Top Five Collateral Reduction Considerations
As staffing businesses grow and credit facilities remain tight, critical attention is being directed towards reducing credit distractors and eliminating collateral redundancies wherever possible. More often than not, CFOs focus their attention on the collateral tied-up in their workers’ compensation program as the likely, and often sole, source of creating credit headroom.
Although reactive credit strategies can have some success, we strongly encourage staffing businesses to think strategically as it relates to the amount of collateral they consciously elect to commit to their insurance program. Here are the top five elements that should be contemplated:
1. Program Structure
In most instances, collateral is a direct reflection of program structure. Qualified self-insured programs, in which collateral is posted to the state rather than an insurance carrier, requires the least amount of collateral. Captive insurance programs, on the other hand, generally require the most.
The magnitude of the deductible in a “traditional” deductible program will also effect collateral requirements with offsetting premium requirements. The larger the deductible, the more collateral required and less premium paid; the smaller the deductible, the less collateral required and more premium paid.
Most carriers prefer to receive an Irrevocable Letter of Credit (ILOC) as the collateral instrument. An ILOC does not, however, deplete during the policy term and usually is adjusted 18 months after policy inception. Cash, on the other hand, depletes as claims are paid and results in less over-all collateral held by the carrier.
2. Financial Statements
Credit officers assign credibility ratings to the level of the financial statement provided. Audited statements receive the highest credibility rating followed by reviewed and compiled. Internal prepared statements receive the lowest.
As the credibility rating of financial statements can have up to a 50% swing in the amount of collateral required, one should consider investing in the additional costs to have audited statements prepared. Audited statements may likely enhance the number of underwriters willing to offer a quotation on your program.
Similar to most business relationships, the better the credit officer knows you, the more likely you are to get more favorable credit terms. We recommend you (with your insurance broker) meet with the credit officer annually.
4. Collateral Agreements
Someday, you’ll want to discontinue the relationship with your current underwriter (provide more to another carrier, sell your business…etc.) and the ability to reduce collateral exposure will become top-of mind. It’s important to negotiate, upfront, how collateral will be reviewed and adjusted in future years. A formulaic approach, with stated loss development factors and adjustment intervals, is preferred over leaving the adjustment process up to the carrier’s discretion.
5. Claims Administration
Closed claims lead to more favorable treatment, as the amounts incurred and paid will have an off-setting impact on collateral requirements. If your organization has a particularly high claim closure ratio relative to your industry, this can be utilized to negotiate larger collateral reductions.
Should your business implement any of these recommendations, additional savings, in terms of collateral expenses, can be realized. Proper planning will help you select the best program structure for your long-term requirements.
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