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Reciprocal Insurance Exchanges: What to Know

What Is a Reciprocal Insurance Exchange?

Reciprocal insurance is a form of insurance in which individuals and businesses exchange insurance contracts and spread out the risk with those contracts amongst themselves. Policyholders are referred to as subscribers within that contract. 

In reciprocal insurance, policyholders insure each other in the simplest terms. One of the benefits to a policyholder is that they may be entitled to dividends.

How a Reciprocal Insurance Exchange Works

Reciprocal insurance exchanges are unincorporated, meaning they have yet to go through the legal process to become a company and separate themselves from their ownership. The subscribers are both the customers and the owners of the exchange. 

The risk of the subscribers is transferred to other subscribers, which varies from the typical mutual insurance, where the risk is transferred to the organization. 

How Reciprocal Insurance Exchanges Are Organized

Subscribers or owners get to choose the board of governors, and they act as an advisory committee and are not the sole decision-makers. The board then will appoint an attorney-in-fact, an individual or a corporation who does the following:

  • Handles the day-to-day operations and issue policies
  • Manages claims
  • Manages the underwriting process, such as pricing and renewing the policies

How Premiums Work in Reciprocal Insurance

Insurance coverage through a reciprocal insurance exchange determines more than just a subscriber’s amount of insurance protection. Subscribers’ insurance premiums — also known as premium deposits by reciprocals — have an impact on the following:

  • How much coverage you receive
  • How much dividends you receive — if any
  • How much you may lose if another subscriber files a claim against you

What To Know About Dividends

When a reciprocal insurance exchange has more premiums and investment income than it needs to cover claims and expenses, dividends are returned to policyholders. Members typically receive dividends based on their contributions and participation in the exchange. 

The attorney-in-fact manages the reciprocal and divides the dividends amongst the policyholders. Shareholders who actively participate and contribute to the reciprocal’s financial well-being are eligible to receive dividends.

Reciprocal vs. Other Insurer Types 

Reciprocal insurance exchange is not the only way an insurance company is structured. There are also mutual insurers, stock insurers, and self-insurance for those who want to avoid going the exchange route. 

Mutual Insurers

Mutual insurers are owned by policyholders who share ownership and decision-making responsibilities. A reciprocal insurance exchange, on the other hand, involves policyholders directly insuring each other. USAA is a reciprocal exchange and is a member-owned pool where risks and rewards are shared.

Stock Insurers

Stock insurers are companies owned by shareholders. Stock insurers operate for profit and are traded on stock exchanges instead of reciprocal insurance exchanges. Investors own shares of insurance companies like GEICO and Progressive, and profits go directly to shareholders instead of directly to policyholders as in reciprocal agreements.

Self Insurance

Instead of purchasing a traditional insurance policy, an individual or entity can self-insure against potential losses. You must set aside funds to protect against liabilities and damages. Self-insured parties manage and bear the financial risks associated with potential accidents rather than relying on an external insurance provider. Many states will require you to prove your financial status to be able to self-insure.

Pros and Cons of a Reciprocal Insurance Exchange 

  • Low overhead
  • Low claims
  • No profit
  • Low participation
  • Limited options
  • Risky

As with everything, there are pros and cons of being a part of a reciprocal insurance exchange. It’s important you evaluate several factors before deciding to join one.

Advantages of Reciprocal Insurance Exchanges

  • Low overhead: There are lower operating costs since a reciprocal insurance exchange is owned and managed by policyholders.
  • Low claims: A reciprocal insurance exchange should experience less claim frequency since the subscribers have more direct handling of the company. Often, a policyholder might drive more carefully and ensure their claims payouts stay low to continue enjoying lower premiums.
  • No profit: Reciprocal insurance exchanges do not have to do annual price increases like some traditional companies.

Drawbacks of Reciprocal Insurance Exchanges

  • Low participation: A newer reciprocal insurance exchange can face lower participation, which means higher premiums to be able to pay claims. There are operating costs like the attorney-in-fact, and the participation has to be high enough to cover all of that.
  • Limited options: Few coverage options may be available with a reciprocal insurance exchange.
  • Risky: Since there is no financial backing to a reciprocal insurance exchange other than what the subscribers put in, there is always a financial risk if there is a catastrophic event. You also cannot get a refund once you have contributed to the exchange.

Should You Consider Enrolling With a Reciprocal Insurance Exchange Company? 

Whether or not to enroll with a reciprocal insurance exchange company will depend on your situation. Reciprocal insurance exchanges are ideal for those interested in streamlined management, who like to have control of their policies, and who are not afraid of sharing risk with others in a similar position. 

You should evaluate an insurance exchange on the following factors:

  • Cost savings
  • Coverage options
  • Financial stability, which could include how long the exchange has been formed

Those seeking several different coverage options and financial backing from a more prominent company should consider a more traditional insurance company. A reciprocal insurance exchange arrangement would be best suited for those who are financially savvy and who prioritize cost-effectiveness and simplicity, as well as trust the management of a reciprocal exchange.

Putting It All Together 

A reciprocal insurance exchange is a type of insurance entity that is formed, managed, and owned by its policyholders. The risk is shared among the policyholders, called subscribers. 

A reciprocal insurance exchange can benefit someone financially secure, does not want to be completely self-insured, and does not need a lot of coverage options. For someone who likes to have several options to choose from, they should stick with a traditional insurance company.

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