Forming a Dealer-Owned Reinsurance Company, Step by Step

Before you start

A dealer-owned reinsurance company is a separate company you own. It takes on the claims risk on the service contracts and other protection products your store sells.

Forming one is a process, not a single form. Each step builds on the one before it. The exact steps depend on where the company is formed and what the insurer backing your products requires. Below is the general path, in plain English.

Step 1: Feasibility review

The first question is simple: does this make sense for your store?

A feasibility review looks at your real numbers:

• How many contracts you sell each month, and how steadily
• Which products you sell, and on what kinds of vehicles
• Your claims history
• Your cancellation history

An actuary, a specialist in pricing risk, may project how claims could develop. Good projections look at more than the expected case. They also test what happens if claims run worse than planned.

Cash is part of the review too. In a published Captive Review Q&A about forming a captive, the owner listed working out how much cash was needed up front, and understanding the captive manager’s day-to-day work, among the biggest challenges.

The outcome is one of three answers: go ahead, wait and revisit, or do not proceed. All three are legitimate.

Step 2: Decide the company’s form and home

Next, you decide what kind of company it will be and where it will be formed. The place where an insurance company is formed and regulated is called its “domicile.”

This choice depends on several factors:

• The laws that apply in each possible location
• Capital and reporting requirements
• Setup and ongoing costs
• What the insurer backing your products will accept

There is no single right answer for every dealer. The choice is made for your situation, not from a standard template.

Step 3: Formation documents and any application

The company now needs its legal paperwork. This usually includes:

• Formation documents (such as articles of organization or a charter)
• Bylaws or an operating agreement
• An ownership agreement, if there is more than one owner
• Named directors or managers and officers

Where a regulator must approve the company, there is also an application. The Vermont Department of Financial Regulation is one example of how a regulator describes this. Its guidance has applicants choose an approved captive manager, meet with the department early, prepare organizational documents and submit an application package that includes a business plan. Other places have their own rules.

Step 4: The reinsurance agreement

The reinsurance agreement is the contract between the insurer that backs your products and your new company. It is the most important document in the whole arrangement.

The insurer issues the policy that protects customers, then passes the risk to your company. This is called “fronting.” According to IRMI, the fronting insurer charges a fee and remains responsible on its policy if the reinsurer does not pay.

The agreement usually covers:

• Which products and contracts are passed to your company
• The fees the insurer keeps
• What reports your company receives, and how often
• How the money is secured (usually a trust account)
• How and when funds above required reserves may be released
• How the agreement can end, and what happens to existing contracts if it does

Read the termination terms carefully. Ending the agreement does not end your company’s duties on contracts already sold.

Step 5: Trust account and starting capital

Your company’s share of the premium is usually held in a trust account. A trust account is held by an independent trustee. The money in it secures your company’s promises to the insurer.

The NAIC’s Credit for Reinsurance Model Regulation sets out rules for trusts that secure reinsurance. These include who may serve as trustee and which kinds of assets may be held.

Your company may also need starting capital. The amount is set by the insurer’s requirements, a regulator, or both. Reserve money can only be invested within set limits.

Step 6: Start writing business

Once the documents are signed and the trust is open, the program goes live. Your F&I office keeps selling the same optional products, the same way. Contracts are issued by the program. The insurer cedes, or passes on, its share of premium for your contracts to your company, usually into the trust.

From the customer’s point of view, nothing changes.

Step 7: Ongoing management

This is where the long-term work happens. A reinsurance company needs regular care:

• Reviewing reports from the insurer and administrator on contracts, claims and cancellations
• Reconciling the trust account
• Keeping the company’s books and records
• Holding and recording board decisions
• Tracking deadlines on a compliance calendar

This is the work a captive manager typically does. Quantum Re is a captive management and consulting company. We keep the company’s books and records and prepare and file its annual statements. Quantum Re does not pay claims and does not sell, place or broker insurance. The company belongs to the dealer.

Step 8: Annual statements and audits

Each year, the company prepares annual financial statements. Depending on where it is formed and what the insurer requires, these may need to follow a standard insurance reporting format, be filed with a regulator, or be audited by an independent accountant.

Missed deadlines can cause problems with the insurer or regulator, so the calendar matters.

Step 9: Runoff and exit

Every reinsurance company eventually stops taking new business. That might happen when you sell the store, retire or change programs.

Stopping new business does not close the company. It enters runoff: it keeps paying its share of claims on existing contracts until they expire. Other paths can include a commutation, a negotiated lump-sum settlement that ends future obligations, or a transfer of the business to another party. After all obligations end, the company can be dissolved.

Captive.com notes that closing a captive takes planning and coordination with regulators, fronting insurers, actuaries and accountants, and that regulators want to be sure no unexpected claims remain.

Plan for the exit at the start. Mercer Capital’s article on valuation shows why: a dealer’s reinsurance company can matter when a dealership is valued, sold or passed on.

The process at a glance

1. Look: feasibility review of your volume, products, claims and cancellations
2. Decide: the company’s form and where it will be formed
3. Form: legal documents and any regulatory application
4. Sign: the reinsurance agreement with the insurer
5. Fund: open the trust account and provide any starting capital
6. Launch: contracts are sold and premium is ceded to your company
7. Run: ongoing reports, reconciliations, books and annual statements
8. Exit: runoff, commutation or transfer, then dissolution

Timing varies widely with the place of formation, the insurer and how quickly documents come together.

Key takeaways

• Forming a dealer-owned reinsurance company is a series of steps, starting with an honest feasibility review.
• The reinsurance agreement is the central document. Read its fees, reporting and termination terms closely.
• Your company’s share of premium is usually held in a trust account under set rules.
• The company needs ongoing care: books, reports, reconciliations and annual statements.
• Plan the exit from day one. Runoff can last as long as the longest contract.