Article

Collateral plays a crucial role in captive insurance arrangements with fronting carriers for several key reasons:

• Security for the fronting carrier: The fronting carrier assumes primary legal responsibility for paying claims, even though the risk is transferred to the captive. Collateral provides security to the fronting carrier in case the captive is unable to meet its claim payment obligations.
• Regulatory compliance: Collateral helps fronting carriers meet regulatory requirements and maintain their financial strength ratings.
• Credit risk mitigation: It mitigates the credit risk faced by the fronting carrier when ceding risk to a captive insurer, which may not have the same financial strength as traditional reinsurers.
• Capitalization of the captive: Collateral can help meet capitalization and regulatory requirements for the captive insurance company.

Collateral in captive arrangements is typically issued in one of three main forms:

• Letters of Credit (LOCs): These are the most common form of collateral. An LOC is an agreement issued by an accredited bank that guarantees the availability of funds to satisfy a payment obligation.
• Cash held by the fronting company: The captive provides cash that is held directly by the fronting insurer.
• Trust agreements: These are funded by the captive's investment securities and can be accessed by both the captive and the fronting carrier.

The amount of collateral required is usually determined by the fronting carrier's actuarial department and can vary significantly upon the type of risk, the carrier, and the line of business. As the captive accumulates equity it can utilize its surplus/equity to draw down on the letter of credit or cash that was posted.

Collateral requirements are typically outlined in the fronting agreement and may be adjusted over time based on the captive's performance and claims experience. As loss periods become actuarially mature and specific plan years are closed, the fronting carrier may begin releasing portions of the collateral.

CONCLUSION

It's important to note that while collateral is a significant aspect of captive arrangements, it also represents a cost for the captive owner. However, it serves as a crucial and necessary mechanism for aligning the interests of the captive and the fronting carrier, ensuring the stability and viability of the insurance program. Captives.Insure (C.I.) works directly with the carrier to determine the collateral that will be required prior to forming your captive. C.I. also offers guidance on how to optimize the way these funds are posted.