Collateral vs. Capital | Part 3

This week we wrap up the conversation with how employers and consultants account for collateral and capital.?

It is important for consultants to differentiate premium from capital and collateral.?Consultants often lump collateral or capital together to get a net value, which they then present to the employer, and they say, to join the captive, you've got to pay $x amount. Well, that's not entirely right. Yes, the employer has to pay for two items, but you can't make those two items become one.?

Collateral is neither an investment nor a premium and is generally not recognized as a deductible expense by the policyholder. As a result, the employer reduces its cash position but does not reduce taxable income.?

For example, the company earns $100 in profit and subsequently pays income tax on $100. However, the company had to post $10 of collateral to their captive’s fronting carrier. The company now has $90 of cash but pays income tax on $100 of profit.

Capital, on the other hand, generally represents equity. If others mutually own the captive, or if it’s a single parent captive, the company (insured) should receive a stock certificate in exchange for cash invested. As the underlying captive’s value appreciates, so should the stock value. As with collateral, capital is generally not a deductible expense to the company, but rather an investment.

Watch last week's video HERE for more details.