Insurance Enters the Asset-Based Financing Arena

This article was excerpted from the FSC & Cross-Border Leasing News, Volume 8, Number 2, June, 1997. Reprinted with permission from The FSC/DISC Tax Association (FDTA).

One of the least-talked about areas of cross-border leasing is the role of insurance. William J. McGreevy (Tri-City Brokers, Inc.), Thomas A. Orofino (RVI Associates, LP), and Patrick R Jordan (J&H Marsh & McLennen) provided a rare glimpse into "Insurance Solutions to Leasing Challenges" at the FDTA's April 1997 conference in New York City.

Orofino set the stage for the group's comments by acknowledging that "Insurance companies will absorb the risk, but they don't want to". But, he stated, the industry is interested in becoming more deeply involved in the cross-border leasing environment. "What we're trying to do he said, "is bring insurance into the asset-based financing arena". By way of explanation, he and the two speakers elaborated on the role of insurance entities in Leasehold Interest transactions.

"Insurance companies provide residual value and financial risk insurance for cross-border leasing transactions," he said. They act as defeasance party takers, equity deposit takers, and equity strip guarantors. In the first role, an insurance entity acts as a trustee, debt monies are deposited with the insurance entity and are administered over time. In the second, the insurance entity receives monies "today" and guarantees the return of those funds at a future date - compounded at an agreed rate of return. For example, the contract can be in the form of a Guaranteed Investment Contracts, (GIC).

The third role Orofino mentioned was the equity strip guarantor. In this, the insurance entity guarantees the exposed termination value, which arises due to the calculation of termination values by the lessee at the transaction debt rate versus the equity yield rate. Orofino pointed out that insurance entity participation in the transaction process provides several significant benefits. For example, it allows for more flexibility in GIC "make whole" and "par put" termination clauses, provides for a combination of more than one role for price and documentation costs and coordination, and offers an aggressive pricing matrix. Benefits also abound in other categories of insurance.

"Residual value insurance is growing in popularity", Orofino noted. Insurance entities today are serving several markets related to cross border leasing, such as aircraft, rail, trailers, containers, construction, and printing. As he explained it, residual value insurance coverage "is written to a minimal loss ratio, net of recoveries. This means that the expectation at any policy's inception is that even if a claim is made and paid, recoveries from liquidation of the asset insured will leave the insurer without loss." He observed that product demand is strong now due the need to create liquidity and yield enhancements in financings. Orofino pointed to several possible uses for FASB residual value insurance. For example, he suggested that residual value insurance Is applicable in synthetic leases or when lessors want to accelerate profit recognition or increase retained earnings and decrease leverage." Jordan was equally positive about financial risk insurance.

"Financial insurance involves the transfer of risk from the insured to the insurer, "he explained. "Risk distribution is accomplished by spreading risk overtime rather than pooling it with other risk over an annual period as is the case with conventional property and casualty coverage." Jordan offered as a selling point the idea that financial insurance is a "finite product," which means that the minimum loss payable by the insurer is predetermined and aggregated over the term of the policy. But, he stressed, even though the whole insurance industry is a "CYA industry, much of the benefit in insurance related to leasing accrues to the insureds.

"Look at the benefits insureds receive," he said - "Financial risk insurance is flexible. Products are tailored to meet the specific needs of a client. It involves multiyear terms. Products are structured as multiyear contracts, which makes them a strategic risk financing tool." And, he noted, there is some profit sharing involved "If loss experience is better than actually forecast, the insurer shares the reward with the insured. "In summary, Jordan averred, risk financing is stabilized over time, coverage can be secured for traditionally "uninsurable" exposures, earnings and/or cash flow can be stabilized, and the variable impact of insurance market forces can be minimized.

Orofino noted that there can be very close working relationships between insurers and insureds, but each has to find out a lot about the other. Looking at cross-border leasing, for example," he said, we don't understanding your business the same way you understand your business". So, Orofino stressed, 'We both have to ask questions of one another to see how we can mutually benefit. After all, most of our best ideas regarding insurance programs come from clients." Finally, he said "The only silly question is the one you don't ask".

That is especially true of the relationship between cross-border leasing and insurance. Many people in both industries have had questions regarding their respective roles. Now, the answers is only an FDTA-sponsored presentation away. All cross-border leasing dealmakers have to do to find out how insurance can benefit them is ask the right questions.

NOTE:       To learn more about the relationship between the insurance and cross-border leasing industries, order the hand-out, "Insurance Solutions to Leasing Challenges, listed on page 11.

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The insurance panel was chaired by Thomas A. Orofino who is managing partner of Collateral Guaranty LLC based in Westport, CT. (203.227.7080) and is responsible for the marketing and product design of asset based insurance products and services worldwide.