When your clients already have a higher initial cost—especially when you add collateral—to join captives, it’s no wonder they might be initially apprehensive. Then they learn they don’t immediately get that collateral back if they decide to leave. It’s a legitimate concern that will need addressing, especially when they’re looking out for their best interest.
And you’re looking out for them, too. As their trusted agent, it's imperative you understand and are able to explain what happens to their collateral if they decide to leave the captive. Transparency on the “good” and the “bad” makes you a professional.
This article will guide you on why collateral is retained with a captive, how it works, how to communicate this information with your clients, and questions you’ll likely be asked. You’ll know how to directly address your client’s questions, comments, and concerns about their collateral and why it’s held after exiting a captive.
Why is Collateral Retained With the Captive Insurer?
Your client can exit a captive insurer at any time. Their collateral stays with the captive for some time because claims might arise years after the policy ends.
Consider collateral like a security deposit—essentially a financial cushion for any outstanding or late claims that must be covered.
For most captives, policy years stay “open” for around seven years. That way, there’s plenty of time for all claims to be processed. For all those years, the captives ensure the funds are available to pay claims from the covered period.
Holding Collateral and How It Works For Agents
1. The Role of Collateral in Captives
Collateral is a line of credit or cash reserve used to secure payment. If the captive lacks the necessary funds, collateral will back up its obligations. Collateral also provides stability and protection to all captive members.
2. Closing Policy Years
An actuary can forecast claims that may occur after a policy expires, referred to as IBNR (incurred but not reported), but this is only a forecast. Only time allows for a complete reconciliation of claims. While this around 7-year process can feel lengthy for your clients, the captive has to do everything necessary to protect itself and appease the fronting carrier.
3. Collateral Return
When all claims years are entirely closed, the unused funds are returned to your client’s business. The better it performs with its safety and risk management, the better its financial return will be.
The Challenges and Benefits of Collateral Retention
Let’s be honest: if your client decides to exit a captive knowing their collateral will be held, they’re more likely to recognize the challenges over its benefits. After all, it’s their money being held.
Challenges of collateral retention
- Delayed Access to Funds: For businesses leaving a captive, waiting years for collateral to return can be financially inconvenient.
- Perceived Lack of Control: Some clients feel uneasy knowing their funds are tied up for an extended period, even after exiting the program. Seven years isn’t a short amount of time.
Benefits of collateral retention
- Transparency: Captives provide clear reporting on how collateral is allocated and why it is held until all policy years close. If there is information your client wants regarding collateral, they have access to it.
- Potential Profit Returns: As said previously, this won’t happen immediately. However, clients may receive unused funds, including underwriting profit, when all policy years close. So, if your client is good regarding claims, they’ll get that money back.
Communicating Holding Collateral to Clients
Like anything in life, there will be benefits and challenges to what your client chooses to do. Giving them the good, the bad, and the ugly of this topic is necessary. Here are ways to communicate this topic clearly and effectively:
Explain why collateral is held. As has been said earlier, collateral is meant to provide financial stability to the captive if claims come up. Here are some reasons why collateral will be held:
- The captive has to consider incurred but not reported losses (IBNR).
- Other members of the captive want to know they aren’t paying more than their fair share for the claims of another member.
- If the captive ever ran out of money, the fronting carrier would be responsible for paying those claims.
Here’s an example you can use: Imagine a business leaves a captive today, but a liability claim surfaces three years later. Without collateral, the captive will sacrifice some of its security and stability when using its funds, potentially making it so the fronting carrier is on the hook to pay claims. The collateral ensures paying claims won't be a potential issue for the captive.
Thankfully, if your client doesn’t have claims, they can expect to get those funds back later.
And don’t be afraid to discuss the downsides: Talk about the negatives, like the delay in returning funds. While there is a significant gap in time, collateral protects the business and the captive as a whole. This gives your clients clear information to see if the collateral retention would benefit or burden their business.
Common Questions Asked By Clients
Yes, some of the answers to these questions will come off as repetitive to previous information provided. We want these FAQs to be easily accessible whenever these questions inevitably arise. Here are some questions you’ll see and how to answer them:
- What happens to my collateral if I decide to exit?
Collateral remains until all policy years close, which can be around seven years. After this period, any unused funds are returned.
- Why Can’t I access my funds immediately?
Captives operate on long-tail risk models, meaning claims can happen years after a policy ends. Having the collateral makes these claims coverable if no other funds are available.
- Is my collateral at risk while it’s held?
Collateral is managed conservatively and securely, so it’s available to cover claims. Since your client puts in the cash or line of credit for the collateral, they can track how the funds are used and safeguarded.
- How can I plan for my collateral to be held?
Agents can help clients budget for collateral retention by incorporating it into their broader financial planning. This makes the delayed return of funds less disruptive to the business.
Learn About How Your Clients Can Profit With a Captive
You’ve learned why collateral is held after leaving a captive and how to communicate this information to your clients. Providing this information lets your clients know the risks they can have when joining (and maybe exiting) a captive. That way, they can make the best decisions for their business’s bottom line.
Next, read our article on how captives can help your clients with cash flow. That way they understand that while the initial investment has a higher upfront cost, they can see cash flow payoffs and underwriting profit as they stay with a captive.
The purpose of Captive Coalition is to educate independent agents on everything regarding captive insurance, including the role of collateral and what happens with it if your client decides to leave. We want to provide you with all the information (the good and the bad) so that you and your clients can decide if captives are best for their business.
Become a member of Captive Coalition to have the tools, resources, and expertise to know if captives are right for your clients.
Topics:
