Collective Reserve Account

The crediting of the collective reserve account is a form of nonmember profit appropriation. These profits are effectively donated to the cooperative by mutual agreement. The profits going into a collective reserve account could instead be appropriated by the members who earned them. One possible solution would be to instead distribute hat profit by issuing preferred shares to the members.

Issuing preferred equity would give clear ownership to the members. By issuing preferred equity, the money that would have gone to the collective reserve account is still there. It still serves as a buffer for the cooperative because the principal of the security never has to be repaid. The members appropriate the profit they earned, just a form that is not redeemable from the coop for cash. The tradeoff is that the coop would have to pay interest or dividends on the amount that would have gone into the collective reserve account. Since the collective reserve account is unowned it is also interest free.

In some cases the incentive for demutualization can be reduced by eliminating the collective reserve account. If a coop were to demutualize by selling itself to a non-cooperative business, the members could get paid for the value of the collective reserve account in the absence of external legal prohibitions.

Insurance Problem

A collective reserve account is not theoretically required for a worker cooperative. It is an account the members can choose to create, to enhance the probability that their internal capital accounts will be paid in full. In theory insurance for the internal capital accounts could be purchased from an outside party.

In practice the collective reserve account is essential for any worker cooperative with internal capital accounts comprising a significant fraction of the assets of the coop. This is due to the obligation of the cooperative to pay out members internal capital accounts when they leave.

Since internal capital accounts have a repurchase agreement associated with them, they do not add unencumbered equity to a coop. Internal capital accounts can be though of as an unamortized (interest only) loan from the members, with a balloon payment consisting of the balance when a member leaves. Since most coops do not issue (preferred) equity to non-members, most coops become effectively zero equity entities without a collective reserve account. This is because the internal capital accounts are functionally liabilities, despite being classified as equity on a balance sheet.

The criticism that the collective reserve account violates member profit appropriation is actually a criticism of the insurance function. Insurance generally does not match what people pay in and what they get out. It is no different when the collective reserve account is used to self insure member equity. Profit paid into the collective reserve account by members does not usually equal what they get in return.

We now turn to the functional aspects of the collective reserve account as insurance. There are two key questions for any insurance product. Are the insurance reserves sufficient to pay out claims? And are the risks to the insurance fund distinct from the product it is insuring?

The value of the collective reserve account is determined by fixed rules dictating the percentage of profit or loss that is added to or subtracted from the account, and the coop’s earnings history. If the members are easily able to change the contribution/withdraw rules, they can unfairly profit by depleting the collective reserve account, so rule changes are discouraged. Flexible rules could facilitate the plundering the collective reserve account by the current members. Most often, collective reserve account contribution rules are set during the coop’s formation and remain fixed.

The fixed contribution formula means the value of the collective reserve account is largely unrelated to the value of the internal capital accounts it insures. There are currently no standards as to the appropriate size of a collective reserve account. In some cases the collective reserve account is insufficient to offer real protection to the members, while in other cases excessive insurance results. Excessive collective reserve accounts can encourage demutualization.

Are the risks to the collective reserve account correlated with the coop finances? The collective reserve account is not a cash account. It is an accounting entry that determines what amount of assets are not an obligation. Similarly the internal capital accounts are not cash accounts. Both the internal capital account and collective reserve account funds are deployed by the coop to purchase assets (durable or not) and make payments (working capital). The overall liquidity of the coop affects both. The collective reserve account does not necessarily mean there is liquidity to pay out the internal capital accounts, though it does help. However, from an insurance perspective the risks to the collective reserve account are completely correlated with the product it insures.

The difficulty of setting a collective reserve account value based on insured assets, makes the collective reserve account a weak form of insurance. If these problems are not carefully analyzed the collective reserve account can create a false sense of security.