How CFOs can free liquidity from insurance ‘collateral jail’

Pressured by soaring inflation and dwindling opportunities to raise capital, some CFOs are turning to an emerging financing instrument that frees up cash locked in “trapped” insurance guarantees by removing letters balance sheet credit.

Known as Insurance Guarantee Funding, the funding product is designed to solve a problem that has long frustrated treasurers and CFOs who opt for so-called loss-sensitive policies to reduce their premiums on indemnification. workers’ compensation, commercial vehicle and other business insurance, according to Stephen Roseman, chief executive and founder of 1970 Group, a venture finance provider that began offering the product when the company launched in 2020. .

While loss-sensitive policies reduce premiums, insurers require businesses to provide collateral to cover the higher risk, and insured businesses typically use a bank letter of credit (LOC) or put cash under escrow to do this, which effectively reduces cash, Roseman said.

To solve this problem, Groupe 1970 works with a network of partner banks to issue letters of credit in the name of the insured company and transfers the guarantee requirement off the company’s balance sheet. “By working with us, you are able to immediately cancel your letter of credit with your existing bank, restoring the full amount of the facility,” Roseman said. Companies can then redirect capital to address a range of strategies such as growth through acquisitions or, in the current volatile environment, to help them solve any cash flow problems they face, he said.

A $300 Billion Problem

“We estimate there’s $300 billion in trapped collateral, known in the industry as collateral prison or collateral handcuffs,” Roseman said in an interview, noting that loss-sensitive insurance is a cost-containment route that the middle market and large corporations are taking as their insurance costs rise. ” It’s a big problem. We solve one of the most common problems that exist in American companies.

Collateral funding usually has a duration of one year which generally coincides with the annual policy that it collateralizes, Roseman said. He declined to give a range of hosting fees charged by the group, but said they were tied to set rates based on the company’s credit profile, with lower quality companies paying more than quality. of investment.

Roseman, a 25-year veteran of the finance and insurance industry, had long observed the unlocked potential of insurance collateral. He has held positions such as chairman and board member of Spencer Capital Holdings and chairman of the USA Risk Group, according to his LinkedIn. When the company was founded in January 2020, it faced an unexpected headwind as companies in struggling industries scrambled to find more cash.

“We didn’t anticipate this when we started the business, but the ripple effect of the pandemic has been that it’s been a benefit.” said Roseman. At first the demand came from hotel companies under pressure from closed hotels, aerospace companies and retail. Later, he said there was an increase in demand from energy companies. Now, he is seeing more demand again amid an uncertain macro economy and with rising insurance premiums as well as the amounts of coverage demanded by carriers.

“The appetite for learning more about what we’re doing has increased dramatically,” he said, adding that companies “need to find a way to mitigate some of that lost liquidity to weather the storm.” .

Rising insurance costs are among the many increasingly costly inputs facing CFOs as they manage growing selling, general, and administrative (SG&A) expense challenges. In the first quarter of 2022 global trade insurance prices rose 11% although the rate has moderated since hitting its recent high of 22% in the fourth quarter of 2020, according to Marsh’s Global Insurance Market Index.

Brian Cohen, founder of general underwriting firm Arden Insurance Services, said he called on the 1970 Group to help him meet a similar warranty requirement in 2020. The move allowed him to grow his business in instead of putting money in to meet warranty claims.

“He’s a game changer,” Cohen said. “What the Group of 1970 said was… ‘you’ll only pay us interest’ and that was a fraction of what I should have paid. Instead, I was able to use most of our money and grow our business by 40%. »

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