Agency Captive Insurance
Captive insurance offers fantastic financial opportunities for insurance agents and brokers. An agency captive provides an opportunity to increase revenues beyond the traditional commission and profit sharing arrangements between carriers and agents. An agency captive allows the agency to capture a portion of the underwriting profit and investment income. Agency captives are unique financial vehicles and present their own challenges in creation. This article explores some of the uses of agency captives and provides some ideas as to how to structure them in order to navigate their inherent issues.
Agency Captives and Reinsurance
The typical agency captive is incorporated as a reinsurance company operated by the insurance agency. The agency enters into a reinsurance agreement with the insurance carrier to accept a portion of the risk of the insurance policies. The carrier receives the benefit of unloading a portion of the underwritten risk while the agency receives the benefit of additional revenue.
Another value of using the reinsurance model is that the insured is generally unaware that anything changed with their insurance. This not only decreases any paperwork confusion for the client, but it also sidesteps any issues with controlled lines. For example, some workers’ compensation and automobile policies require a certain financial strength rating. Some mortgages demand that property insurance have a minimum AM Best Rating. Reinsurance captives never change the “paper” (the insurance company insuring the client) and do not interfere with any financial strength regulations.
Structuring Your Agency Captive
One of the first hurdles to address with an agency captive is structuring how much risk to place with the captive. For most agency captives, taking 100% of the risk written by the insurance carrier would be unreasonable. This means that the agency has to figure out how much risk per policy to place in the captive. The reinsurance captive will take a layer of the total risk from the insured. This may be the first $25,000 of each claim, the first $100,000 after the insured pays its deductible, or some other calculation. This is an individual assessment based on what types of insurance the agency sells. Determining the appropriate amount of risk to place in the agency captive is partly a function of underwriting and will likely include the expertise of a third party actuary.
Is an Agency Captive Right for You?
Not every agency should consider the use of a captive. Captives are financial vehicles. This means that they exist to make money and the way a captive insurance company makes money is the same as any other insurance company: underwriting profits and investment income. Clearly, if the agency’s clients suffer routine large losses, then those clients should not be reinsured through a captive or else the reinsurance vehicle will quickly be insolvent. Rather, financially stable organizations with favorable loss histories are excellent candidates to reinsure with an agency captive as the insurance carrier likely generates a great deal of profit from them.
Captive insurance companies are most popular during hard markets. When premiums are high and reserves are providing lower returns, business owners are generally more interested in alternative risk management discussions. Relatedly, agency captives thrive during hard markets as their commissions grow in proportion to the underwriting profit captured by the captive. As of the writing of this article in early 2017, we remain in a historically long soft market. This is a prime opportunity to establish a captive when the frictional costs are as low as possible. In this manner the agency is primed to capture maximum profit as the market naturally hardens in the future.
Agency Captives and Protected Cell Structures
Agency captives enjoy all of the flexibility afforded to other forms of captive insurance as well. For example, a property insurance agency may wish to incorporate their agency captive through a protected cell structure. One of the many advantages of the protected cell corporate structure is that it provides asset protection between the various cells. Thus, if a hurricane hits South Carolina and results in catastrophic losses, those losses will not carry through to the rest of the book of business and overall profitability is preserved.
Another use of the protected cell structure is that an agency captive with less liquidity may be able to incorporate a captive insurance company and write a healthy book of business without the financial strain of a single parent captive. There are any number of ways to share capital in a protected cell and an agency captive may consider the use of a cell structure if liquidity is an issue. Note, however, that protected cells are not cheap captive insurance and a lack of liquidity is not synonymous with a lack of profitability.
Of course, there are advantages in combining a multitude of risks in order to create a stable book of business that is not rendered insolvent by any black swan event. While reinsurance and excess policies can assist with solvency, the separation of risks may not make sense for all captives. Again, experienced underwriting and actuarial analysis will assist the agency in arriving at the best fit for their situation.
Agency captives are powerful financial vehicles that open up a new line of revenue for the agency. They can be structured in a wide variety of ways in order to mitigate the overall risk of the book of business while maximizing long term profits. Also, captive insurance companies are tax efficient vehicles which further increase the agency’s bottom line. The point of creating a business is to make money and captives unlock a tremendous stream of tax-favorable revenue which can transform an agency into a stronger player in the market.