Assessing Collateral’s Impact on Underwriting

For an insured, collateral in a deductible insurance policy is a critical factor when considering a loss-sensitive insurance program. For a carrier, collateral is held to secure the credit risk exposures created by the policy for expected losses within the deductible. While an organization’s financial wherewithal is vital in determining policy conditions, a respective amount of collaboration between an insured, broker, and carrier can, in some cases, allow for more creative opportunities.

“Credit risk’s role in underwriting includes reviewing an insured’s financial statements, financial disclosures, and projected losses within the deductible to arrive at a collateral need,” said Stephen Sicking, Director – Credit Risk Underwriting at Safety National. “In some cases, while less discussed, communication with the broker and insured is critical in assessing credit risk policy considerations. Open and transparent conversations around an organization’s business and financial performance can allow our insureds to provide critical context to key factors that are not apparent by looking strictly at numerical financial results.”

Determining the Weight of Collateral

Collateral cost is often a key consideration to the overall cost of risk when pursuing a loss-sensitive insurance program. The level of significance can vary based on the organization’s policy structure and financial condition, which drive the underlying need for collateral. However, sometimes, it is not as influential of a consideration when compared to other critical factors. For example, if the insured has minimal losses, their projected loss within the deductible can be projected to be very low, reducing collateral need. In those cases, the policy structure and the premium amount bear greater significance. For those insureds with a higher level of predicted loss within the deductible, their collateral requirements are much higher, becoming one of the primary considerations.

Quantitative factors such as the insured’s financial statements and various financial ratios are reviewed and analyzed to see how they compare to other entities in the same class, as well as a broader segment of entities. In addition to quantitative analysis, many qualitative factors are reviewed, such as understanding the company’s debt structure (interest rates, when debt matures, compliance with loan covenants), ongoing material litigation, mergers and acquisitions, and any economic-related concerns.

Involving Stakeholder Communication

The process of assessing credit risk for the calculation of collateral is part science. The review and assessment of numerical financial results is part art, as it is a subjective assessment of how financial performance relates to and impacts underlying credit risk for an insured. This makes it increasingly important for carriers to communicate their terms with context that all parties understand.

Reasonable people can disagree on numbers, as the interpretation of those numbers can vary from one stakeholder to another. When there is a significant collateral request, and an insured is attempting to move carriers while on a loss-sensitive program, it may not be possible for them to have immediate access to their collateral with a previous carrier. In this instance, listening to an organization’s chief financial officer or other financial management team members can help provide better context to their financial assessment, allowing for more flexibility in certain cases.

Prior to renewals, brokers and insureds, along with the carrier, will set up calls to discuss the insured’s financials and business performance. While the credit risk underwriter needs to be consistent in their approach, these discussions can allow insureds to express why their perspective might differ from how their financials present. The insured should be available to answer any questions the credit team may have and be forthcoming with any other information they can disclose that could impact the company financially. An open dialogue with the carrier’s credit team will give them a holistic view of an insured’s overall financial wherewithal.