paramount during this period of economic volatility.
What can CFOs do to alleviate this collateral and liquidity crunch?
Insurance collateral funding is a solution that enables companies to not only fund their insurance collateral requirements, but to transfer it off their balance sheets. It replaces any form of collateral including existing letters of credit, cash escrow and surety bonds and can free up significant amounts of capital to deploy to business operations and investment opportunities.
Critically, insurance collateral funding can be treated as off-balance sheet financing, and is cost-competitive against other sources of corporate debt financing. It can scale to meet a broad range of collateralization needs and offers full flexibility on the timing of collateral, independent of policy renewal dates. Amounts can be modified up and down depending on the needs of the company, inclusive of annual renewals, with no need to re-negotiate revolvers with banks and other credit providers.
The advantages versus traditional collateral solutions are clear. Firms utilizing surety bonds may encounter that those bonds come with their own challenges, as some may still have collateral obligations and most have issuance limitations. Further, traditional letters of credit are a drain on corporate liquidity, reducing the amount available in a firm’s credit facility.
Are there certain types of industry sectors where this is being embraced?
Insurance collateral funding works across a wide range of industries, including retail, industrials, energy, transportation/logistics, manufacturing, construction, healthcare and agriculture, as well as with private equity sponsors who want to unlock additional capital across their portfolio companies. Essentially, this is for any company and industry with loss-sensitive insurance programs.
Experience has shown insurance collateral funding appeals to any firm with liquidity needs, whether to provide complementary financing for business expansion or to help address financial uncertainty. It is also being used as a valuable tool to enable the transition from guaranteed cost to loss-sensitive insurance plans, and additionally as a means for CFOs to migrate to lower cost carriers without the dreaded double collateralization required during plan transitions.