How can LOCs in your insurance program strangle your growth?
An LOC is designed to cover obligations that extend for many years. That means that as you continually stack consecutive years of those obligations, the LOC amount increases, as well. Normally, the amount of credit needed levels off in about five years.
If you are the owner or executive of a business for which the conditions show a need to borrow money as a catalyst for growth, the LOC amount may be limiting your capacity to do so.
If the LOC needs approximately five years to level off, what happens each year to determine the need?
Each year of obligation stacks another year of an LOC need. During the year, a business is paying losses that reduce the need of the previous year(s).
While a new year starts with a full year’s exposure, the older years(s) have diminished by the payments made contractually. An insured business needs to have its broker do an analysis of the claim paid and incurred to determine the future need. A loss triangle would reflect the specific financial exposure of that business.
Finding the results is a very complex process.
How can companies determine whether they should be using LOCs, and what alternatives are available?
Every business needs to measure its own specific needs. To secure your obligations to the insurance company, you generally have the option (if the insurance carrier allows for it) of using an LOC, cash held by the carrier, or a bond or a third-party collateral trust.
Trust programs are becoming more relevant to businesses as an option. The trust account can allow you to deposit cash/securities to a third party, and you would retain the investment control and the growth of the funds held to your benefit. It is generally accepted that monies held in this fashion to secure your obligations need to be stated as ‘restricted cash’ in your financials.
You may also be able to get your auditors to agree that it is not restricted if certain documentation is afforded.
What advice would you give to companies considering using LOCs?
When you consider the rising costs of LOCs and the possible impediment on your balance sheet for borrowing purposes, consider looking at a properly drafted trust as an alternative.
One last note to considered is that your documents with the insurance company should be written in such a fashion that would allow a business the options to choose the above collateral methods and allow the specific measurement of losses be accounted for to minimize future financial exposure to the business.
Daniel R. Slezak is a vice president with ECBM Insurance Brokers and Consultants. Reach him at [email protected] or (610) 668-7100.
