Insurers typically request insureds to provide collateral as security for their obligations under a reimbursement or reinsurance agreement. This most commonly comes in the form of a letter of credit (L/C). Each year, an L/C can cost an insured tens of thousands of pounds in fees.

Bradley Saunders, an analytics development leader and senior vice president at global insurance and risk advisor Marsh, says insureds could consider using an independent actuarial valuation to analytically challenge an insurer on its demanded level of collateral, thus minimisingL/C costs.

Insurer's L/C collateral

In a hypothetical example in an 'Insight' written by Saunders, he posits an insured with a collateral requirement from its insurer of £12 million (US$15.6 million) for the coming policy year and any historic years.

The insurer's preferred form of collateral is an L/C and subject to credit rating and other factors, a bank's fee for an L/C may be approximately 0.75 per cent of the value of collateral required. Therefore, with a collateral requirement of £12 million, the L/C would cost £90,000 per annum.

Independent actuarial calculation

Subsequently, the insured and their broker negotiate with the insurer, using an independent actuarial calculation of expected retained claims costs (the credit risk borne by the insurer) to achieve a £2 million reduction in the collateral requirement.

Therefore, with a proportionate reduction in the cost of the L/C from the bank, the insured could save £15,000.

With a reasonably consistent risk and claims profile and consistent self-insured retention level, Saunders concludes that the insured could then stand to save that £15,000 on an annualised basis, or £75,000 over five years.

The 'Insight' written by Bradley Saunders, Letters of Credit: Challenges to insurer collateral requirements, can be found here.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.