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The Purpose of Collateral in Workers’ Compensation

The Purpose of Collateral in Workers’ CompensationUnder large-deductible workers’ compensation plans, the insurer contractually agrees to pay all claims as they occur, while the policyholder is obligated to reimburse the insurer for all claims that fall under the deductible amount. It provides the same insurance coverage as a traditional guaranteed insurance plan, just with an added special deductible endorsement.

When a company has a large-deductible workers’ comp plan, they are taking on the risk of being financially responsible for paying for all claims up to their deductible amount. While those claim payments are ultimately the responsibility of the insured, the carrier is still contractually obligated to financially cover all claims until they are reimbursed at the end of the policy period. If a policyholder were to run into financial trouble or file for bankruptcy, without some kind of guarantee in place for reimbursement, the insurance carrier would be left to pay for the claims. That’s where collateral comes in.

Setting aside adequate liquid funds to pay for future losses is a surplus requirement for insurance carriers and a key factor in their overall financial rating and profitability. Collateral is used to ensure that claims are paid in the event the employer is no longer able to pay their claims. Insurers may require the company to submit thorough financial audit, open an escrow account or have funds held by the state in order to secure coverage.

How is the Appropriate Collateral Amount Determined?

Insurance carriers’ base collateral requirements are usually established by their estimated loss projection. Carriers may adjust their pricing up or down for a client on a case-by-case basis, taking into account each client’s unique factors and finances. Some of the drivers commonly used to determine the necessary amount of collateral are:

  • Retention/deductible level versus historical loss experience.
  • Results of a review of the client’s past and present financial statements, as well as financial projections, available liquid assets, debt leverage ratio, coverage ratios, etc.
  • The safety initiatives and protocols that are already in place by the employer to mitigate losses.
  • Forms of existing collateral that are guaranteed to other creditors.

What are Acceptable Forms of Collateral?

The traditional and most common form of collateral is a Letter of Credit (LOC) from the client’s bank or financial institution. This serves as a guarantee that the client will pay up to the agreed upon amount to the carrier, and if they are unable to do so the bank will be obligated to pay the full amount or remaining balance. However, there are some alternative forms of collateral that may be used to secure deductible responsibilities, including surety bonds, credit buydowns, pledge of security arrangements and, in some cases, cash.

While collateral can be a challenge for many clients, with frequent and open communication, thorough analysis and the exploration of alternatives, agents can help their clients find a solution that works best for their business.

About ASIA Workers’ Compensation

Associated Specialty Insurance Agency, Inc. has been “The Workers’ Compensation Specialist for Brokers and Agents” for the past two decades and is committed to providing brokers and insurance agents across the East Coast with expertise and services to develop a Workers’ Compensation policy. For more information about how we can assist you with claims management, anti-fraud measures, and more call (610) 543-5510 to speak with one of our professionals.

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