Trust in an alternative
Having been a contributor to Intelligent Insurer on numerous occasions, I have often written about the differences between the collateral alternatives used for reinsurance and insurance-linked securities (ILS) programmes. And through the various captive publications, I have written about collateral alternatives for captive insurance programmes. The subject has also been raised at conferences more times than I can remember.
But having just finished a phone call with some industry contacts of mine, I realised that not everyone understands the alternative forms of collateral available for what is, most likely, the most common type of corporate insurance: large corporate deductible programmes. Never one to miss an opportunity to get the word out (or create something my mother can hang on her refrigerator), I am happy to explain.
In the interest of creating some level of credibility, I will say that I have been working on developing alternatives to letters of credit (LOCs) used to collateralise insurance programmes for more than 13 years. In that time, my team has helped our clients replace (or eliminate the need for) more than $100 billion worth of LOCs.
The trust concept
The concept of the Wells Fargo Deductible Trust is simple in its design. My clients who use the trust simply place cash or cash equivalents (to the same amount as the LOC) into a trust account where their insurance carrier is named as the beneficiary. From a regulatory and carrier standpoint, this satisfies the collateral requirement. There are details one needs to know before a decision on use of the trust can be made and I will cover those shortly. But, for now, it really is this simple.
Since the trust is not a credit mechanism, Wells Fargo charges far less than a bank would charge for an LOC—often as much as 95 per cent less. This is why the trust has grown in popularity in the corporate, captive, reinsurance and ILS spaces.
So why are so many people unaware of their ability to use the trust for their deductible programmes? It is hard to say. Because the trust is included in reinsurance regulations as an acceptable form of collateral, most people in both the reinsurance and the captive worlds are clear on what they can do.
But in the deductible world, there really are no “regulations” as to what are the acceptable forms of collateral. So in the past, the carriers just went with what people were giving them: LOCs.
Since my efforts to help define the trust as an acceptable form of collateral for deductible programmes started 13 years ago, however, we have seen many carriers not only accept the trust, but embrace it. The reason for this is that they clearly see the value the trust presents their client. Further, they are keenly aware of the credit issues many companies face these days and understand that the trust is an effective remedy.
So now it is up to me to be sure that risk managers around the US understand that, for deductible programmes, there is a much better way to collateralise their insurance programmes.
The UK and the EU
I have been working with a number of the primary casualty insurance carriers based in London on use of the trust for European programmes. Indeed, these carriers hold collateral for UK and EU corporate and captive programmes (for the same reasons as their counterparts do in the US) mostly in the form of LOCs. So why not allow for the trust? In fact, the big four corporate carriers in London do allow for the trust in lieu of LOCs collateralising traditional and captive insurance programmes in the UK and the EU.
What you need to know
To lay the foundation, I will say that when a deductible programme is created, the insurance carrier must be clear on a few issues. One is that they are giving a discount on the insurance programme in question on the basis the corporate client assumes the “first so many dollars” of each claim.
They call these “large deductible programmes” (for good reason). The “first so many dollars” might be anything from $250,000 to over $1 million, or more. With these programmes, the maths often works in the client’s favour. Meaning: the sum of all the deductibles (the loss pick) is actually less than the discount the corporate client gets by putting in place such a programme. Stated another way, the client might have to pay out $10 million a year in deductibles, but it saves $15 million in premiums.
The issue facing the carriers (that instigates the entire collateral conversation) is that the regulators (basically) tell the insurance carrier, to the extent that the insurance is covering a third party (workers’ compensation, auto, general liability for example), that if the corporate client can’t or won’t pay the deductibles, the carrier must. For large deductible programmes, the carrier not only takes on insurance risk with the client, it has also taken credit risk.
This credit risk is the reason the carriers ask for collateral for a large deductible programme.
The trust versus LOCs
For many corporate deductible collateral requirements, LOCs used are carved out of the corporations’ revolving lines of credit. Otherwise, they would be stand-by LOCs. Often they are not directly collateralised LOCs but sometimes they are. For our purposes we will assume they are not.
In the uncollateralised environment, these LOCs can cost anywhere from 100 to 400 basis points, or more. For the sake of an example, let’s go with 150 basis points. A $10 million collateral requirement, therefore, would cost $150,000. The trust would cost anywhere from $3,500 to $7,500 (depending on a few things). At $7,500, the trust would create a cost saving of 95 per cent. If it is $3,500, the saving is 98 per cent.
Of course, the trust does have to be funded in an amount roughly equal to the amount the LOC would otherwise have been. But the clients who are able to fund the trust should be sure to take advantage of this opportunity. At a minimum, risk managers should investigate the opportunity to realise such savings.
The work load
The trust with Wells Fargo should also require far less work to establish than LOCs. That is because Wells Fargo has pre-established the required trust document with most of the primary casualty carriers in the US and the four discussed in London. So “setting up” a trust is a simple matter of a quick legal review of the document and supplying the trustee with the required due diligence information.
It is also important to remember that once the trust is established, it does not need to be “renewed.” This renewal process, as well as enormous (and often increasing) costs is one of the key problems with LOCs.
50 million Elvis fans
After 13 years discussing the trust, I am happy to see so many corporations have taken advantage of what it has to offer. Having established more than 1,000 trusts eliminating the need for more than $100 billion in LOCs and saving clients at least $1 billion in LOC fees, I can only think of one expression to use: 50 million Elvis fans can’t be wrong…right?
Robert Quinn is a senior vice president at Wells Fargo Insurance Trust. He can be contacted at: firstname.lastname@example.org