You’re likely familiar with collateral when it comes to captives. It’s one of the biggest financial hurdles in captives. While you and your clients likely understand why collateral exists, the cost doesn’t make them enthusiastic. High collateral can strain cash flow, limit growth, or make a captive feel like the wrong move.
So here’s the real question: how can a client lower their collateral cost?
This article will show you:
- The biggest factors that influence collateral costs.
- Strategies that businesses can use to reduce collateral requirements over time.
By the end of this article, you’ll understand what influences the cost of collateral and have a clear framework to help your clients potentially lower the cost. That way, you can help protect their bottom line.
Understanding Collateral in Captive Insurance
Collateral is a necessary part of any captive insurance program, acting as a financial guarantee to ensure claims are covered. It’s a line of credit or cash reserve used to secure claims payment. Fronting carriers want as much collateral as possible to protect their own risk. Of course, your clients (understandably) want to minimize that cost to free up capital.
What Determines Your Client’s Collateral Cost in a Captive?
The requirements vary depending on the captive structure and the fronting carrier’s risk tolerance. The biggest factors include:
- Program Type: Quota share captives typically require 15% of the gross premium for collateral, while other structures (like an A/B fund) may demand two times the A fund amount.
- Expected Losses: Higher projected claims result in higher collateral.
- Financial Strength: Clients with strong financials and low-risk profiles may negotiate better collateral terms.
It’s simple: more risk to the carrier equals higher collateral.
How Does a Client’s Claims History Impact Their Collateral?
Collateral is directly tied to a client’s claims experience.
- High claim frequency or severity? Expect more collateral.
- Consistent low claims? Collateral could be adjusted over time, but reductions are slow.
A history of proven loss control gives your clients leverage when negotiating collateral rates. Your clients shouldn’t expect an immediate drop. Collateral adjustments typically follow sustained improvements in risk management.
Do you want to know your client's upfront costs (including collateral) to join a captive? Use our Captive Insurance Calculator.
How Do Different Captive Structures Affect Collateral?
Not all captives require the same collateral levels.
- Group Captives: Collateral is pooled, meaning one high-loss member can impact everyone. This structure may limit flexibility in reducing collateral.
- Single-Parent Captives: Captives assume 100% of the risk but have more control over collateral negotiations.
- Cell Captives: These provide collateral formulas with limited flexibility.
Depending on the captive structure, initial collateral could be reduced, and better long-term management options could be provided.
Why Do Fronting Carriers Want More Collateral?
Fronting carriers protect themselves by requiring as much collateral as they can justify. Their goal is simple: minimize financial exposure if the captive fails to pay claims.
Clients could potentially push back by:
- Presenting strong financials to demonstrate their ability to fund losses.
- Negotiating with multiple carriers to compare collateral requirements.
- Leveraging low loss ratios as evidence that they are a low-risk insured.
Can Clients Renegotiate Collateral Over Time?
Sometimes, but not frequently.
Collateral is typically locked in for multiple years, and reductions are slow. However, your clients can renegotiate if:
- Their claims performance significantly improves over multiple years.
- They reduce exposures, such as removing high-risk operations.
- They switch to a more favorable captive structure with lower collateral requirements.
Clients won't see reductions immediately. However, consistent improvements can lead to adjustments over time.
Steps Clients Can Take to Lower Their Collateral
Lowering collateral isn’t a quick fix. Don’t expect it to happen in the first year. However, there are clear strategies your clients can implement:
- Improve Risk Management: Fewer claims mean lower expected losses.
- Choose a program with lower collateral formulas: Quota share structures often require less upfront.
- Demonstrate strong financials: Clients with high liquidity and strong credit can negotiate better terms.
- Monitor and adjust exposures: Reducing risk-heavy operations can lead to lower collateral needs.
Each strategy requires time and consistency, but they make a measurable impact on collateral requirements.
How Risk Management Impacts Collateral Reduction
Risk management is about reducing claims and proving to underwriters that future losses will remain low.
Clients need to focus on:
- Implementing safety programs to prevent accidents and claims.
- Using data-driven loss control measures to track and mitigate risks.
- Partnering with third-party risk management firms to enhance credibility with underwriters.
A multi-year trend of strong risk management can shift collateral requirements over time.
How Does Financial Strength Lower Collateral?
A client’s financial health directly influences their collateral rate.
- Well-capitalized businesses with strong credit are seen as lower risk.
- Clients who post collateral in cash instead of a letter of credit may get better terms.
- Financial transparency and reporting can improve a client’s position when negotiating collateral.
How Independent Agents Can Help Clients Lower Collateral
Here are some strategies you can use to educate your clients:
- Setting Proper Expectations: Collateral reduction is a long-term strategy, not an immediate fix.
- Positioning Risk Management as a Priority: The best way to lower collateral is to reduce losses.
- Helping Clients Look at Alternative Captive Structures: Choosing the right structure fit for them can make a difference.
For a look at captive structures, read our article on single-parent vs group captives.
Setting Up Clients for Long-Term Success
Lowering collateral isn’t something that can happen as soon as tomorrow. However, clients can make progress by improving risk, demonstrating strong financials, and choosing the right captive structure for their business. Collateral can be a controllable part of a captive strategy.
Next, read our guide on the upfront costs of joining a captive insurer. That way, they understand the costs and have an inkling of how much they would have to spend to be a captive owner.
If you want to know more about collateral and all captive insurance, become a member of Captive Coalition for free to access tools, resources, webinars, and training.
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