If you’re unfamiliar with reciprocal insurance, you’re not alone. It’s a small segment of the insurance market, generally focused on high net-worth individuals and entities. Unlike conventional insurance companies, which are either owned by shareholders for stock companies or policyholders for mutual companies, reciprocal insurance companies are owned by its subscribers, or members. They insure each other, in a reciprocal arrangement, by exchanging indemnity contracts among themselves. Subscribers are not just individuals, but may consist of partnerships, corporations, LLCs and even municipalities.
Reciprocal Exchange Structure
Reciprocal company is actually a misnomer, since these types of private, nonprofit insurance entities are not incorporated. They are more accurately known as interinsurance exchanges or reciprocal exchanges. Subscribers most often insure each other’s real estate and motor vehicles. Members of certain groups or organizations may form a reciprocal to protect each other’s property. For example, a sailboat racing club might form a reciprocal to indemnify each boat owner for damages to their individual sailboats during the racing season. A more sophisticated reciprocal is that of the Michigan Professional Insurance Exchange, which offers coverage for medical liability insurance premiums for its physician members.
A board of governors oversees a reciprocal exchange, and among their duties is choosing an attorney in fact. Premium surpluses are put in separate accounts and used for specific purposes. However, these surplus accounts may be used to pay subscriber claims. Reciprocal insurance policies are typically nonassessable, meaning the policyholder is not charged more money if operating costs for the reciprocal exchange are greater than expected. In essence, a subscriber’s financial liability is never more than the policy’s cost. As with a conventional insurance company, a reciprocal should make a profit, but these profits are not always passed on to subscribers. Instead, they are often kept, helping pay for future claims or other liabilities. Some reciprocals do pass on any annual savings to subscriber's savings accounts. It all depends on the way the contracts are written.
The Attorney in Fact
Management of a reciprocal exchange falls to the attorney in fact, a separate legal entity, who also holds power of attorney over the reciprocal. This individual, partnership or corporate entity issues policies, manages investments and attends to any claims. The attorney in fact receives their payment for this management from commissions and fees. The attorney in fact is not a subscriber of the exchange, and also does not assume any of the risks. The person or entity holding this position must adhere to the reciprocal’s bylaws.
Reciprocal Insurance History
The first instance of reciprocal insurance dates back to 1881, according to Insurance Thought Leadership, and resulted from six New York merchants’ dissatisfaction with standard insurance companies. These store owners had first-rate, well-maintained buildings, but their premiums reflected the way risk was classified in that era, in a sort of “one-size-fits-all” arrangement, and they felt they were paying too much. Because these successful businessmen were well-capitalized and could absorb a certain amount of loss, they decided to self-insure to lower their rates. At that time, subscribers in effect “passed the hat” when a member suffered a fire or some other type of loss, but that could lead to delays in payments to the affected member. Reciprocals began collecting annual premium deposits, as they are known, for easier access when claims arose.
Reciprocal Insurance and State Laws
Most states allow the establishment of reciprocal insurance exchanges, although all such entities are subject to state and local law. Reciprocals are commonly used by municipalities wishing to create an insurance exchange with other government entities, such as counties, in a way that is less expensive for these governing bodies than participating in traditional insurance plans.
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