Reciprocal Resurgence Canada’s Quiet Contribution to Alternative Risk

Since the mid-’80s, reciprocal insurance exchanges have provided public sector and professional groups with some protection from the vagaries of the general insurance market cycle. With a proven track record and a solid history of offering members, or “subscribers,” stable premiums and loss reduction programs, it seems that reciprocals may be experiencing yet another growth phase.

The challenging conditions of the most recent hard market have spawned several new or expanded reciprocal exchanges in Canada. Municipalities across Nunavut (as well as the Northwest Territories) have their own reciprocal, as do roofing contractors in British Columbia and Alberta. Registered real estate agents in Saskatchewan and Alberta can now get insurance coverage through an expanded entity known as the Real Estate Insurance Exchange. Groups as diverse as the voluntary sector, building inspectors and municipal governments in Atlantic Canada are reportedly looking into setting up reciprocals to provide insurance protection that is more stable than the mainstream market.

“There are a number of groups that are both interested in and looking at the formation of reciprocals,” executive vice president of Willis Canada Peter Kelly, who also heads up the brokerage’s alternative risk transfer practice, says. “Reciprocals appeal to groups of people who believe that the price of traditional insurance is unrealistic for their risk and also to professional groups and associations for mandatory errors and omissions coverage.”

Several representatives of reciprocal insurance exchanges note that they have been contacted by interested groups to, as acting executive director of the Ontario Municipal Insurance Exchange (OMEX) Linda Boyle puts it, “pick our brains.”

COVERAGE COMPULSION

The so-called “liability crisis” of the ’80s resulted in the formation of several reciprocals. As risk coverage (and limits) shrank and premiums soared, various organizations looked for alternatives; the most obvious choice for many “deep pocket” public sector groups was a sharing or pooling of risks. Reciprocals created during this period extended to munici-palities (OMEX, Municipal Insurance Association of British Columbia, Alberta Municipal Insurance Exchange), electrical utilities (Municipal Electrical Authorities Reciprocal Insurance Exchange, Alberta Local Authorities’ Reciprocal Insurance Exchange), health care (Healthcare Insurance Reciprocal of Canada), school boards (Ontario School Board Insurance Exchange, Alberta School Board Insurance Exchange), and universities (Canadian Universities Reciprocal Insurance Exchange). Each municipality’s initial purpose was to obtain more stable coverage at lower prices, while spreading the risk through a relatively homogeneous membership base.

“Reciprocals really try to avoid the cyclical ups and downs of the traditional market,” Boyle says. “We level it out a bit more, so that our members are not looking at huge peaks and valleys in insurance costs.”

While many reciprocals operate on slightly different models, they share some common elements. A reciprocal is a non-profit group of individuals or corporations who pool their insurance coverage requirements. It is a means of sharing risk among members with similar exposures, with few variations in the coverage provided.

RECIPROCALS AND RETENTION

Reciprocals are licensed by provincial regulators and operate similar to an insurance company, but with some important exceptions. They are not incorporated; instead, they operate through a principal attorney (an individual or a corporation). Reciprocals also usually nominate an advisory board, which oversees membership and operating issues.

The provincial requirements for capital and surplus are far less stringent, since a reciprocal does not have to be fully “capitalized.” Reciprocals also have the right to “retro-assess” members if there is a shortfall in funds. While reciprocals can invest funds just like an insurance company, they do not hold any surplus capital. If there is a surplus, it is refunded to subscribers. Reciprocals are also not taxed on investment income.

“I think reciprocals are here to stay,” Keith Gibson, risk manager for the Municipal Insurance Association of B.C. (MIABC), which counts 161 local governments as members, says. “(But) reciprocals are not viable for every organization. They represent a more homogeneous assessment of risk where the true cost can be measured and projected into the future.”

“We are the forgotten ones of the insurance industry,” Peter Flattery, chief executive officer of the Healthcare Insurance Reciprocal of Canada (HIROC), which has more than 500 health care facilities as members, says. “Yet we are still a big part of insurance in terms of what we provide for clients. We are involved in a big way on the commercial side because we still use reinsurers and, in some cases, insurers for excess coverage.”

In most cases, reciprocals write coverage on a primary basis, and use reinsurers or specialty insurers for excess layers. Here, reciprocals are still subject to at least some swings from the traditional market. In addition, some sources say that a reciprocal is not a panacea for a bad loss problem or a short-term solution to avoid price hikes.

“As a reciprocal you still have to collect premiums and you still have to buy excess reinsurance above the retention,” Keith Shakespeare, president of the 56-member Canadian Universities Reciprocal Insurance Exchange (CURIE), says. “It will not solve a bad loss problem. You are not out of the commercial marketplace entirely, but only for the piece that you keep. And that is where most of the losses are going to be.”

Nevertheless, the popularity of reciprocals has spread well beyond public sector organizations to include lawyers, real estate agents, oil companies and community newspaper groups. The Community Newspapers Reciprocal Insurance Exchange (CNRIE) started in 1985 after insurance coverage for perils associated with publishing, such as libel and copyright, dried up.

“There was a gap in the market and at that time a lot of independent publishers didn’t really have anywhere to go to get a cost-effective product,” Shelley Ford, general manager of the 235-member CNRIE, which recently expanded its coverage to members of the Canadian Business Press, says. “That is the reason why a lot of reciprocals start up. They are looking to insure specific perils associated with an industry and they just can’t find the coverage for a very good price.”

