UPDATED: Mar 13, 2020
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Capital, when used in the context of insurance companies, refers to the difference between the insurance company’s assets and liabilities. It’s the total equity of an insurance company.
The most important thing you need to know about insurance companies and capital is that insurance companies use capital to cover claims. If an insurance company runs out of capital, then it cannot cover claims. If you make a claim with your insolvent insurance company, then your claim might be denied.
The more capital an insurance company has, the better the ability it has to pay off its claims.
Outside of the insurance world, ‘capital’ is a general term for financial assets. It can refer to funds held in deposit accounts or funds obtained from special financing sources. Capital can be held through financial assets or raised from debt or equity financing.
Most companies have three types of business capital, including:
- Working Capital
- Equity Capital
- Debt Capital
All three types of capital play a crucial role in running a business. This capital is also used to finance capital-intensive assets.
Capital assets can be found in the current or long-term portion of the balance sheet. An insurance company might list cash, cash equivalents, and marketable securities, for example, on its balance sheet as capital assets. Other businesses might list manufacturing equipment, production facilities, and storage facilities as capital assets.
Types of Capital
There are four broad types of capital, including:
Debt Capital: Businesses can acquire capital by assuming debt. Debt capital is obtained through private or government sources. Businesses may acquire debt from friends, family financial institutions, online lenders, credit card companies, insurance companies, and federal loan programs, for example. As an individual, you can also obtain debt capital: if you have an active credit history, then you can obtain debt capital, then repay that debt capital with interest.
Equity Capital: Equity capital can consist of private equity, public equity, and real estate equity.
Working Capital: Working capital refers to a company’s most liquid capital assets. These are the assets used to fulfill daily obligations. Working capital is the short-term liquidity of the company, including its ability to cover its debts, accounts payable, and other obligations due within one year. You can calculate working capital using the following formulas: current assets – current liabilities; or accounts receivable + inventory – accounts payable.
Trading Capital: Trading capital is held by individuals or firms who place a large number of trades on a daily basis. This is the amount of capital used to buy and sell various securities. Investors may attempt to add to their trading capital using various trade optimization methods.
What’s the Difference Between Capital and Money?
Capital is money. However, when speaking from a financial or business perspective, capital is viewed as an operational or investment asset, making it slightly different than money.
Capital usually comes with a cost, for example. With debt capital, this cost is the cost of interest required when paying the capital. For equity capital, this cost is the cost of distributions made to shareholders.
Capital generally refers to assets that are used to shape a company’s development and growth.
What is a Capital Stock Insurance Company?
Some insurance companies are known as capital stock insurance companies. These insurance companies get their capital from stockholder contributions in addition to their surplus and reserve accounts.
In other words, a capital stock insurance company gets most of its assets or money from the sale of shares of stock to stockholders.
Most American insurance companies are one of two types of insurance companies:
- Capital stock insurance companies
- Mutual companies
The main difference between the two companies is that a stock insurance company is owned by its shareholders, while a mutual insurance company is owned by its policyholders.
Just because a company is known as a capital stock insurance company does not mean the stock is publicly traded. A capital stock insurance company can be privately held or publicly traded. The insurance company may distribute profits to shareholders in the form of dividends. Or, it may use profits to pay off debt or reinvest in the company.
With mutual insurance companies, the surplus may be distributed to policyholders in the form of dividends. Or, it could be retained by the insurer in exchange for reductions on future premiums.
What Happens If an Insurance Company Runs Out of Capital?
When an insurance company runs out of capital, the insurance company is effectively insolvent. The insurance company has exceeded its ability to meet its claims, and it has no more funds it can use to pay benefits.
Sometimes, the insurance company declares bankruptcy and shuts down. In other cases, the insurance company can come back out of insolvency: say, if new owners are found who are willing to cover the insurance company’s liabilities.
If the insurance company runs out of capital and is declared insolvent, then the first goal of the insolvency proceedings is to cover the needs of policyholders. During the bankruptcy proceedings, the company’s assets will be liquidated and distributed to policyholders based on their outstanding claims.