If you scour the insurance journals and periodicals of the world you will rarely find any mention of agency captives. Even Paul Bawcutt, long recognised as a guru for captive insurance companies, in his book on the subject makes no mention of agency captives. Yet, in reality, such operations represent a reasonable portion of the captive population in the Caribbean captive centres, and, with a continuing hard market, will maintain and increase this market share.
An agency captive is not a cost centre – it is a profit centre that rewards owners willing to risk capital to participate in the insurance of their customers, with substantial underwriting and investment income as the reward.
Agency captives (also called MGA captives) differ from the standard offshore insurance company in that all the risk is third party risk. The agency captive falls under the definition of a Producer Owned Reinsurance Company (PORC), and is a specific subset of the PORC owned exclusively by agents and brokers. Most players in this market prefer the term ‘producer captive'.
The business is predictable, typically low value/high frequency. Reinsurance by the captive can vary from 100% of the agent's entire book of business to a specific quota share on various lines of business. Indeed, the most important part of a captive feasibility study is to identify which parts of the agent's book of business are the profitable and predictable covers, and to negotiate with the fronting company to reinsure these lines to the captive. Such negotiations can be complicated, because the concern of onshore insurers is that might be left with the poorly-managed risks.
Typically, though, if an agent is prepared to provide capital to support underwriting of its own book of business, numerous benefits accrue for the insured, the agent and the insurer. How many independent agents around the world would like to own an insurance company in which to place a portion of the risks they write? A captive insurance company provides this opportunity, and when located in an offshore jurisdiction, does so with minimal bureaucracy and regulation, yet still designed to protect the policyholders. The ability to earn commissions on upfront sales, and then underwriting profits on the ultimate loss ratios, is an excellent way for the agent to earn a very healthy living from the field of insurance, and is one reason why agency captives are becoming increasingly popular.
Is there a moral dilemma here, in that the agent is able to pick and choose which risks to reinsure and which risks to ignore? Yes and no. Certainly, the onshore insurer must make certain that it is not prejudiced in terms of risk selection. Remember that for every risk reinsured to the captive, the agent's own capital is exposed.
The agent/broker is best placed to know the business of his client. If the following rules are adhered to, then the agency captive is likely to succeed:
As noted above, agency captives work best for low value/high frequency, predictable insurance programmes. These are typically personal lines programmes. Commercial business with predictable ratios does fit the model, although the expense loading may be higher. Once you accept that an agency captive can reinsure any personal lines or commercial business, there appears to be no limit as to the numbers of covers that can be underwritten.
As the insurance market hardens, and capacity diminishes, there will inevitably be more and more demand for agency captives, firstly because increased premiums will result in greater profit being earned by the agency reinsurer. Secondly, decreased capacity in the reinsurance market will have to be offset somehow, and an agency reinsurer should be welcomed in this regard.
Interestingly, exact numbers of agency captives in each offshore location are not available. Table 2 is an estimate, with only Cayman and BVI able to provide exact numbers. Even these figures may not be totally accurate, as some rent-a-captives and SPCs will include PORC business. US onshore states generally prohibit third party captives – Vermont allows PORCs, for example, but does not encourage agency captives. The position will probably change as Hawaii and Nevada review their legislation.
One of the most successful facilitators of these structures is RiskCap, formed in 1976, which experienced growth of 50% in 1999 and 38% in 2000. It targets small niche producers in the commercial market in the US, typically producers who average $25,000 per policyholder or less, depending on volume. A RiskCap-managed captive, for example, owned by the National Auto Dealers Association (comprised of over 40,000 new car and truck dealers), provides insurance to cover a golfing hole in one. The captive has more than 4,000 members. Over 30,000 charitable golf tournaments are held annually in the US. The captive charges an average premium per event of $450, and losses amount to 30-60 cars per year. This is an unusual yet innovative and successful use for a captive.
“We chose Cayman as our principle domicile for producer-owned captives after surveying all the offshore domiciles,” Michael Murphy, managing director of RiskCap Cayman Ltd, which is represented by HSBC, comments. “At the time, Bermuda was reinventing itself as a reinsurance centre as opposed to a captive centre, and we felt that this type of business was not that welcome. Cayman was very friendly and accommodating, and showed a good understanding for what we were trying to achieve. The regulation is excellent and there is a lot of insurance expertise on the island.”
Caledonian Bank & Trust Ltd currently manages four agency captives, the oldest of which was established in 1981. The company reinsures life and disability on behalf of auto dealers in the US, and has distributed in excess of $22m in dividends since inception (see charts 3 and 4). The number of shareholders will top 500 this year, and all shareholders actively participate in the development of the captive, meeting colleagues and making new friends and contacts at their annual meeting in Grand Cayman.
A second agency captive managed by Caledonian – Hartville Insurance Company, owned by a pre-eminent US pet insurer – is a classic example of captive insurance meeting new technology, and demonstrates the flexibility and innovation in the insurance market. The captive, formed in October 2001, provides cover for veterinary bills to pet owners in the US. The owner/agency operates a website and call centre for policy quotes, issuance and claims, and handles a 20% quota share reinsurance via Hartville, whose first year projected net premium is $1.2m. The historical loss ratio on the book is less than 60% on net premiums, and the structure fits the key recommendations for a successful agency captive.
Agency-owned captives, and PORCs in general, will be the fastest-growing sector in the offshore insurance market in the next decade. It should be a pre-requisite of all domiciles to follow the example of Cayman and BVI, to encourage growth in this market, and to account for these captives in their annual statistics.