How Agency Captives Can Provide Exciting Opportunities Even During the Hardest of Markets

By: | April 22, 2021

Carol Frey is the divisional vice president of Great American Alternative Markets. Frey is a 30+ year veteran in the Property & Casualty industry where she has held a variety of financial, underwriting, managerial and captive leadership positions. She can be reached at [email protected]

Agency captives are unique in the captive segment. In many cases, they come to mind in times of hard cycles, market dislocations, coverage gaps or emerging exposures in the industry or when carriers adjust contingency or profit-sharing requirements.

Most of these are not necessarily the best stimulus in terms of assuming risk by the agency. In fact, many of these factors would suggest that the captive may face adverse selection unless there is considerable prudence in the underwriting and financial due diligence.

So, when market cycles are hard, is there a potential for additional revenue for the agency beyond standard commission? Potentially, yes.

The question really becomes whether that play has longevity and if the capital requirements to form and support the captive are worthwhile given that by doing so, the agency may be sacrificing contingencies that are based solely on production, not profit.

That sacrifice of capital for a captive may force an agency to postpone hiring of new producers, investing in technology, rewarding and retaining key staff and/or preparing for the retirement of a producer book or owner.

The agency captive concept is generally no different than any other captive formation. Evaluating the performance of the book of business and identifying the potential severity and unpredictable frequency is key to this process, not to mention constructing key underwriting guidelines and specific exposure eligibility or ineligibility.

Part of this process is also the approach.

Placing business generates revenue that is critical to agencies. Often, the revenue is also perceived as profitable business. While that may be true, only a formal actuarial review of the book will determine profitability. Good business has various definitions, and it is critical that be understood by all the parties involved.

The foundation of an agency captive’s success lies in the objective evaluation and planning of:

  • Risk Selection identifying the niche or book of business for the agency or key agency producers that are “go to” for their insureds.
  • Profitability  projecting true profitability and addressing claims incurred but not reported (IBNR), trends and pricing to determine current profitability and/or how to improve it.
  • Capital Cost Comparison conducting an analysis that compares current “as is” contingency to future captive profit/dividend distributions and the cost of capital in terms of its rate of return by not investing that capital in other agency-related ventures or improvements.
  • Collateral or what some refer to as “patient capital;” the ability to post collateral and wait for distributions that could be three to five years down the road.
  • Agency Planning reviewing the agency’s 5- and 10-year strategy to assure that the captive is a fit now and in the future.
  • Captive Champion designating an “owner” at the agency to monitor the captive, the business, the results and the resources to support the endeavor.
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An agency captive is not for everyone. Many have succeeded, but many have failed.

It is a sophisticated, long-term play that requires significant investment in time, money, education and resources.

This investment could easily outpace the “opportunistic” play, and therefore, while it may be a product for that environment, chances are for the captive to be successful, it will need to plan beyond what may be currently happening in the marketplace. &

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The R&I Editorial Team can be reached at [email protected]