American Oil and Gas Reporter - December 2022 - 67

SpecialReport: Well Control & Insurance
New Method Collateralizes Insurance
By Stephen Roseman
The past few years have highlighted
how important liquidity can be to oil and
gas companies' viability and long-term
prosperity. When geopolitical events or
economic growth spur increased demand,
firms with access to capital will be in the
best position to capitalize on higher prices.
If unexpected events bring prices down,
those same firms will have the financial
cushion to weather the tough times and
take advantage of the lull in activity to
test new ideas.
Liquidity's importance will likely increase
with time. Recent history suggests
prices will remain volatile, requiring
producers and service firms to bring
greater flexibility to their balance sheets
in readiness for multiple market scenarios.
With the cost of debt rising rapidly, corporate
liquidity strategies can help firms
position themselves to capture near- and
long-term opportunities, while managing
the anticipated volatility in shorter-term
pricing and production volumes resulting
from the geopolitical and economic
forces in play.
One important and often overlooked
means of raising corporate liquidity is
unlocking capital trapped in a company's
commercial insurance program, including
workers compensation, general liability
and commercial vehicle coverages. Many
mid-to-large-size companies in the oil
and gas production industry have benefitted
from the move away from guaranteed
cost insurance programs to high deductible
loss-sensitive programs in order to lower
insurance premium costs and increase
company cash flow. With these loss-sensitive
programs come requirements from
insurance carriers that collateral be set
aside to cover program deductibles.
The leading solution used by finance
and risk teams to collateralize their insurance
requirements is letters of credit, a
common vehicle offered by a firm's banking
providers. However, letters of credit (LOCs)
suffer from a major drawback: They are
treated as drawn capital with respect to a
company's credit facility, effectively reducing
the amount available to a company
to operate and grow its business.
The following example illustrates the
loss of liquidity being widely experienced
across the industry. A natural gas producer
that has a $40 million credit facility with
its banking provider approaches the bank
for a $10 million LOC to satisfy its insurance
carrier's collateral requirements. With
the LOC treated as drawn capital, the firm
immediately would lose 25% of its liquidity
that otherwise would be used for a variety
of business investments.
To make the problem worse, premiums
are rising in response to more stringent
underwriting and higher claims
costs, which have forced carriers to
push for higher collateral requirements
in high deductible programs. Inflationary
trends have compounded the problem
even further.
A New Solution
The loss of deployable capital has
stymied finance teams for decades, with
various proposed solutions-including
cash escrow, surety bonds and the aforementioned
LOCs-only partially addressing
the problem. However, after years of
development, a new risk financing solution
has been brought to market that fully releases
capital trapped in collateral obligations.
Insurance collateral funding (ICF)
accomplishes this goal by transferring a
company's collateral obligation off its
balance sheet.
Because it can be treated as off-balance
sheet financing, it typically is excluded
from financial covenants. Unlike
a traditionally sourced LOC, it does not
reduce the amount available under a
firm's credit facility. As a result, the
company regains access to its capital
without impacting its leverage ratios,
an improvement over the alternative of
accessing private or public markets for
additional credit.
Freeing capital is powerful enough
that ICF has grown rapidly. Since 2021,
the solution has been deployed in numerous
business sectors, including energy,
transportation and pharmaceutical manufacturing.
Service industries such as
healthcare, hospitality and food service
also love it, as do a variety of retail and
wholesale distributors.
How ICF Works
Developing ICF required a deep understanding
of carrier requirements and
credit structures, as well as robust banking
relationships. But for an oil and gas company,
the solution is easy to implement.
The company only needs to share information
about its insurance program with
an ICF specialist, which works with its
partner banks to issue a replacement LOC
for the client's existing LOC or other
forms of collateral supporting its policies.
This substitute LOC is delivered to
Insurance collateral funding enables oil and gas companies to collateralize insurance
policies without restricting the amount of capital available through their credit facilities.
Instead, an ICF specialist works with an extensive network of banks to provide a new
letter of credit. The process is quick and affordable, making it a compelling way to
improve liquidity.
DECEMBER 2022 67

American Oil and Gas Reporter - December 2022

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