Oft times, managing general agents, wholesalers and insurance brokers
feel they are inadequately compensated for the important services they
provide in proportion to the substantial profits they see going to their
carriers or fronting companies from their book of business. This is
particularly true during a hard market.
Typically, carriers and fronting companies charge substantial
fronting fees, upwards of 6-10 percent, for the use of their ratings,
licenses, admitted/non-admitted paper, etc. Brokers with good
underwriting (i.e. low loss ratios) cannot help but salivate at the
thought of eliminating these heavy fronting fees and combining the
savings with the substantial earnings potential they could realize by
retaining the risk themselves.
Before racing to purchase an insurance company, one must consider the
various other means of participating in profits. Probably the most
common method is by way of profit sharing commissions with carriers.
However, this limits the broker to only taking a small portion of
profit.
The next step up is likely some type of quota share arrangement
between the broker and the carrier in which the broker agrees to assume a
percentage of the risk, backed by a letter of credit (which ties up
capital), in exchange for a percentage of the profits. This option,
though not always available, does afford the opportunity to hold on to a
slightly larger percentage of the profit.
The only way for a brokerage to capture all the profit is to set up
its own insurance company. If successful, this act enables the brokerage
firm to “control its own destiny.” To do this is no easy task, but it
is possible. The key is in knowing exactly what is at stake and knowing
all the elements that must be in place before proceeding.
Let’s assume that start up capital is not a problem. Many additional
things must be considered, implemented and achieved before a successful
start-up can be realized. The decisions to be made are seemingly endless
and begin with the geographic footprint desired, where the company
should be domiciled, and statutory surplus requirements of the states
involved. Additionally, the complexities involved in obtaining a
charter, the multi state regulatory approvals processes and achieving
the A.M. Best rating required all must be navigated without mistakes.
Collectively, these obstacles, and many more, present a drain on a
broker’s time, resources and the ability to run the day-to-day business.
Thankfully, there is a commonly used shortcut which avoids some of
the problems associated with starting an insurance company. Several
early hurdles may be cleared by simply purchasing one of the many shell
insurance companies on the market today. Ideally, a “clean shell” will
be available. This is an insurance company with licenses but without old
insurance liabilities or legacies.
Purchasing a shell will not eliminate critical decisions such where
to domicile or in which states are licenses needed. Nor will it
guarantee the required A. M. Best rating or state regulatory approval of
the new ownership. However, most importantly, it will be a company that
already has a state of domicile charter and existing licenses in most
or all of the states desirable to the buyer.
What is the cost to acquire a clean shell?
Shells in today’s market are plentiful, but there are significant entry fees. The seller of the shell will want two things:
1) A dollar for dollar exchange for delivering the shell to the buyer
with the capital tied up in the shell. Some shells are accompanied with
as little as $2 million in capital and surplus.
2) Consideration for the number of states in which the shell is
licensed to write business. For example, if the shell has existing
capital and surplus of $5 million and is licensed in 10 states, the
buyer will need to deliver $5.5 million to the seller at closing. This
assumes that the seller will sell the licenses for $50,000 per state.
The price paid for a license depends on the number of licenses
carried by the shell, and, of course, where the shell is licensed to
write business. Highly populated states such as California, New York and
Florida typically are priced at a premium when compared to other
states. Usually license prices are in direct proportion to the
population of the state. The most costly shells are those licensed in
all or most of the 50 states and the District of Columbia. Over the past
nine months, the prices of these licenses have been, on average,
$139,233 and as high as $250,000. Conversely, shells licensed in less
than 30 states are generally sold for approximately $60,000 – $65,000
per state license.
How to proceed?
What else should be considered when acquiring a shell?
First, it is important to understand that some states have minimum
capital requirements. Ratings from A.M. Best are also a key issue. A
company unable to get the appropriate rating may not be able to write
business directly and instead must settle on a fronting carrier. This
would revert to paying the fronting fees of 6-10 percent.
Also, how much additional capital is needed to support the new
business that goes into the shell? What levels of net written premiums
to surplus ratio must be maintained going forward? If you can bring
significant premium volume, perhaps a large capital raise from a private
equity group is worth exploring.
The real key is in knowing all the issues that must be addressed to
insure ultimate success. The considerations can be intimidating unless
the buyer fully understands the process. If this expertise is not
available in house, the broker would be wise to hire an advisor that has
been through the process, understands the regulatory issues and
comprehends capital and ratings requirements.
In the event start up capital may not be readily available, there are
ways to obtain this funding. In many cases, this is not an
insurmountable issue but it does require expertise and experience in
dealing with the capital markets. Access to capital will depend on the
broker’s success record, the strength of management, the business plan
and the amount required as well as the proper relationships with
investors.
Undertaking the start up of an insurance company, although daunting,
is not an insurmountable objective for brokers who are qualified,
capitalized and well advised.