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
- 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
- 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!