We recently followed up with Chris Kramer, Senior Vice President, Business Development, Caitlin Morgan Captive Services , who attended the Target Market Program Administration Association (TMPAA) annual conference in Arizona last month. Chris participated in a panel workshop, “New Capital – New Opportunities, Captive and Other ART Options for Programs,” where he spoke to program administrators (PAs) about the benefits of setting up an agency captive. Chris’ primary role at Caitlin Morgan is to develop, market, and execute the company’s strategic plans involving captive insurance and alternative risk solutions for agents and policyholders.
This year’s TMPAA conference broke association attendance records with over 850 program business professionals participating. “The TMPAA conference didn’t just give me an opportunity to network with program business professionals but as a panel participant I was also able to get feedback from a larger, diverse audience on the need/desire to achieve greater profits in their books of business,” explains Chris.
As a former insurance agency owner, Chris understands firsthand the many variables it takes to make a profit on a book of business. “No matter how much expertise you have in a particular program, niche, or specialty, very often the largest variable impacting your bottom-line profit is the commission income you receive from a particular carrier. Moreover, although the majority of expertise in a specialty risk or niche market lies with the program administrator, affinity agency, broker, MGA, or any entity that serves as an intermediary facilitating the transaction for coverage and pricing, the lion’s share of the profit remains with the insurer. That’s because the insurer puts up the risk capital. Of course, most carriers do offer incentives and contingencies (also known as profit-sharing plans) to help motivate the production of a profitable book of business, but these can be limited and restrictive and usually have some sort of ceiling on how much can be actually realized. For an agency that typically uses commission to pay for day-to-day expenses and salaries and looks to break even, a contingency or profit-sharing check from its carriers most often results in whether the agency makes a profit or not on the year. But is that all? As an agency owner, you may successfully negotiate a contingency of three or four points on your book of business, and in some cases, there is a “swing-rated” contingency whereby the program administrator or agency must put up some collateral if the book doesn’t perform as expected. For example, let’s say you receive 15 cents on every transaction as commission. At the end of year, you can receive as much as three points – that’s the upside. If the book underperforms, however, the carrier reserves the right to claw back 2%-3%. This is a good return except when you realize that the carrier, which put up the risk capital, makes a profit ten times this amount.”
“When considering whether you are a good candidate for an agency captive, the book of business can be almost any mix, but I typically see a homogenous class of business (although that is not to exclude heterogeneous books), and a coverage line such as workers’ compensation, auto, or general liability. Even BOPs can be considered under an agency captive. The program administrator should have the experience and expertise in writing this particular program or risk, with control over a minimum of $3-4 million of premium the first year when placed in an agency captive…”
During the panel discussion at the TMPAA conference, Chris shared real-life experiences and guidance on how an agency captive can be a viable profit-potential strategy for PAs looking to increase the share of the business they are building. “When considering whether you are a good candidate for an agency captive,” Chris notes, “the book of business can be almost any mix, but I typically see a homogenous class of business (although that is not to exclude heterogeneous books), and a coverage line such as workers’ compensation, auto, or general liability. Even BOPs can be considered under an agency captive. The program administrator should have the experience and expertise in writing this particular program or risk, with control over a minimum of $3-4 million of premium the first year when placed in an agency captive. From an underwriting perspective, loss ratios must show profitability. Books of business that historically show a poor underwriting performance or profit are not suitable under an agency captive.
While the average rate of return under an agency captive is largely dependent on the loss results, those with lower ultimate los ratios will provide higher returns. Chris explains that a PA must also must have enough cash to support not only the expenses associated with running the captive but also for captive collateral purposes as dividends from the agency captive may be several years or as the claims are closed. The agency captive, just as in the case of the carrier in a non-captive relationship, wants to see that there is cash to support an adverse development. “For instance, the carrier fronting the captive will require a letter of credit or that a trust be set up by the PA to guarantee that if there is a bad year, the PA has ‘skin in the game.’ Under this arrangement, however, the carrier shares in the underwriting profit with the PA in addition to the commission received. In fact, the PA’s contingency can be five times from the shared underwriting profits under an agency captive as compared to the three points the PA would receive in a non-captive relationship. There is true incentive on the PA’s part to share in the profits and generate more income off their expertise and experience. Furthermore, the relationship between the carrier and the PA in a captive is based on trust, integrity and a mutual willingness to put money on the line and encourage an underwriting profit. This is a strong and synergistic foundation for a relationship with the insurer.”
“…the relationship between the carrier and the PA in a captive is based on trust, integrity and a mutual willingness to put money on the line and encourage an underwriting profit. This is a strong and synergistic foundation for a relationship with the insurer.”
Agency captives can also be useful as an incentive to retain top producers, owners and staff. In addition, they can be an ideal platform from which owners can provide additional capacity and coverage to clients, leading to the potential for higher retention ratios and increased client loyalty.
Not all potential agency captives see the light of the day, however, most often, because a PA doesn’t have the capital needed. “A feasibility study will indicate that a captive agency is beneficial for a PA but the owner(s) doesn’t have the money to get it off the ground,” says Chris. “Perhaps the PA has the money needed for a year but not for years two and three. At Caitlin Morgan, we work with Oak Street Funding, which is known for providing funds to firms for new producer hires, buyouts or investments in technology. Oak Street works with us to underwrite loans for capital to owners looking to set up an agency captive. The collateral is the book of business. Coincidentally, the carrier/fronting company is going to be doing the same level of due diligence required for a PA to get a loan, which is why we are increasingly bringing in Oak Street as a source of capital.”
Agency captives, estimated to represent about $3 billion in premium based on several sources, are gaining in popularity. “As information technology becomes much more reliable, underwriting becomes much more systematic and, as more valid information is produced, more integrity in the underwriting process is placed,” says Chris. “Carriers recognize they have the ability to offer more risk-sharing agreements than ever before to get a PA’s book of business. They can acquire a very profitable book of business by getting into risk-sharing agreements with agency captives, which is much more economical than organically acquiring the business.”
To discuss whether your firm is a good candidate for an agency captive, contact Chris at 317.575.4440 or via email at firstname.lastname@example.org.