As insurance costs have continued to increase, many organizations are choosing to self insurance all or parts of the risk. These self insurance plans often require insurance deductible bonds to guarantee that claims will be paid.
An insurance deductible bond is a surety bond that guarantees that the company will pay for any deductible that it becomes responsible for under an insurance policy. The bond is considered a straight financial guarantee because the surety bond company is guaranteeing that the principal company will have the money available to pay their deductible. If they cannot, the surety bond company will be responsible for the payment.
On almost any type of insurance policy, a company could choose to self-insure or have a high deductible plan. Common types of insurance policies for these arrangements include:
In most self-insurance or large deductible plans, the company or policyholder sets an amount that they will be responsible for if a claim occurs. This includes a single claim limit and an aggregate or total claim limit. The company then purchases excess or reinsurance to cover claims that exceed those amounts. The insurance carrier or reinsurer will pay claims as they occur and then the policyholder will reimburse them.
Insurance carriers will typically ask for a financial guarantee that the policyholder will be able to pay the claims for which they become responsible. These guarantees are usually in the form of a letter of credit, cash deposits, or an insurance deductible bond. Here is an example:
ABC Companies purchases a general liability policy with a $250,000 single claim policy deductible and a $500,000 aggregate deductible. Should a claim occur of less than $250,000, the insurance carrier will pay the claim and then get reimbursed from the policyholder. Depending on the policy, the insurance company might ask the policyholder to provide security for their $250,000 single deductible, or their $500,000 aggregate.
The company purchasing the insurance coverage (the policyholder) is referred to as the principal on the bond. The insurance carrier is referred to as the obigee. The surety is a third-party bond company providing the bond. In exchange for payment and indemnity from the principal, the surety provides a financial guarantee to the obligee. If the policyholder fails to reimburse the insurance carrier, the carrier can make a claim against the bond to the surety. If the claim is valid, the surety will have to pay the carrier. The surety can then go back and seek reimbursement from the policyholder.
Because insurance deductible bonds are financial guarantees, they are considered high risk. The company will need to show that they have the financial strength to meet their obligations. Surety underwriters will ask for 3 years of company financial statements, information on lender relationships, and copies of the insurance policies. Surety bond companies will be looking for strong liquidity to make sure the company can meet its deductible obligations.
One major concern for underwriters will be the possibility of long tail coverage. For example, worker's compensation claims may not surface for months or years. A bond company may no longer even write the bond for a principal when a claim occurs. Bond underwriters will carefully consider how long their tail coverage may last.
Insurance Deductible Bonds are often non-cancelable. The surety bond company must be replaced by another bond company or other substitute to get off the liability. This adds risk to these bonds.
Irrevocable Letters of Credit (ILOCs) are a popular way to guarantee insurance deductibles. The biggest advantage to ILOCs is that they are widely accepted by insurance carriers. The downside to ILOCs for the policyholder is that the ILOCs tie up a company’s borrowing. This borrowing may be needed for business operations or growth. ILOCs may also require collateral from the company’s lender in order to issue an ILOC.
Unlike ILOCs, an insurance deductible bond does not usually require collateral. Surety bond companies rarely file liens or make UCC filings unless there is an issue. Therefore, the company can use their borrowing elsewhere.
Learn more about surety bonds versus ILOCs by clicking the image to the right.
Another option for guaranteeing insurance deductible payments is to post cash. This is usually held in an escrow account between the insurance carrier and the policyholder. The advantage to cash, if a company has it, is that there is typically no or little cost to using it. The problem with using cash is the opportunity cost. Businesses need cash to operate and grow. An organization’s cash is normally better used elsewhere.
The biggest challenge with using an insurance deductible bond is that not all insurance carriers will accept them. A claim against a surety bond requires the surety company to investigate and possibly defend the principal. Some insurance carriers would prefer to have easier access to funds if a problem occurs. In these cases, there are other surety products such as a surety backed letter of credit that may be used. When possible, most companies will find many benefit to obtaining an insurance deductible bond than other products though.
Companies must still qualify with a surety company to obtain an insurance deductible bond. They must meet certain financial and operating requirements for a bond company to write a bond. Companies with financial challenges may find it more difficult to qualify for insurance deductible bonds.
Many companies are choosing to self insure risk through captive insurance programs. There are many types of captives, but two popular structures are single parent captives and group captives. As part of a captive program, a insured is usually required to post letters of credit or cash as the other programs. Unfortunately, most captives will not allow an insurance deductible bond to replace the ILOC requirement. There may be other solutions, however such as Surety Backed Letter of Credit.
Insurance deductible bonds are a great way for companies to free up borrowing and liquidity if they have a self insurance or high deductible insurance program. These bonds allow company cash and resources to be used elsewhere. There are many other surety and credit tools that may be able to help orgranizations as well. Contact the bond experts at Axcess Surety today to learn more about insurance deductible bonds and other resources.
Axcess Surety is the premier provider of surety bonds nationally. We work individuals and businesses across the country to provide the best surety bond programs at the best price.
