How Carriers 'Pick' on You

Here's how a loss-sensitive, five-year collateral-based system might work:

Initially your carrier sets up your collateral requirements to project your losses for the first year of the policy, the loss pick. The loss projections are based upon your total book of claims at that point, plus your own loss data and that of comparable industries. For this example, the loss pick is $5 million, so your insurer requires a letter of credit in that amount--a multiple of your anticipated claims. This first-year loss pick acts as the basis for each year's collateral for your claims.

Wrestling with Collateral (12/17/12)
Culture Change in Finnegan's Wake (11/01/11)
Irene: One Year Later (07/24/12)
Women, Boomers Filing More LTD Claims (10/11/12)
Claims (05/01/13)

At the second year, during the annual adjustment period, the carrier deducts whatever you've paid in claims the previous year, and adds in the second year's loss pick. As in the above example of a $5 million loss pick, if you paid out $1 million to cover your first year claims, (leaving $4 million collateral) plus the $5 million loss pick, your total collateral would be $9 million. But you've only paid out $1 million, so you're already overcollateralized.

Consider, too, that many times your renewal discussion takes place only nine months into the policy year, and at that point you may already have $1 million in claims, so additional claims could erupt during those last three months, raising your claim total for that year and giving the insurer additional ammunition for either keeping your excess collateral, or even requiring more.

At year three, the adjustment process continues along the same lines, assuming the $1 million you've paid out in claims in year two--leaving $4 million in collateral. Now you're on the hook for $2 million for year one --leaving $3 million. So when the $5 million loss pick is added in again, your total collateral reaches $12 million. However, instead of $1 million in claims, maybe this year you've only had $500,000 in claims, so you could argue that you want your collateral reduced because maybe no other claims emerged beyond the $1 million the previous year.

By the fifth year, accounting for the prior losses of $1 million paid out each year, the first year's collateral requirements have been reduced to $1 million, the second year's to $2 million, the third year's to $3 million, the fourth year's to $4 million, and the fifth year adds in the original loss pick of $5 million, for a five-year total of $15 million. So the collateral requirements are now flat, because at the five-year mark, the total collateral adds up to the loss pick projections over five years.

And that makes this a good time to ask your carrier to hand over the excess collateral, $10 million in this example. After all, you're overcollateralized and you've had five years to prove to your insurer that you've got a handle on your claims. But this is frequently where the communication breaks down because carriers are known to drag their feet in releasing the collateral.

October 1, 2006

Newsletter Sign-up