Reciprocals have been around for many years, but many times get looked over for more popular types of insurance, most notably Mutual Insurance Companies(State Farm, Nationwide, Liberty Mutual) and Stock Insurance Companies(Allstate, Geico, AIG). However, in recent years there has been a rise of interest in reciprocal insurance, especially as more nonprofit groups search for the best means to insure their members without creating taxable income.
So what are reciprocals? Reciprocals are usually defined as a group of individuals, corporations or entities who, as members, agree to exchange contracts of insurance (policies) and share their insurance risks among themselves within their select group. Each member (policyholder) of a reciprocal exchange individually appoints and authorizes a common attorney-in-fact to manage the affairs of the exchange. Therefore, they are similar to mutuals except the people that manage the policies are not employees of the company, but these “attorney-in-fact’s” who manage the reciprocals finances and deals with underwriting, claims administration, investments and any other day to day operations. The attorney in fact is usually paid a percentage of total profits for their service.
Reciprocals also have a “subscribers advisory committee”(SAC), which is essentially a governing board. Like the attorney-in-fact, the subscribers appoint the body of persons to become the SAC. The SAC has general responsibilities for the finances and insurance activities of the reciprocal. For instance, the compensation of the attorney in fact will usually be determined by periodic negotiations with the SAC.
As far as tax advantages, all insurance companies, including reciprocals are regarded as corporations when it comes to federal income tax purposes. This means that the insurance company is subject to the double tax that is applicable to most corporations. Therefore, income is taxed once at the corporate level and taxed again when distributed to the company’s shareholders. Reciprocals, however, have a unique tax advantage over other insurance companies in that they are allowed to take a deduction for the amount of its annual net income that is allocated to the subscriber SSAs. (Subscribers Savings Account).
What is a Subscribers Savings Account? At the end of each year, the remaining premium will be deposited into the Subscribers Savings Account, which is held in the name of each active member. The company typically does not pay tax on the money deposited into the SSA accounts, allowing the surplus balance to build faster than retained earnings in a typical insurance company.
Nearly all types of insurance are available through a reciprocal insurance exchange, from Florida homeowners insurance through Privilege Underwriters Reciprocal Exchange(PURE), or auto insurance through USAA. Other popular reciprocal insurance exchange companies are Farmers Insurance Group and Erie Auto.
The reciprocal insurance structure has been used by groups of professionals including doctors, lawyers and architects and some industries, including pharmaceutical manufacturers, when coverage they need has become scarce and extremely high priced. Pure Insurance, a Florida reciprocal insurance exchange start up made news for offering insurance to residents of hurricane-prone coastal areas of Florida, where most companies refused to write policies.
Though reciprocals represent a smaller number of insurance companies, they are a viable option and shouldn’t be overlooked when searching for the right coverage for your specific needs.