Self-Insured Retention Plans often require security to be put up against the self-insured portion of the plan. Insurers agree to take a risk over a certain level, provided the company retains the risk below a certain level. Insurers are willing to do this because security is put up to secure the insurer for the level taken by the company or the insured. Traditionally, this can be cash, a surety bond, or a Letter of Credit.
When you put up a Letter of Credit, you use the portion of your revolving credit facility outlined in the carveout provision for a letter of credit. The bank charges an annual fee for the letter of credit, an application fee for the letter of credit, and an interest rate on the portion of the credit facility used for the letter of credit. This should be outlined in your agreement for the credit facility. These fees can add up quickly, and tying up capital that could be used for other purposes significantly increases the cost as well.
Another option would be depositing cash which you will lose use of in an account to secure the Self-Insured Deductible amount. Tying up cash for this purpose rarely makes sense. The cost of capital for the company will be the cost of tying up the funds. The other issue is reducing the available liquidity to that company.
The last option, which is almost always the best option, is to use a surety bond to secure the obligation. Surety companies will review your most recent financials which are your most recent year-end profit & loss statement (P&L), a year-end balance sheet, your most recent quarter’s P&L, and balance sheet. The surety will also need to know what credit lines (if your company has them) are, the expiration, the current usage, and your internal covenant calculations to determine what the terms for the bond will be. Many times the surety will offer terms secured by an indemnity agreement only, as well as annual bond premium which will range between 1%-3% per year. Given the lack of collateral normally required, this could end up saving a company 7%-12% of the bond amount annually, which is a significant amount of money.
Another reason to explore a surety bond is that there are surety companies that would be willing to tie up assets that are not traditional forms of collateral. Traditional forms of collateral are cash or a letter of credit. Non-traditional forms are real estate and a pledge of a non-retirement brokerage account.
With interest rates continuing to rise, the cost of capital has been increasing significantly. One way of freeing up capital and lowering your cost is by using a surety bond to replace the security behind self-insured retention plans. Call me to discuss your self-insured retention program and the security supporting it. Many times, we have been able to free up capital and lower the client’s cost of securing that plan.
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