Our "Q&A"
section highlights the expertise of our attorneys on timely
issues impacting California employers.
The question-and-answer format allows for expert feedback in a
concise and logical manner.
Click below for previous expert Q&As:
Indian Sovereignty
For more information about one of our Q&As, please feel free
to contact an RPNA partner, or e-mail us at
rpnalaw@rpnalaw.com. |
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COLLATERAL REQUIREMENTS
Michael Adreani has focused his practice on a wide variety of insurance related matters
with an emphasis on risk management, coverage, and workers'
compensation cost containment. High collateral requirements
set by insurers is an important issue for any organization
with an alternative risk transfer program that can
dramatically impact bank ratings, shareholders, and business
relationships as well as restrict cash needed for business
growth. Here Michael
discusses how collateral requirements are set by insurers, the
causal relationship between carriers' claims handling and
reserving on collateral requirements, and what employers can
do to avoid unjustified collateral increases. |
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Q |
How is collateral initially setup? |
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A |
Initially, collateral is set by projecting losses over the
life of the one year policy. This is called a "loss pick" and
is based on either the past experience of the employer, the
past experience of the carrier, or a combination of both. The
more "true" and “verifiable” the actual experience of the
employer, the more likely that experience will be used. If the
employer has had recent experience with a carrier that has
gone insolvent or the data is deemed corrupted by the carrier
for some other reason and is, therefore, not verifiable, the
carrier is more likely to use its own database of loss
information.
Once a loss pick is established by the actuaries, the carrier
will demand that the employer set aside some percentage of
that number as collateral for the policy. This is subject to
negotiation between the employer’s risk management team and
the carrier’s sales team.
Because the initial loss pick is generally determined by the
carrier, employers may wish to hire their own independent
actuaries to make this projection from the employer’s
standpoint (perhaps by putting more emphasis on the employer's
experience than the carrier's) in order to better negotiate
the initial collateral requirement.
Be sure to check your policy and/or financing agreement
to see exactly how the carrier defines "collateral." If
the term is vague or ambiguous, you will have a better shot at
negotiating a more manageable figure.
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Q |
When is it reviewed? |
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A |
Typically, collateral is
reviewed yearly. However, check your policy. Some
policies do not have a pre-set review period at all. This may
be interpreted to mean that a review of collateral is at the
carrier's sole discretion, or it could mean that the carrier
is not entitled to collateral after the first year.
When collateral is adjusted throughout the life of the policy,
there is a slightly different means of calculating the amount
required. As the policy lifecycle develops, there are "actual"
losses under the policy to use in the determination. These
losses (payments on claims, case reserves, and IBNR) are
multiplied by loss development factors (LDF) which project the
losses over their life to come up with an ultimate loss
number. This number is what needs to be collateralized. Again,
carriers like to use LDF's from their own databases and
experience. If, however, the employer has enough verifiable
history, LDF's can be employer-specific so as to more
accurately determine the proper ultimate loss figure.
Again, LDF's are a complicated matter. The use of experienced
professionals in negotiating collateral adjustments may allow
the employer to more profitably utilize its cash assets.
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Q |
What if the collateral is too high? |
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A |
It is important to negotiate the initial
collateral from a position of strength by having some
actuarial or legal analysis of the factors that go into the
collateral formula. If the collateral is reviewed yearly, the
employer will have the opportunity to present its case for a
reduction. Have your risk manager do a report on the payments
on claims compared to the outstanding reserves. Is the carrier
asking your company to post collateral at a level many times
the amount of outstanding reserves? This could be an issue of
the carrier's lack of faith in its own adjusters'
handling/reserving on the claims. Why would you need $1
million in collateral if the adjusters have set outstanding
reserves at only $300,000?
Clearly, claims handling and reserving play an integral role
in the determination of collateral - a role carriers sometimes
ignore. If there is a vast discrepancy between the collateral
required and the outstanding reserves on files - particularly
if you are two or more years into your policy - there may be
grounds for challenging that good faith of those claims
practices under the well established case law of California (Notrica,
etc.)
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Q |
What if they threaten to draw down on
the collateral? |
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A |
This is a serious matter that
will affect your cash, your credit rating, and your
shareholders. Any such threat should be immediately turned
over to an experienced professional. First, check the policy
for the notice requirements on any such draw down. Second, get
behind the threat: Why does the carrier believe it needs the
money? This could be something as simple as some tardy
reimbursements which got ignored in accounts payable. However,
this could also be the result of neglect by the carrier
itself. If the claims have been poorly managed, it may be the
carrier who is at fault. If this is the case, not only have
the claims been over paid and over reserved, but the threat of
a draw down is completely unfounded as well.
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Q |
What if they seek an increase
that is not justified? |
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A |
Increasing collateral into the policy lifecycle is rare, and
is a definite red flag. If a carrier asks for you to post more
than was already posted, seek the help of a professional to
review the collateral and the underlying claims which gave
rise to the requested increase.
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Q |
How are my claims affecting my collateral requirements? |
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A |
There
is a direct causal connection between the handling and
reserving of claims and the amount of collateral required. In
fact, "development" on claims is nothing more than the
adjusters handling and reserving of them. These are your
"losses" which are multiplied by the LDF to come up with the
collateral. The behavior of the adjusters in making decisions
on your claims, therefore, has a direct impact on your
collateral. Be sure to have your risk manager monitor claims
developments and request updates and adherence by the
adjusters to the carrier's best practices and special service
instructions. After all, these are the services you negotiated
in agreeing to this policy in the first place. If the carrier
is willing to accept your cash as collateral, you should be
able to expect strict adherence to the guidelines the carrier
advertised during the selling process. |
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