Not so secret: agency captives

On June 12 Connecticut became the latest US state to introduce legislation allowing for agency captives, as governor Dannel Malloy signed law SB 377.

Senator Kevin Kelly and representative Peter Tercyak had co-sponsored the legislation to further the captive insurance sector in Connecticut by introducing agency captives as a new structure.

Janet Grace, programme manager, captive division at the Connecticut Insurance Department, says agents and brokers are facing increasing competition to grow and retain profitable business, and that an agency captive is a nice way to integrate both.

“Single parent captives, owned by the world’s largest companies, are a bit of a saturated market. As you move downstream, the risk management needs of the rest of the market are a bit different.

“Those firms may not have the sophistication or dedicated risk management staff to focus on developing and managing a captive solution,” says Grace.

An agency captive is a reinsurance company controlled by an insurance agency or broker. Through an agreement with a traditional insurer, the agency captive takes a share of the premiums written, and has to pay its share of claims.

Agency captives are by no means a new concept, but in the last few years a number of states have either been introducing agency captive legislation or streamlining their current legislation to make the process of setting one up easier.

In May 2017, Vermont governor Phil Scott signed captive bill H 85, which added agency captives to the types of structures that can be formed in the state, with a capital requirement of $500,000.

That same month, Georgia governor Nathan Deal signed Senate Bill 173 to revise certain definitions in the state’s captive law, such as allowing pure captives or agency captives to be incorporated
as a stock insurer or organised as a manager-managed limited liability company.

Another example is North Carolina, which amended its captive laws in 2014 to provide definitions for special purpose captives. This type was added to provide for the operation of captives that are deemed appropriate by the Commissioner but not already defined in the Act. Previously undefined types of captives such as group captives and agency captives could now be licensed in the state.

Debbie Walker, senior deputy commissioner at the North Carolina Department of Insurance (NCDOI), says that the purpose of this change was to better meet the needs of the captive industry.

A stronger player in the market

Agency captives are seen as powerful financial vehicles that can open up new lines of revenue for the agent, and allow all the flexibility that a captive insurer offers.

Furthermore, a well-run agency captive could provide the agency that owns it a strategic advantage against competitors, provided the entity is well structured and carefully managed, says Grace.

Jesse Crary, attorney and shareholder at Primmer Piper Eggleston & Cramer, says that Vermont’s new agency captive law is “purposefully designed to allow for innovation, growth and creativity over time”.

“While some agencies may have existing books of business that could immediately turn more profit if an agency captive were utilised, the market differentiators in this arena will find creative ways to share the financial upside such that their prospective clients can easily understand why one agent’s programme is superior to that of its competitors,” Crary explains.

Christopher Murray, president of Caitlin Morgan Insurance Services, suggests an agent might consider an agency captive if it has a good book of profitable business and it wishes to maximise income.

“As they grow the captive and create surplus they could introduce additional coverages to set them apart from other agencies; they could also allow an insured to have partial ownership in the captive and they would have more control over claims and underwriting,” says Murray.

Andrew Barile, CEO of Alternative Global Risk Management, a firm that offers agency captive feasibility studies, says that today’s agent is a lot more sophisticated at making a profit for their agency.

“We see them creating a new profit centre, where the agent actually owns an insurance company. And now we have the encouragement of the domestic domiciles,” says Barile.

With agents having to purchase an errors & omissions policy—a requirement from the carriers they represent—this can create new opportunities for the agency captive.

When carrying out feasibility studies for the agency captive, Barile points out policies the owners have bought and simple things they can do within their captive—such as writing another layer of protection above what the surplus lines is giving them, and then charging a premium for that.

One of the biggest benefits from an agency captive, in Barile’s point of view, is the way it can grant the agent a greater understanding of the industry it operates within.

“The agent today is very curious about understanding the business a lot better than just collecting commission to sell a policy. And they’re very fearful that the high-tech companies are coming in to take their businesses away,” he says.

“The agent of today can no longer just sell policies and collect commissions. Once an agent owns its own insurance company (in the form of an agency captive), they now understand exactly how the business works because they see how their insurance company makes money.

“In the same way they see how the insurance company that they represent as an agent makes money.”

Another trend Barile is seeing in some of the more sophisticated agents is their ability to retain talent within the agency and offering them rewards through owning a stake in the agency captive.

“The owners of the agency captives are some of the biggest producers of business for the agent. In addition to getting a salary as a producer of an agency, the owner gets a salary that is equal to a bonus which is a compensation of stock in an agency captive that’s growing,” he says.

“Because he or she also owns the stock and its values, somebody trying to poach him or her will have a degree of difficulty because they’ll say they can’t leave because they have a lot of money tied up in the agency captive that the agent owns.”

Hard and soft markets, and the future

The formation of an agency captive—just like any decision to start a captive—requires a careful evaluation of the business, financial factors and strategic fit that comes out of a full feasibility study.

Murray suggests that agency captives have probably slowed down in the current soft market cycle, and he finds a lot of agencies are not willing to expend the capital that is needed for the long term.

He believes the attractiveness of agency captives may change depending on whether the market is hard or soft but says the time to start preparing would be during a soft market, so that the agent can be ready for any market changes.

“Even in a soft market there are niches that might not be as soft or are very profitable business. It depends on the lines of business, industries insureds, etc,” says Murray.

Crary also states that it would be potentially advantageous to establish an agency captive programme in advance of a hard market so that it is in place and ready to take advantage when commercial prices begin to rise.

Grace suggests that market cycles aren’t what they once were—and that perhaps they never were a good reason to form a captive.

“While hard markets where consumers experience large price increases might increase interest in alternatives, more successful captives drive risk management results regardless of insurance market conditions,” she says.

“Agencies, as distributors, hold a unique market position and know a great deal about their clients and the market. Throughout the market, what economists refer to as ‘more perfect information’ is far more readily available than it once was, and how agencies use their position to develop a captive strategy will be key to success.

“With increasing use of artificial intelligence and big data one could foresee big changes in the captive sector, including agency captives.”

Crary suspects the agency captive laws will undergo further development as different programme ideas come to light.

“I expect further development in the area of agency-sponsored captives as many agents will appreciate having the flexibility to legally segregate different agency programmes without having to establish separate captive facilities to do so,” he concludes.