Whether it’s a hard or soft market, there are some good motivational purposes for a managing general agent–or for any agent with a program–to consider forming an agent-owned captive, experts say.
However, it is not for everyone, according to Richard L. Suter, assistant vice president, program business development, alternative markets and middle-market programs for The Hartford in Connecticut.
Agents need to know that setting up a captive requires personal financial investment, a strong program and a willingness to take on risk that is traditionally the domain of insurers.
“You need a program of some size that has performed well over time,” Mr. Suter said. “You need capital and the [type of] personality that understands you are taking a risk position–taking a chance.”
“If a typical carrier takes 100 percent [of the risk] and has a bad year, you [the agent] walk away with commission,” he said. In an agency captive, however, “you lose money.”
It is the kind of commitment that is not done on a whim, he said. It really requires the agent to understand what he or she is getting into.
“Do your homework and profit from the arrangement,” he continued. “That is what we want to see, too–mutually profitable, long-term relationships with our partners.”
Captives are usually formed during a hard market and they are typically prompted by the need for capacity. An agent-owned captive, however, can offer benefits to an agent beyond capacity. In addition, in a soft market, a captive can help boost an agent’s finances when commissions are reduced in the face of softening premium rates.
“In a soft market, there is typically more appetite for program business in general [among the standard market carriers] and therefore less pressure on the MGAs to take substantial risk in a captive,” observed Doug Bennett, senior vice president in charge of the MGA specialty practice at London-based Benfield in the United States. Because of this, agents are more willing to take sliding scale commissions, instead of pursuing captive arrangements.
Yet deciding to commit to an agent captive may be a benefit in the long run, he suggested. “It shows that [the agent is] substantially committed to the underwriting profitability of the program, and that’s a good signal for the insurance and reinsurance companies to support.”
Agents see their commission dollars going down in a soft market, explained Tom Colosi, director of captive programs for The Hartford. “But with a profitable captive book, they get a piece of the underwriting income that can supplement their commission income.”
The structure of the program and the compensation may vary, he said, but the program can serve a purpose beyond just generating more compensation–opening the doors to creativity in compensation.
Mr. Suter explained that a program’s financial rewards can also be used to compensate key players in an agency or for estate planning.
Both Hartford executives, who will be discussing this topic at the midyear meeting of the Wilmington, Del.-based Target Markets Program Administrators Association (taking place in Atlanta on April 7-9), noted that other benefits to forming a agency-owned captives program include greater management over loss control and claims.
There is also more stability in a captive program because there is no worry about a standard market carrier’s appetite changing with market cycles, the executives said.
An agent-owned captive, involving a commitment to risk by agent and fronting insurer, means an alignment of interest that is missing from a purely commission-based relationship, Mr. Suter said. The captive’s existence is based on the book’s performance, he said, suggesting that this enhances program stability.
Still, creating these programs does mean overcoming some hurdles, the executives noted.
One of the big ones “is just getting a basic level of understanding of the advantages” and an understanding of how they work, Mr. Suter said.
Michael Schroeder, president of West Lake, Ohio-based Roundstone Insurance Ltd., an organization that manages and develops captive facilities, said “anyone taking risk needs to realize that there is some capital involved in that endeavor,” identifying the commitment of capital as another obstacle.
Mr. Schroeder said in the past captives were made “overcomplicated.” He said his company stresses speed to market and ease of coming in and out of the captive, with an emphasis on efficiency.
However, Mr. Suter said captives are long-term commitments that are not easy to unravel. This is primarily due to the amount of collateral committed and the claims tail on the risks insured, particularly for general liability, workers’ compensation or auto programs. Some programs can involve directors and officers or errors and omissions, but not as many, he said.
Mr. Suter said capital commitments can be “north of $500,000″ depending on the size of the program.
“The bigger your program, and the more risk you take, the more collateral involved,” he said. The numbers can run into several million dollars over a three-year period, added Mr. Colosi.
All the executives said the programs that will be placed in captive facilities are the best risks in the agent’s portfolio. Mr. Schroeder said Roundstone will not accept risks with a loss ratio above 50 percent or with expense above 40 percent. “The margin is too thin to make it work,” he said.
Book size is a minimum of $5 million to make the program work adequately and ensure there is enough premium to survive a large loss, the executives indicated.
Mr. Schroeder said a facility can have management fees ranging from 2 percent to 5 percent on the assumed premium, but the return on investment can range from 30 percent to 100 percent.
“The benefit is risk participation,” noted Mr. Bennett. “The agent gets to participate in the underwriting profits and investment income instead of just commissions and…typically has greater control of [its] destiny through substantial risk participation. That is true in a hard or soft market,” he said.
“I would call it patient capital,” said Mr. Suter. “You have to believe so strongly in the performance of your program that you’re going to commit your capital. You have to be patient with it, because the collateral stays tied up for many years.”
“But if you are right, and your program continues to perform well, you will benefit greatly from the arrangement.”