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The last two years have delivered an unprecedented combination of macroeconomic events, forcing CFOs to adopt a more strategic view specifically with respect to risk assessment and contingency planning. As uncertainty continues with the lingering pandemic, rising interest rates, supply chain disruptions, and the threat of a recession looming, corporations are responding by fortifying their balance sheet with simple to execute liquidity tools. One area of increasing focus among finance and risk teams are insurance collateral requirements that continue to trap capital in this unstable climate.
To the dismay of CFOs, the collateral required to back their property and casualty insurance programs has risen rapidly in recent years. Negative claims trends have increased carrier demands for higher letter of credit face amounts, which have reduced available revolver lines dollar for dollar, further lowering corporate returns on capital. The situation has additionally worsened for several unpredicted reasons.
To begin, labor competition due to pandemic-created labor transitions has driven wage inflation to its fastest rate in decades. Workers’ compensation and general liability claims and collateral move in tandem with these rising wages. The fight for talent has also led to a reduction in pre-pandemic hiring standards in some industries, with less experienced workers filling positions abandoned during the Great Resignation. In fact, the federal government is considering lowering the age for semi-truck licensing to age 18 in response to the acute needs of the transportation and logistics industry. Manufacturing, energy, mining, agriculture, and other industries will need to carefully monitor on-the-job injuries and other claims events.
The resulting demand for more collateral by insurance carriers threatens to lock liquidity just as the economy begins to slow down, a time when corporations need this same liquidity to weather uneven revenue performance. And for those firms built to weather a recessionary storm, a loss in liquidity due to collateral obligations impacts their ability to out-invest or acquire weakened competitors. In all scenarios, locked liquidity stems the normally flowing currents of highly functioning balance sheets.
To free up capital that is trapped in insurance collateral requirements, companies are turning to a new solution called Insurance Collateral Funding. A relatively new financing instrument, Insurance Collateral Funding provides relief and flexibility to corporations and unlocks the fuller potential of 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 unlike letters of credit, it does not reduce the amount available under a firm’s credit facility. The company regains access to its capital without impacting leverage ratios, unlike the alternative of having to access private or public markets for additional credit. The solution is also cost-competitive against other sources of corporate debt financing. Finally, 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.
The market is seeing applications of Insurance Collateral Funding for multiple purposes, and across many business sectors. For example, within the oil and gas industry, in mid-2021 the liquidity this solution provided was earmarked for continuing business operations and easing capital expenditures in the face of depressed energy prices. By the second quarter of 2022, in the wake of soaring oil prices, these same firms were seeking to rapidly release capital for acquisition and infrastructure investment purposes.
Across the retail and services sectors, macroeconomic conditions are impacting industries in different ways. As an example, some retailers are less able to pass on inflationary price increases, and thus the liquidity provided through Insurance Collateral Funding provides these companies with the time to react accordingly. In another example, a company facing supply-chain challenges utilized the solution to purchase more inventory when product became available, and in so doing also hedged against further inflationary pressures.
For firms looking to mobilize liquidity, whether to provide complementary financing for business expansion or to help address financial uncertainty, identifying insurance collateral funding solutions is essential to driving business growth. It is also 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.
A review of all potential sources of liquidity is paramount during this unsettled economic backdrop. A CFO’s liquidity plan should be inclusive of the often overlooked but easy-to-implement release of capital trapped in insurance programs.
Stephen Roseman is founder and CEO of 1970 Group.