2022 and 2023 are lining up to be historically expensive years for commercial P&C insurance. The headwinds of inflation, labor instability and anticipated economic downturn have CFOs concerned about not only rising insurance premiums but also the rapidly growing opportunity cost of capital that is tied up in insurance collateral obligations. These factors can present a competitive advantage to companies with strong balance sheets. In response, top-performing brokerages need to introduce solutions for insurance-related collateral to help clients manage their balance sheet and to increase corporate financial liquidity and flexibility.
A rapidly evolving P&C environment for corporate clients
In recent years, large companies have migrated away from guaranteed cost insurance programs to loss-sensitive and captive insurance programs due to their ability to lower premium costs and increase company cash flow. The primary focus of management continues to be on premium costs, but this addresses only half of the expense issue. The market has overlooked the very real cost of foregone economic value caused by insurance collateral requirements.
The leading solution used by companies to collateralize their insurance requirements, letters of credit, suffers from a major drawback. These letters of credit are treated as drawn capital with respect to their corporate credit facilities, thereby reducing the amount available to the company to run and grow their business. The amount of collateral companies are required to maintain via these letters of credit is often higher than the realized, or paid, claims.
To make the problem worse, recent years have seen marked premium increases due to more stringent underwriting and higher claims costs, which have forced carriers to push for higher collateral requirements in deductible programs. Workers’ compensation coverage, commercial auto and general liability insurance programs have become more expensive in terms of both premium prices and the opportunity costs associated with inaccessible, collateralized balance sheet capital.
Troubling skies ahead: Balance sheets under threat
Looking ahead, collateral requirements are set to rise significantly in loss-sensitive programs, driven by multiple factors. Expected wage inflation is helping to boost overall renewal premiums collected for workers’ compensation insurance, according to Travelers. With respect to claims experience, that same report says workers with less than a year’s time on the job filed 35% of all workers’ compensation claims, a troubling statistic considering employers are in the midst of an historic hiring spree.
According to the American Trucking Associations, there is a driver shortage of more than 80,000 positions. Amid the shortage, many organizations have lowered driver applicant standards, a practice that comes with risks, as these new employees are more likely to be involved in a vehicular accident. The projected outcome of these factors is an increase in claims and a resulting acceleration in collateral requirements within deductible programs.
The increasing possibility of a recession in the wake of global central bank tightening will further contribute to a liquidity crunch and strained balance sheets. The combination of stricter lending requirements and fluctuating cash flows will have CFOs intensely focused on balance sheet and liquidity management. While less competitive companies will need this liquidity plan to manage financial performance fluctuations, stronger companies will seek to increase and deploy accessible capital toward business investment and M&A.
See also: Catastrophe Bonds: Crucial Liquidity
Skilled brokers required to navigate clients through the storm
In this turbulent environment, a focus on price negotiations with clients’ carriers is not enough. Brokers will need to fully navigate clients through this tempest by providing liquidity solutions that enable growth, reduce cost and provide competitive advantage. The burden of collateral obligations associated with insurance programs can be remedied through Insurance Collateral Funding - a solution that enables companies to not only fund their insurance collateral requirements but to transfer them off their balance sheets to free significant amounts of capital to deploy toward business operations and investment.
Insurance Collateral Funding replaces any form of collateral including existing letters of credit, trust accounts and surety bonds, and can be treated as off-balance sheet financing.
Here are four actions brokers can take today with their clients using a solution like Insurance Collateral Funding:
- Provide liquidity. Have a liquidity plan in place for your clients that will release trapped insurance-related capital if your clients have the need during uneven business cycles.
- Enable growth. Know which clients are positioned to out-invest their competitors in a recessionary backdrop. Firm acquisitions will be less expensive, and the acquiring firm will benefit from additional liquidity to capitalize on these opportunities.
- Create client choice. By moving an insured’s insurance collateral off the balance sheet, you are giving your corporate client choices when it comes to program design and how they work with their carrier.
- Open the loss-sensitive door. For those firms still in guaranteed cost programs, brokers can move them to loss-sensitive programs without the historical friction involved in so doing.
Brokers are in a position to advise their clients on how to unlock the full potential of their balance sheets. The most capable brokerages will be rewarded for operating as skilled navigators through the choppy waters ahead.
