Desire for greater control and a share of the profits
drives some agents to form their own captives
By Barbara A. Morris
Insurance agents are entrepreneurial by nature, go-getters who identify and seize upon opportunities, unafraid to forge ahead in their careers even when faced with mounting obstacles. Some agents are taking their entrepreneurial spirit to a new level, convinced that they can gain tighter control over their professional and financial destinies if they can likewise exert greater control over their product sources, the business they write, and the underwriting standards to which that business is held. They are making the transition from insurance marketers and advisors to risk takers--investing their own dollars and financial futures in agency-owned captives.
Is the formation of the agency-owned captive a common occurrence among independent agents? No, say agent organizations and consultants. But is the captive concept drawing increased inquiries and interest from among the agency population, and is it being consummated by a small, yet growing number of risk takers? By all accounts, report experts, the answer is yes.
In fact, Andrew J. Barile, CPCU, reports that his insurance and reinsurance consulting company receives several inquiries daily from agents interested in at least exploring their captive options. Their growing interest in the concept, says Barile, president & CEO of Andrew Barile Consulting Corporation, Inc., is being fueled, in part, by concerns that commission income may not be adequate to guarantee their financial futures, and that their commission structure does not accurately reflect the underwriting profits being enjoyed by insurers. Bottom line, observes Barile, is that some of the more adventurous agents are looking to glean "a piece of the underwriting and investment profit" that involvement in an agency-owned captive can generate.
Likewise, continues Barile, the author of a white paper titled "The Agent Owned Captive Insurance Company," some agents are seeking to use the inevitable industry cycles to their advantage--rather than being victimized by them. They are employing captives when the marketplace hardens, recognizing that if need be, the company can "sit dormant" when softer conditions prevail, poised for the next hard cycle to recur. "If agents play the cycles right, they can make a lot of money," says Barile. He maintains that formation of an agency-owned captive to serve as a market for needed products when conditions are hard or when insurer underwriting appetites change, is one strategy that can potentially enable agents "to play the cycles" to their advantage.
Patricia Borowski, vice president at the Government and Industry Affairs Division of the National Association of Professional Insurance Agents (PIA), stresses that the majority of insureds, over the long term, "will benefit and be best served from a traditional insurance market."
Some agents are making the transition from insurance marketers and advisors to risk takers--investing their own dollars and financial futures in agency-owned captives.
Yet Borowski concedes that "there are some types of exposures--either over a period of time or endemically, that can benefit from some type of alternative insurance mechanism." She likewise points out that the "stampede" to captives during an extended hard market in the 1980s was fueled by the same issues that seem to be driving agent interest in captives today--lack of market choices and the need to "better control their own destiny." What is somewhat different 20 years later, observes Borowski, is growing interest among insurers in working with agents to engage in these captive arrangements. The expertise that insurers can lend to these arrangements, she believes, is critical; but she cautions that agency-owned captives will succeed and effectively serve their customers only if they are grounded in "sound insurance, financial, and structural procedures."
"Agency captives have been a long-overlooked segment of the captive insurance industry," says Steven B. Bankes, CPCU, ARM, vice president of captive and unique opportunities, a department within the Standard Lines Division of CNA. CNA is one insurance group that has taken an active role to facilitate formation of agency-owned captives. The company first reinsured business to an agency-owned captive in 1998.
"From our perspective, agency captives are the ideal vehicles for aligning the interest of the insurance carrier with our distribution partners by proportionately sharing premium, losses and expenses," says Bankes. He explains that for the larger independent agency, CNA offers an individual equity captive, typically set up as a "Class 2" Bermuda reinsurer, with an expected minimum capital contribution of $375,000. CNA also works with agents in establishing a segregated account captive, which typically has multiple participating agents. In this arrangement, the capital contribution is significantly lower and the fixed expenses of running the captive company are shared by many participants.
The captive arrangement, continues Bankes, "is invisible," with CNA reinsuring business with agency-owned captive companies. Profits are derived from both underwriting income and investment income on premium dollars invested until claims need to be paid. Such captive arrangements, observes Bankes, best lend themselves to frequency-driven business and longer-tail lines, such as workers compensation, general liability, commercial auto, and package business.
Bankes says that 36 CNA agents currently are involved in captive arrangements with CNA, approximately 28 of whom are joined together in a Segregated Account Captive, while 15 other agents are on a "waiting list," poised to establish another Segregated Account Captive. Prospective captive participants are recommended to CNA through its branch offices and are generally HPA (High Performance Agents) with whom the company "wants to grow," says Bankes. CNA, he adds, "protects" its agency-owned captives by assuming all risk over the captive's retention levels, typically $100,000 to $200,000 per occurrence, and providing stop loss coverage for frequency. He stresses, however, that while CNA offers guidance and support to such agency-owned captives, underwriting and other key decisions are ultimately controlled by the owner-agents, including which risks to reinsure.
