Communication Is Key to Successful Collateral Negotiations
From:, August 27, 2018
By Derek Freihaut, FCAS, MAAA, Pinnacle Actuarial Resources, Inc.

Collateral negotiations can often be contentious. While collateral is required for a variety of insurance programs, opinions of how much collateral is necessary can differ significantly. These differences are born out of different perspectives and motives between parties involved in the negotiation. An objective discussion between the actuaries behind the loss projections on both sides of the negotiation can help find valuable middle ground.

Ultimately, collateral is protection against the financial risk of a risk-bearing entity (RBE) defaulting on payments for future retained losses. There are several various types of RBEs, such as large deductible policyholders, self-insureds, or fronted captives. Each of these RBEs is ultimately responsible for the retained losses they cover. However, if the RBE has a policy-issuing carrier (PIC) and the RBE is unable to meet its claims obligations, the PIC must act as a backstop and is responsible for all claims payments. The PIC offsets this credit risk through the requirement of collateral.

The credit risk to the PIC is the most obvious concern, but it also needs collateral to meet statutory requirements since an RBE will not typically qualify as an admitted reinsurer. Rating agencies also have concerns regarding the amount of collateral the PIC is holding as they assess the risk posed to the insurer. Self-insured workers compensation programs without a fronting insurer may also have significant collateral requirements imposed by the state.

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