For most agencies, revenue consists of commission and companyprofit-sharing. Profit-sharing is a beautiful thing — typically ano-risk, upside-only bonus paying up to five percent of annualpremium written. However, there is a way to earn a much largerbonus — one that is not capped at a certain percentage of premium.This is possible through an agency captive.

A captive gives an agent access to forms of revenue typicallyenjoyed exclusively by carriers: underwriting profit and investmentincome. These arrangements are not without risk, but for agentswith the proper profile, a captive facility can offer a dramaticenhancement to the agency's revenue stream and valueproposition.

How does an agency captive work?

An agency captive is a reinsurance company that an agencycontrols. Through an agreement with a fronting carrier, the agencycaptive receives a share of all premiums written and has anobligation to pay its share of claims. The agency typically engagesa captive manager to create the captive facility and overseeongoing operations. The fronting carrier usually handlesunderwriting and provides specific and aggregate loss protection.This creates a finite worst-case scenario for the captive. Thesekey relationships — captive manager and fronting carrier — limitthe financial risk and administrative burdens on the agency. Agencycaptives create a truly unique relationship between the agent andthe carrier. All interests are aligned: appetite, risk selection,pricing, loss control and claims management. Success, or failure,is shared.

For the agency's producers, CSRs and customers, the captive islargely invisible. The customer gets a normal “first-dollar” policybacked by the financial strength of the fronting carrier. The salesand service experience for the customer and agency personnel are asnormal. Commission levels and payments to the agency are the sameand not affected by the results of the captive.

Not just revenue —exclusivity!

An agency captive can give you a product that no one else has.The facility can be branded and bundled with other services offeredby your agency. Typically, policyholders are notified on the quoteproposal that the agency has a risk-sharing relationship with thefronting carrier. Some agents decide to take this further and usethe captive facility as a sales tool and point ofdifferentiation.

“Because our agency takes underwriting risk on yourbusiness, you can be assured that we will give you the highestlevel of risk management service.”

Imagine how difficult it will be for competitors to sell againstthis unique value proposition.

Does a captive make sense for you?

An agency captive can be owned by any type of agent. Thus, aretailer can write generalist (heterogeneous) accounts in theirfacility, while an MGA or program administrator can write program(homogeneous) business in theirs. While in theory an agency captivecan be used for any line of business, most focus on somecombination of BOP, package, GL, E&O, WC and auto.

Agents should be prepared to write at least $5M into theircaptives within the first three years. Achieving critical mass isnecessary in order to weather the effects of shock losses and enjoythe benefits of the law of large numbers.

To own a captive, an agency needs to have a high tolerance forrisk. Unlike with company profit-sharing plans, you canlose money with an agency captive. Even with good riskselection, adequate pricing, critical mass, aggressive claimsmanagement, etc., an adverse outcome is always possible.

Additionally, in order to have a captive, an agency needs tohave capital and patience. Agency captive profits do not startpaying out for several years. Also, because the maximum obligationof the agency is potentially greater than the captive's share ofthe premium (“loss fund”), the fronting carrier will require theunfunded liability to be collateralized. Depending on how muchpremium is written into the program, the collateral requirementscan be significant — often reaching seven figures. The good thingis that all of the agency's money (loss funds and collateral) canearn investment income while it is encumbered.

Selecting a carrier

Not many insurance companies offer these risk-sharingopportunities to agents. Some carriers that do so limit themselvesto program/MGA relationships. Very few are willing to allow aretail agent share risk on a generalist book of business. There aremany factors to consider when selecting a carrier.

• Financial strength/rating
• Commitment level to the captive model
• Internal channel conflict
• Products: forms, pricing ability, state filings, billingoptions
• Technology and systems
• Services: UW, claims, loss control
• Level of “captive infrastructure”
• Sophisticated reinsurance accounting
• Dedicated actuarial support
• A plan for closing/commutating old years
• Good choices for collateral — cash option with guaranteedinterest
• A sponsored captive manager and/or cell facility

Agents interested in a captive should seek a customized proforma from their prospective fronting carrier that includes anactuarial analysis of the target book of business and modeling ofvarious loss-ratio outcomes.

Conclusion

Company profit-sharing is a significant revenue source for mostagencies. It should certainly be kept in place for the majority ofan agency's business. However, for the agent's most-profitableaccounts, a captive can lead to a much higher level of income whilecreating a competitive advantage that truly distinguishes theagency in the marketplace.