According to Bankes, the agency-owned captives have been profitable to date, with growth of the captives increasing "dramatically" in 2001, as the marketplace has hardened. Looking ahead, he says CNA views the agency-owned captives as a continuing win-win for both participating agents and the company. For the agents, he believes, "The benefits are obvious, creating a new profit center and a new revenue stream, while elevating their relationship with the carrier and creating new networking opportunities." And while he believes that the benefits to the carrier are less obvious, he stresses they are no less important. For as Bankes observes: "The single biggest benefit is the alignment of interests with our agents. We either win or lose together, and since agents are focused on winning, we expect the captive will attract their very best business."
The Independent Insurance Agents Association of New York (IIAANY) has also entered the captive arena, lending its expertise and resources to the formation of Bermuda-based Leading Edge Holdings, Ltd., opened up to agent investors in November 1999.
Creation of the company, says John R. Costello, CIC, IIAANY president-elect and a board member of Leading Edge, was prompted by the association's analysis which concluded that "neither the traditional market nor the alternative market--for different reasons--was offering a consistent, responsive, value-added service to agents or to much of the business represented by agents. In varying degrees," concluded IIAANY, "independent insurance agents need to become risk partners to ensure a viable future for agents in the developing insurance marketplace."
Independent agents invest in Leading Edge, which provides reinsurance on a personal umbrella program underwritten through RLI Insurance Company. The level of agent investment translates into stock ownership in Leading Edge, with the "risk" to agents hinging directly on the underwriting performance of Leading Edge.
Costello, who is a partner in the Rochester, New York-based Costello, Dreher, Kaiser Insurance, says there are currently 13 agent investors in Leading Edge, with their level of financial commitment ranging from $22,000 to as high as $109,000. To date, he reports, the company has been profitable and as the marketplace continues to harden, he is "very optimistic" about its future performance.
Another agent experience in the formation of a captive illustrates the extensive preparation process that is required. Timothy B. Derham and his brother, Donald, took over their father's agency in Bellerose, New York, to create Inter-Insurance Agency Services, Ltd., in 1992. The business, which had its roots as a captive agency for a major national carrier, was a successful, mid-sized property/casualty operation. Yet Derham became intrigued by the potential profitability of several niche programs that his agency was developing and how they might share in that profitability. Ultimately they decided to form an agency-owned captive.
It took two years for them to establish the captive, which now operates as International Underwriting Insurance Company, Ltd., domiciled in Barbados. "I read up on it (captives) and purchased several books on the subject," says Derham, who also reports that he attended the annual World Captive Forum, where he met with many vendors who could potentially provide services to help his captive get up and running.
Next followed a feasibility study to explore several key issues, including whether or not a captive made sense for his agency, the cost to the agency to set up the captive, the premium volume necessary to support a captive, staffing needs, and the level of financial risk the agency would be willing to absorb. Also requiring extensive research was the proposed domicile of the captive, with serious consideration given to such issues as desirability of location, the domicile's legal and regulatory environment, capitalization requirements, and overall reputation. The agency received hands-on assistance from an experienced captive consultant. It worked with a Barbados-based captive management company to oversee the operation at the local level and negotiated with reinsurance markets to provide stop-gap treaty protection.
Launching the captive also required the infusion of some $60,000 to fund start-up costs, and the introduction of an aggressive marketing effort to attract the minimum half a million dollars in premium their feasibility study determined to be the necessary minimum book of business to make the project worthwhile.
The captive became operational in 2001. Originally it was conceived as a captive market for several of the agency's niche programs, such as Japanese-owned restaurants and sushi-bars, New York City-based habitational properties, and truck rental fleets. Now the potential of International Underwriting Insurance Company to serve other purposes is beginning to become clear, says Derham. He sees unending potential, not only in realizing underwriting profits derived from his agency's niche programs, but underwriting profits emanating from homogeneous programs presented through other agencies, or revenues in the form of administrative fees gleaned from rent-a-captive arrangements facilitated by the agency.
Derham stresses, "Each (captive) deal is different," with each requiring due diligence to thoroughly analyze with an eye toward both financial responsibility and potential profitability. And while Derham concedes that the results of his agency-owned captive "are too soon to tell," he is confident that by the end of the year profits will begin to flow. Once in the captive, he adds, the business that had always required extensive remarketing is likely to become less vulnerable to the changing cycles of the insurance industry.
And new business, he anticipates, will be more attracted to his agency because an agency that can bring its own captive to bear on the discussion with a potential client, "is able to have an entirely different conversation." *