SUPERSIZE ME SERVICE

Ford notes that reciprocals are “not a common, well-known structure. When people hear the terms ‘insurance provider’ and ‘non-profit’ it doesn’t sit that well in their minds.”

In addition to the main advantages of tax-free status and more stable premiums, sources say reciprocals can give members other benefits. A strong area of focus for most reciprocals is risk management and loss prevention programs.

“Most if not all reciprocals place a lot of emphasis on risk management and loss control,” Boyle says. “So it gives the opportunity for people you insure to really get involved in not just trading dollars with an insurance company, but finding ways to reduce losses and making things better for members. If you are running better facilities, you are also doing a better job for the people who use them.”

“Once the reciprocal is up and running, the real value is the services it provides other than the insurance placements,” Shakespeare says. “That could be loss control or access to other members. If you have a particular problem, instead of reinventing the wheel every time, a reciprocal allows members to access information from others and bounce ideas around.”

If a reciprocal experiences a good loss history, members can also benefit from refunds. Flattery says HIROC has refunded more than $70 million to members over the years. It has also expanded its coverage from the original casualty emphasis of medical malpractice to a “one-stop shopping” model that includes property and other risks. Its expansion involved setting up a management company (HIROC Management Ltd.) and a licensed brokerage (HIROC Insurance Services Ltd.). Flattery says that while the original reciprocal focused on hospitals, HIROC now looks at providing a wide range of coverage to any non-profit health care organizations.

“When HIROC was formed, the understanding was that we were not going to be the cheapest rate in town,” Flattery says. “This was a long-term solution. We looked at risk management in a very significant way and that became a cornerstone in our foundation. That is one of the reasons why we have been successful and why we have grown over the years. Our new vision is partnering to create the safest health care system. It is another example of how a reciprocal can be different from a commercial insurance carrier. You wouldn’t see this kind of vision with an insurance company.”

Boyle notes the original focus of OMEX on casualty coverage shifted after the property coverage crunch post – 9/11. “We initially went into more the casualty side, so we wrote more liability, E&O, environmental and auto,” she says. “The property market by the time we were up and running was pretty soft so we didn’t worry about it too much. Subsequent to September 11, we started to write all the property coverages as well. Now we offer a full program.”

COLLECTIVE COMPETITION

As reciprocals expand their coverage, the obvious result is a loss of business for traditional insurance companies. Flattery, who previously worked for a commercial insurance carrier, says: “The unfortunate thing is that once they leave the commercial market, very few of them come back. I do not think the lessons are being learned.”

“You get into situations where you think the insurance companies have learned their lesson in terms of price slashing, but you get into a competitive marketplace and you never know what they are going to do,” Boyle says. “With that said, sometimes what happens globally impacts local insurance companies and they don’t have a lot of control over what they are able to do. This is why reciprocals are attractive: we don’t necessarily have to write insurance that reinsurers dictate.” As long as we fund for our claims, we can write the coverage within the reciprocal.”

Shakespeare says, “I think brokers and insurers kind of look at this (reciprocals) short-sighted. It is no different from a large corporation taking a big deductible. We still use some sort of reinsurance or excess insurance and most people use a broker to do that. It seems to me that some brokers will lose business. But rather than having 56 universities dealing with 10 different brokers, we use one broker to place 56 institutions on a reinsurance basis. So that broker gets more business.”

BOLSTERING BROKER BUSINESS

Reciprocals are a method of alternative risk transfer with big potential for brokers, according to Kelly. “From a broker’s point of view, I think there are opportunities to be had in reciprocal formation, both in setting them up and managing them – including running the claims, doing the administration, finance and accounting,” he says. “We also usually place the excess reinsurance, so there are a number of areas that a broker can assist. Many clients sort of look for a path to independence, where they utilize the broker’s services for most tasks in the early years and then gradually become more independent.”

The major downside to a reciprocal is the possibility of severe losses or long-tail claims that deplete funds and result in heavy retro-assessments to subscribers. This could lead to resignation of members and a wind-up of the reciprocal. This has not happened with any of the Canadian reciprocals to date. “Of the reciprocals that formed in the 1980s, none that I am aware of have left those reciprocals or closed them down in soft market conditions,” Kelly said. He added that he is conducting two feasibility studies for groups interested in forming reciprocals.

Sources say that homogeneous risk profile management, team-tailored loss prevention programs and a long-term approach are the best chances for a reciprocal to succeed. In addition, while interest in reciprocals is high, many say the urgency of finding an alternative solution may be waning due to improved conditions in the traditional market.

“I expect to see a continued growth in reciprocals, but it depends on the cycle,” Flattery says. “There is a flurry of activity going on now, but that will likely end in a year or two.”

“The big concern when you are trying to set up a reciprocal is people making a commitment: the softer the market, the harder it is for people to commit themselves to a group,” Shakespeare says. “As the problem slowly goes away, so does the interest.”

“I think the sense of urgency has gone a little bit, but there are people with long enough memories that they never want to get caught in the same situation as they were two or three years ago,” Kelly says. “I think reciprocals are here to stay – for the right people.”