Reinsuring The Agent-Owned Captive Insurance Company

The insurance agent has been given very little exposure to and education in the world of reinsurance. Most agents only become aware of reinsurance when an insurance company underwriter tells the agent that they cannot write that risk because our insurance company's treaty reinsurance agreements prevent us from writing that type of business.

Since reinsurers over the years have been the traditional risk-taking company, their influence in determining underwriting philosophy for primary insurers has grown significantly. Many reinsurers today, because they are taking a larger amount of exposure on a particular insurance company's individual risk, now dictate the primary pricing, the amount of the deductible, the amount of the credit or debit. Reinsurers now have to know a great deal more about the primary insurance business.

The agent should consider the purchase of a reinsurance program for its agent-owned captive insurance company. Many of the approaches to buying reinsurance are similar to what a traditional insurance company uses. The agent needs to be familiar with the various types of reinsurance:

1. Quota Share Reinsurance

2. Excess of Loss Reinsurance

3. Catastrophic Reinsurance

4. Aggregate Excess of Loss Reinsurance

5. Stop Loss Reinsurance

6. Finite Risk Reinsurance

Although the capital requirements for starting agent-owned captive insurance companies, particularly those in the offshore domiciles, are comparatively small, careful consideration should be paid to the structure of a comprehensive reinsurance program. Gone are the days when aggregate stop loss reinsurance could be easily ascertained to guarantee underwriting profits for the agent-owned captive.

Bearing this in mind, the net retention of the agent-owned captive should be compared to its financial structure and the agent owner's risk taking philosophy. Most agent-owned captive insurance companies operating today have too great a new retention when contrasted with traditional insurance companies, and also taking into consideration their financial structure.

Whether the agent-owned captive purchases only quota share reinsurance or uses a combination of several types of treaty reinsurance agreements, the reinsurance program must be monitored and consistently evaluated. The degree of difficulty increases dramatically when designing a reinsurance program for a newly formed agent-owned captive insurance company.

Reinsuring the Policy-Issuing Company
with Your Agent-Owned Captive

A policy-issuing arrangement in your agency-whether it be a retail agency, wholesale agency, or managing general agency-is when a policy is issued by a licensed property/casualty insurance company, whether admitted or non-admitted. Then it is reinsured up to 100% by the traditional reinsurance company market that would include the agent-owned captive insurance company. This type of arrangement is sometimes referred to as "fronting" and is almost always used when the agent has formed an agent-owned captive.

The policy-issuing company is paid a "fronting fee," and is reinsured 100%. Some property/casualty insurance companies have had as their franchise model offering their "A" rated carrier as a "frontier," thus transferring underwriting risk for financial risk. Fronting companies must consider state premium takes, residual mods, government schemes and assessments, and that is why the agent needs to be trained in negotiating a fronting fee. Experience with this type of fee shows that the pure profit margin on a fronting fee can vary from 3% to 7.5% depending upon the fronting insurer.

For example: An agent-owned captive insurance company operating in the Florida restaurant insurance marketplace reinsures the first $75,000 of underwriting loss behind the policy-issuing company. In addition, the reinsurer also owned by the same financial group that the policy-issuing belongs to, writes the excess of loss reinsurance above $75,000 up to $500,000, at a rate of 17.5% of GNWPI. The excess of $500,000 up to $1,000,000 of limit for the restaurant program has another rate, as a percentage of gross net written premium income. The reinsurer is a direct writing reinsurer, and negotiates its excess of loss treaty reinsurance agreement directly with the policy-issuing insurance company, since they also have other treaty reinsurance agreements in place with each other, none of which has to do with the agent-owned captive insurance company.

To have a successful agent-owned captive insurance company, the agent has to understand the negotiating process when buying reinsurance either in the direct reinsurance market or through the reinsurance intermediary market. The agent will also get a better understanding why the underwriting cycles exist in the property/casualty insurance industry, and be able to take advantage of these underwriting cycles. When policy-issuing insurance companies take very little underwriting risk, and the actual underwriting risk is transferred to the traditional reinsurance market (as well as the agent-owned captive insurance company), the agent will begin to need to negotiate with reinsurers.

Using Quota Share Reinsurance Provided
Only by the Agent-Owned Captive

Here is another example: The Cayman Island agent-owned captive insurance company originally started to write horse mortality insurance, and was capitalized substantially by a bank, using the collateral of the agency. On the basis of this substantial capitalization, the agent-owned captive was able to write 100% of the quota share reinsurance of the policy-issuing insurance company. Policies originally written in the agency were issued in the policy-issuing insurance company, 100% reinsured to the agent-owned captive, who in turn purchased an outgoing going reinsurance program, consisting of a combination of quota share reinsurance and excess of loss reinsurance.

The accumulation of profits in the Cayman Island agent-owned captive insurance company was used to purchase a "shell" property/casualty insurance company which went on to be an "A" rated specialty niche program insurance company after several stock offerings.

Conclusion

The owner of a retail insurance agency (i.e., program administrator) the owner of a wholesale, excess and surplus lines insurance agency, and/or the owner of a managing general agency need to explore the feasibility of implementing an agent-owned captive insurance company. Recapturing investment income and underwriting profits gives the agent-owner significant returns on investment.