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Dulling the Pain of Collateral a Proactive Collateral Management Strategy Can Drive Efficiencies and Produce Significant Economic Benefits

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Dulling the Pain of Collateral a Proactive Collateral Management Strategy Can Drive Efficiencies and Produce Significant Economic Benefits Dulling the Pain of Collateral A proactive collateral management strategy can drive efficiencies and produce significant economic benefits July 2012 • Lockton® Companies Economic Uncertainty Creates Array of Collateral Gary Shertenlieb, Jr. Challenges Senior Vice President Financial Solutions Insureds are dealing with the ramifications of the global (816) 960-9416 recession in every aspect of their businesses. Companies across [email protected] all industries are employing strategies to strengthen balance sheets and ensure capital is being deployed in the most efficient manner. For those companies with loss sensitive insurance programs, the renewed focus on capital preservation has attracted greater internal The renewed focus on capital scrutiny of collateral posted to support insurance programs. preservation has attracted greater internal scrutiny of The current credit environment has created three distinct but collateral posted to support interconnected obstacles for companies that utilize loss sensitive insurance programs. programs: 1. First, some insureds are dealing with changes in credit lines and borrowing/letter of credit rates. For example, at the same time an insured’s new credit facility is reduced by 20 percent, the rates for letter of credit issuance may have increased threefold. 2. Second, insurance carriers are underwriting their credit exposure to their insureds more stringently in the backdrop of the global economic slowdown. Bankruptcies, and the credit downgrades that are supposed to signal future problems, LOCKTON COMPANIES are major concerns for the carriers. Carriers However, a worry that they may be left unsecured if unpaid different challenge deductible reimbursements to the carrier exceed presents itself collateralization. when companies 3. Insurance carriers have been actively monitoring use these their credit concentrations to the banks alternatives to and financial institutions that are providing revolver-based collateral on behalf of their insureds. In light of letters of credit. recent ratings actions against the largest banks and Because of the failures of many smaller banks, carriers are carefully low interest rate managing their aggregate credit exposures to these environment, returns institutions. Insureds are finding that their letters on trust assets and of credit can often be deemed unacceptable due to cash deposits can counterparty credit underwriting by the carriers. be meager. Many carriers offer money market deposit alternatives as All insureds face these challenges, and a good insurance collateral, but the poor investment return compared to broker should anticipate and inquire about these issues the cost of this capital often outweighs the advantages well in advance of program renewals. A good broker of using these assets. should always be attuned to changes in each client’s capital structure, credit rating agency ratings, and But, there are solutions available that can counterparty risks. provide better returns on these collateral deposits. Looking for Alternatives In light of these challenges, many insureds are exploring more efficient collateral alternatives for their programs. But, there are solutions available that can provide Preservation of credit lines and a general aversion to better returns on these collateral deposits. Several letters of credit have created the need to explore these financial institutions that specialize in insurance-related alternatives, such as using cash and other securities for collateral programs offer insureds enhanced returns on collateral purposes. Trusts, cash deposits, and asset- their deposits. These financial institutions understand the backed letters of credit are the most popular alternatives. purpose of insurance collateral, the protections afforded in the bankruptcy courts, and the multiyear payout Trusts, cash deposits, and asset-backed horizons of long-tail liabilities. Lockton has partnered letters of credit are the most popular with several financial institutions that can provide alternatives. collateral solutions paired with asset-management strategies designed to enhance those returns. 2 July 2012 • Lockton Companies For example, a company that wants to use other assets for collateral instead of posting revolver-based letters of credit can construct a tailor-made An Example: Enhancing Returns collateral facility as a replacement. The selected financial institution will then issue an acceptable collateral instrument that incorporates the client’s One insured may utilize a cash-funded investment objectives. There is flexibility in the type, amount and duration collateral structure available in the of this solution because the financial institution will construct an asset insurance marketplace. However, this cash capital will likely yield low money management strategy to provide both the collateral requirement and desired market investment returns provided by the investment return of the insured. Such a proactive collateral management insurance carrier. strategy can often drive efficiencies and actually produce significant Another insured may employ a collateral economic benefits. alternative enhanced with an asset management strategy to significantly Delivering Answers improve investment returns while maintaining a strong collateral position Alternative collateral strategies can make a significant impact on the with the carrier. The enhanced returns efficiencies and cost-effectiveness of a complex insurance program. By could help subsidize current insurance understanding that the insurance placement is truly a utilization of capital, we costs and provide enough capital to work with our clients to deliver creative, value-added solutions in challenging broaden insurance coverages, limits or program improvements. economic times. 3 Our Mission To be the worldwide value and service leader in insurance brokerage, employee benefits, and risk management Our Goal To be the best place to do business and to work www.lockton.com © 2012 Lockton, Inc. All rights reserved. Images © 2012 Thinkstock. All rights reserved. .
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