Pressured by rising inflation and shrinking opportunities to raise capital, some CFOs are turning to an emerging financing tool that frees up liquidity tied to “captured” insurance collateral by taking letters of credit off the balance sheet.
Known as insurance collateral funding, the financial product is designed to solve a pain point that has long plagued treasurers and CFOs who choose so-called loss-sensitive policies to lower their premiums on workers’ compensation, commercial vehicle and other company insurance, according to Steven Roseman, CEO and founder of 1970 Group, a venture finance provider that began offering the product when the company launched in 2020.
While loss-sensitive policies reduce premiums, insurers require companies to provide collateral to cover the higher risk, and insured companies typically use a bank letter of credit (LOC) or put money in escrow to do so, effectively draining liquidity. , Roseman said.
To address this issue, 1970 Group works with a network of partner banks to issue letters of credit on behalf of the insured company and transfer the collateral requirement off the company’s balance sheet. “By working with us, you can immediately cancel your letter of credit with your existing bank, thereby recovering the full amount of the facility,” Roseman said. Companies can then redirect the capital to a number of strategies, such as growth through acquisitions or, in the current volatile environment, to help them deal with the cash flow problems they’re facing, he said.
A $300 billion problem
“We estimate that there is $300 billion trapped in collateral, which is known in the industry as collateral prison or collateral handcuffs,” Roseman said in an interview, noting that loss-sensitive insurance is a path to cost containment that the middle market and larger corporations assume insurance costs are rising. “This is a big problem. We are solving one of the most common pain points that exists in corporate America.
Secured financing usually has a one-year term, which usually coincides with the annual policy, which provides, Roseman said. He declined to specify the scope of the group’s accommodation fee, but said it was tied to rates determined by a company’s credit profile, with sub-investment grade companies paying more than investment grade.
Roseman, a 25-year veteran of the financial and insurance industry, has long seen the unlocked potential of insurance collateral. He has held such roles as president and board member of Spencer Capital Holdings and president of USA Risk Group, according to his LinkedIn. When the company was launched in January 2020, it enjoyed an unexpected headwind as companies in stressed sectors struggle to find more liquidity.
“We didn’t plan for it when we supported the business, but the side effect of the pandemic was that it was a benefit,” Roseman said. In the beginning, demand came from hospitality companies under pressure from shuttered hotels, aerospace companies and retail. He later said there had been a surge in demand from energy companies. Now, he is seeing more demand again amid an uncertain macro economy and insurance premiums, along with the amounts of collateral required by carriers, are on the rise.
“The appetite for learning about what we do has increased dramatically,” he said, adding that companies “have to find a way to mitigate some of that lost liquidity to weather the storm.”
Rising insurance costs are among the many increasingly expensive inputs CFOs face as they manage growing SG&A challenges. In the first quarter of 2022 global commercial insurance rates up 11% although the rate has eased after reaching a recent peak of 22% in the fourth quarter of 2020, according to Marsh’s Global Insurance Market Index.
Brian Cohen, founder of managing general insurance firm Arden Insurance Services, said he tapped 1970 Group to help him meet a similar collateral requirement in 2020. The move allowed him to grow his firm instead of putting up cash , to meet collateral requirements.
“It’s a game changer,” Cohen said. “What the 1970 Group said was…’you’ll just pay us interest’ and that was a small part of what I had to give. Instead, I need to use most of our money and grow my business by 40%.”