Your client has two options for posting collateral. Cash or a letter of credit. That's it. And each one has a different trade-off worth understanding before you sit back down with them.
If they post cash, that money earns investment income while it sits there. It's not frozen. It's working. The trade-off is that it does come off their balance sheet. For some business owners that's not a concern. For others it is.
If they post a letter of credit, they're not tying up any cash at all. They're using their banking relationship to satisfy the collateral requirement. The trade-off is that the line of credit has a cost to it. They'll pay their bank for access to that credit facility. It's not free. But they get to keep their cash working in their business while the captive runs.
Both options are acceptable. Neither is wrong. It comes down to your client's balance sheet, their banking relationships, and what matters more to them. Some clients don't want to touch their cash position. Others would rather pay a small cost than deal with a bank facility. The right answer depends on the client.
Here's what's worth adding to the conversation. As your client starts earning underwriting profit from the captive, those distributions can be applied directly toward the collateral. At that point the captive starts funding itself. They're playing with house money. That's the goal and it's realistic based on their performance history.
And here's something worth knowing for clients where collateral is a real sticking point. A quota share structure significantly reduces the collateral requirement because risk is shared with a reinsurance partner. If collateral is what's stopping the conversation from moving forward, that's worth exploring as an alternative path.
Don't let the collateral conversation kill a deal before the client understands all their options. This is a solvable problem and we'll help you walk through it.
It's always your client. Never ours.