Integrating Insurance into your Balance Sheet & Treasury management

 

The insurer’s business model

  • Receive premium typically several years in advance of the claim needing to be paid
  • Add 12% IPT as a cost to you, pass straight through to HMRC
  • Thus can invest premiums for medium/long term
  • Effectively, you have lost this investment income, rarely part of Cost of Risk considerations
  • In addition the IPT cost is rarely part of your Cost of Risk considerations
  • Insurers will have set the premium to make a reasonable ROC, thus unlikely to lose in the long-term
  • Thus thinking like an insurer can substantially benefit your balance sheet

Accounting Issues

  • Over-Reserving

  • Are you over-reserved for historic risks? Could these be released for future risk taking?
    • In most cases, data for legacy liabilities is sparse eg historic headcounts for asbestos claims.
    • Where there are gaps, it is prudent to carry higher balance sheet reserves
    • We have years of experience help clients to “fill the gaps”, safely reducing the balance sheet reserves required, without compromising the security for your claimants
  • Over-Hedging

  • Some risks are already indirectly hedged on the balance sheet – no need for insurance
    • We often see clients asking for coverage for historic absestos claims/deaths
    • Since these claimants will usually be Pensioner members of your pension scheme, increased asbestos claims/deaths (which are usually at relatively young ages for Scheme Pensioners) is usually a benefit to the pension scheme.
    • Thus insurance is not required.
    • Furthermore, this also impacts on the cost/benefits of buying-out the pension scheme, since there is a natural on-balance sheet hedge (early asbestos deaths from the insurance fund) to absorb increasing longevity risks, the typical reason for considering pension fund buy-outs
  • Over-Estimating Insurer Credit Quality

    • Insurance recoveries are balance sheet assets, the same as any other assets.
    • Since Solvency II, there is now substantial publicly available evidence on insurer credit quality
    • Credit ratings/bond ratings/issuer ratings are simply inadequate for insurance purposes
    • How do you manage insurer security risk, if the insurer will not allow commutation/cancellation?
  • Balance sheet materiality

    • A “large claim” may be a small impact to your (large) P&L/balance sheet, or even exceptional, not affecting investor metrics
    • For asset losses, there may be no balance sheet write off at all, if the asset was undervalued/not booked in the first place
    • Insurance recoveries (especially for litigated claims) can be uncertain – and thus not booked until crystallised
  • Corporate Governance: Are your claimants’ safe? Can you afford high policy excesses?

    • Reducing premiums is easy by increasing excesses; protecting claimants is harder
    • Other advisors just increase excesses, we give claimants’ security as well.
    • Your claimants are usually more at risk of your failure than insurers’ failure!

“Ask John to perform his version of search and destroy on your premiums”

“Ask John to perform his version of search and destroy on your premiums”