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What Is a Reciprocal?

A reciprocal insurance exchange (or reciprocal) is a form of risk transfer that a group of members or “Subscribers” will set up and fund as an alternative to purchasing insurance from the traditional commercial insurance market. Each Subscriber assumes part of the risk of the group so when a claim is submitted, the losses are covered by the Subscribers collectively.

How Does a Reciprocal Insurance Exchange Work?

A reciprocal insurance exchange is a specific not-for-profit business structure for an insurance company in which a group of subscribing members are also the owners of the company.

When a Subscriber becomes a member of a reciprocal insurance exchange, they enter into a Subscribers Agreement stating that they will contribute to fund the losses of the other Subscribers in the exchange.  They are effectively committing to claims being paid for losses suffered by any member of the group subject to the agreed upon policy terms of the exchange.

If loss experience is less than anticipated for the year, Subscribers may benefit by receiving a refund in the form of dividends or the surplus can accumulate inside the Reciprocal for future years.  Unlike traditional insurance from a commercial insurer, there is no additional premium loading for anticipated profits. A Reciprocal has a unique mandate of providing insurance protection for the member subscribers and any profits are returned to the membership.

There are additional benefits to a Reciprocal including lower capital requirements than traditional insurance companies, and the ability tailor specialized insurance requirements to meet the needs of the Subscribers.

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Management of a Reciprocal insurance exchange is performed by an Attorney-In-Fact (AIF) who makes decisions for the company. The AIF also oversees an advisory committee of elected policyholders who assist with the company decision-making. They will manage operations in the company including administration, underwriting, and possibly even claims management. An AIF can either be employed by the Reciprocal, or the company may choose to go through a third party to contract one.

Reciprocals are permitted and regulated by each provincial Insurance Act and must still follow all insurance laws as well as licensing requirements specific to each province.  However, they are unincorporated associations and therefore do not need to go through the same legal process to become a company.  Reciprocal insurance exchanges have only been around for a few decades and there are approximately 30 in Canada covering a wide variety of industries.

The History of Reciprocal Insurance Exchanges

While reciprocal insurance exchanges really got their start in Canada in the late 1980’s,  the first instance of reciprocal insurance came about in 1881 in New York.

As the story goes, there were some dry goods merchants who were tired of the high prices they were paying to insurance companies to insure their buildings. Initially, they decided to cancel their insurance and simply pay the losses when they experienced them.

However, this got complicated as it would often take time for a merchant to receive the money from the other merchants when something went wrong.  They decided it would be more efficient to pool a group fund by making monthly deposits into one account. Then when a loss happened, money would be removed to pay for it.

While this early idea had some flaws, especially when it came to who got to withdraw the money from the account, this idea of a group pooling money as a way to self-insure immediately caught on.

Characteristics of a Reciprocal Insurance Exchange

What else should you know about Reciprocal Insurance Exchanges?  Here are the main benefits and one challenge:

Low Start Up Costs and No Profit Margins

A key benefit to opening a reciprocal insurance exchange is that there is very little capital required to get started. The objective of the Reciprocal is risk pooling, and contrary to an insurance company there is no expectation of generating shareholder profits which reduces the premiums charged to the Subscribers.

Control Over Claims and Operating Costs

Subscribers will also have control over the coverage offered, claims process, and operating costs in order to meet their specific needs and operational goals. This is a huge benefit compared to typical insurance companies often choosing not to cover certain less profitable or riskier coverages.  Subscribers may collectively choose the limits and coverage offered in their insurance contracts.

Additionally, because reciprocal insurance exchanges are typically based on the common needs of its members, this allows Subscribers to receive insurance specific to their sector to cover risks specific to their industry. Therefore, a reciprocal may offer a type of insurance not offered anywhere else.

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Direct Input in How the Reciprocal is Run

Reciprocals are run by an elected Advisory committee, and if Subscribers do not like the way things are currently being run, they may decide to elect a new advisory board to select and work with the AIF.

Reciprocals are not companies so much as they are groups of insureds with a mutual interest who have collectively decided to insure the others in the pool. This allows the Subscribers to control much of how the reciprocal is run.

The size of the reciprocal will affect an individual company’s say in the reciprocal, but because many reciprocals are industry specific, you will find the advisory board is generally made of people who understand your business and needs.

Access to Reinsurance Market to Limit Losses

Reciprocals may limit their exposure to loss by purchasing reinsurance protection for all the Subscribers of the Reciprocal.

The reciprocal will typically offer reinsurance protection against large catastrophic losses, as these are the ones they are likely to be unable to cover within the reciprocal.

Difficult to Get Started

A reciprocal insurance exchange often depends on having enough Subscribers to cover the losses of any single Subscriber. This means a Reciprocal can be risky for the Subscriber if the pool is too small.

In addition, though it isn’t expensive to start a reciprocal, there are costs that still must be covered, such as the payment for the AIF, and any organizational costs. When the pool is too small, these costs may raise the prices of premiums for Subscribers.

You also need a committed group to agree to pool losses together and go through the steps of creating a reciprocal. This is why existing Reciprocals focus on certain groups or associations, as this enables them to have a large pool of Subscribers, lowering the risk of all of the policyholders in the pool.   Once a reciprocal pool is large enough, the Subscribers feel they have the same security as any other type of insurance purchased.

Ready to Become a Reciprocal Insurance Company?

Does a reciprocal insurance company sound like an ideal setup for your group or association? Droits d'auteur is ready to discuss how you can get started and help you through every step of finding the right insurance for you.

Beyond just helping you get set up, Droits d'auteur can also help you with the day-to-day operations of your reciprocal insurance exchange.

No matter what your questions regarding reciprocal insurance may be, contact Droits d'auteur today to discuss your options.

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