Reciprocal Insurance Exchange: Definition, How It Works, Example

What Is a Reciprocal Insurance Exchange?

Reciprocal insurance exchanges are a form of insurance organization in which individuals and businesses exchange insurance contracts and spread the risks associated with those contracts among themselves. Policyholders of a reciprocal insurance exchange are referred to as subscribers.

How a Reciprocal Insurance Exchange Works

A reciprocal insurance exchange is formed by bringing together two separate entities—a reciprocal inter-insurance exchange and an attorney-in-fact (AIF). The reciprocal inter-insurance exchange is used to allow subscribers to exchange policies through the attorney-in-fact, which allows them to spread around risk. Authorized reciprocal insurers are often governed by legislative provisions expressly made separate to domestic reciprocal insurers.

The attorney-in-fact is authorized to perform business transactions on behalf of another entity, which, in this case, is the reciprocal insurance company. The AIF runs the day-to-day operations of the reciprocal and is provided with a power of attorney status by the reciprocal. The AIF may be owned by the reciprocal, referred to as a proprietary reciprocal, or may be contracted from a third party, referred to as a non-proprietary reciprocal.

Advantages and Disadvantages of Reciprocal Insurance Exchange

Pros of Reciprocal Insurance Exchange

There are many reasons why companies would seek a reciprocal insurance exchange structure. Reciprocal insurance exchanges can and often operate on a nonprofit basis with the goal of giving their policyholders affordable coverage. In comparison to standard insurance choices, premiums may be lower because policyholders share risk and costs.

To assist policyholders in minimizing risks and minimizing losses, the exchange may offer risk management services such as loss control programs, safety training, and risk assessment. In addition, the directness of communication, improved comprehension of the terms, and speedy resolution of any questions or complaints are all made possible by this type of relationship.

In the event that the reciprocal insurance exchange generates a surplus, it may return earnings to policyholders in the form of dividends or premium credits. Because of this potential organization structure, reciprocal insurance exchanges usually place more emphasis on upholding long-term stability and sustainability.

Cons of Reciprocal Insurance Exchange

Reciprocal insurance exchanges frequently target particular industries or professions, so people or organizations outside of those niches might not have access to or use them. There may also be prerequisites or requirements that must be met beforehand; as a result, not everyone may be eligible to join a specific exchange.

Like any traditional insurance entity, reciprocal insurance exchange's financial sustainability and viability are significantly dependent on the combined contributions and premiums from its policyholder members. Plus, it often operates with fewer resources, smaller staffs, or smaller networks. Therefore, reciprocal insurance exchanges often run with stronger financial risk.

In contrast to typical insurance plans, coverage provided by reciprocal insurance exchanges may be difficult to transfer to another insurer. There may be less flexibility if they want to move insurers or change their coverage.

Last, because reciprocal insurance exchanges rely on the concept of risk pooling in which policyholders share risk and monetary obligations, this also means that policyholders indirectly carry the risk of other members' claims. If a small number of policyholders incur large losses or liabilities, it may have an impact on the exchange's general viability and solvency. This may potentially lead to an increase in premiums for all members.

Special Considerations

A board of governors manages a reciprocal insurance company. The board is responsible for choosing and monitoring the attorney-in-fact, approving rates, and providing oversight of the operations of the reciprocal. Surpluses from premiums are held in separate surplus accounts devoted to a specific purpose, though the accounts can be commingled and used to pay claims against the policies.

Reciprocal insurance companies can issue both assessable and non-assessable policies, with the latter being the most common policy issued. A non-assessable policy keeps the policyholder from being charged an additional amount of money if the cost of operating the reciprocal is higher than expected. This means that the financial liabilities of the policyholder are limited to the cost of the policy.

A reciprocal insurance exchange is different than a mutual insurance company, in which individuals and businesses with similar insurance needs, such as doctors, come together to pool risks and obtain better rates.

Example of Reciprocal Insurance Exchange

Reciprocal insurance exchanges got their start in 1881 when six dry-good merchants in New York agreed to indemnify each other because of their shared discontent with insurance companies.

This group's members all had buildings of superior construction and maintained them well, but they were all charged premiums that did not correspond to the potential losses for similar commercial buildings.

At the time, insurance companies applied broad strokes in their classification of risk; modern rate-setting techniques hadn't quite been developed yet. Able to absorb certain losses, the merchants had the incentive and ability to “self-insure” to lower their costs.

The Bottom Line

A mutual insurance company known as a reciprocal insurance exchange allows policyholders to pool their risk and financial obligations. Owners who are also policyholders gain from personalized coverage, low costs, and direct contact with underwriters. The exchange runs on a nonprofit basis with an emphasis on the welfare of its users and long-term stability. It promotes a sense of community among subscribers and provides insurance solutions tailored to specific industries.