Tight credit markets that have raised risk management collateral costs are not expected to ease significantly in 2010, but policyholders have new options and strategies that can help, experts say.

Despite slight improvements in economic conditions and credit availability in last year's fourth quarter, insurers continue to aggressively manage the credit risk they take on from policyholders. At the same time, the cost and limited availability of bank letters of credit remain a challenge for policyholders.

Risk managers, meanwhile, are under pressure from upper management to reduce collateral costs and limit their LOC use to keep scarce capital available for other corporate needs.

“It's not only the diminished capacity in letters of credit that banks are willing to put up, but the increased costs for them,” said Dominic Zullo, director of risk management for San Diego-based Cubic Corp., a defense and transportation contractor. “It's double-headed.”

Brokers note that costs for bank-issued LOCs are four or five times higher than a year ago, prompting risk managers to turn to other strategies, such as new trust accounts arranged by insurers, surety bonds and loss-portfolio transfers. Also, some are aggressively seeking to free up old collateral insurers hold for past policy years.

In recent years, LOCs have been the most widely used instruments for posting collateral that insurers require to guarantee payment of commercial auto, general liability and workers compensation claims falling within large deductibles.

Self-insurers also use them as the collateral state regulators require to guarantee payment of workers comp obligations should an employer face financial problems.

Credit concern “is probably the most frequent phone call (subject) I get from customers right now,” said Gary Kaplan, president of construction for Zurich North America Commercial. “They are absolutely lasered in on this.

“Their executive committees are looking at where their capital is being utilized, and there is lots of pressure on them to make sure they are utilizing it to the maximum” benefit, he said.

Last fall, some insurers introduced new trust accounts as alternatives to LOCs.

Zurich, for instance, offered customers with cash an opportunity to place money in either a trust fund or a certificate of deposit as collateral. Zurich works with banks that hold the funds and pay interest to insureds.

Travelers Cos. Inc. also introduced a collateral account product. It allows qualifying customers to invest their collateral.

“It's a cash collateral product, but it comes with an asset management feel rather than (the bank or insurer) just holding the cash,” said Pam Ferrandino, executive vp and casualty practice leader for Willis HRH in New York.

The savings potential is substantial, said Eric Silverstein, casualty practice leader in Atlanta for broker Beecher Carlson Holdings Inc.

“Instead of (insureds) paying somebody for their LOC—maybe 300 or 500 basis points—they get 50 or 75 basis points on the money in trusts,” Mr. Silverstein said. “That is a pretty significant advantage, if you have the cash.”

The insurer arrangements are simplified Regulation 114 insurance trusts that banks have provided throughout the years for risk management needs, such as captive owners needing collateral required by fronting insurers, sources said.

Yet some risk managers still prefer to get their collateral from banks rather than from their insurers.

“They feel a sense of control, having a third party hold their assets,” Ms. Ferrandino said.

Even before turning to a trust or other alternative to LOCs, however, companies should demand a full accounting of how their insurer will calculate their collateral requirements, said Marc Kunney, casualty practice leader at Integro Insurance Brokers in San Francisco.

The calculations typically are based on loss projections and the insured's creditworthiness. But buyers should seek to understand the parameters insurers will use to calculate those factors, Mr. Kunney said.

Using sureties for collateral also is growing, sources said.

That approach has proved challenging, because surety companies have declined to include certain wording in their contracts insisted upon by insurers requiring collateral.

But “a couple of surety carriers have now agreed they will use wording in the surety bond that mirrors what's in an LOC,” said Len Churnetski, chief operating officer in New York for the national casualty practice of Chicago-based Aon Corp. At the same time, some insurers that previously rejected sureties recently have agreed to apply them to satisfy about 20% to 30% of the collateral they demand.

“They are putting their big foot out on the ice and trying to decide if it's thick enough to stand on,” Mr. Churnetski said.

Loss portfolio transfers, an arrangement in which underwriters essentially issue a new policy for older, unpaid losses already covered under a past year's insurance policy, also are gaining interest as some insurers find the deals generate substantial premiums, several sources said.

“We have (about) half a dozen (loss portfolio deals) outstanding right now, where a year ago we didn't have anywhere near that,” Mr. Churnetski said.

Because LPTs allow insureds to transfer older liabilities by paying a one-time premium, they eliminate collateral requirements for those liabilities.

LPTs also can eliminate a policyholder's administrative responsibility for older claims, but paying an LPT premium also requires cash.

The interest rate environment also limits their appeal because insurers typically offset the cost for assuming the claims by investing the LPT premium. With investment returns low, insurers can't significantly discount the premium.

Still, some insurers recently have developed an appetite for LPTs, if the price is right.

“There is much more activity now because (some) carriers are more aggressive,” Mr. Churnetski said. “They want the premiums.”

Another strategy requires negotiating with insurers to release past-year policy collateral held for accounts they no longer insure, Ms. Ferrandino and Mr. Silverstein said.

Often, there is little incentive for insurers to release the collateral on “runoff accounts,” Mr. Silverstein said.

But recently, some insurers have done so in cases where the losses are winding down and they hope to improve their relationship with a broker or win back an old client.