What Is a Dealer-Owned Reinsurance Company?

The short answer

Your store sells vehicle service contracts. It may also sell tire and wheel protection and key replacement. A vehicle service contract (VSC) is an optional contract that pays for certain repairs after the sale.

Part of the price of each of these products is set aside to pay future claims. Somebody carries the risk that those claims will cost more, or less, than the money set aside. In most programs, that somebody is a third party.

A dealer-owned reinsurance company changes who carries that risk. It is a separate company that the dealer owns. It takes on, or “reinsures,” the claims risk on the products your own store sells. Reinsurance simply means insurance for an insurance company.

Mercer Capital, a valuation firm that writes about dealerships, describes it this way: the dealer forms a separate entity and keeps the underwriting risk on F&I products instead of passing it to a third party.

This kind of company is a form of “captive” insurance. A captive is an insurance company owned by the business whose risks it covers. State insurance regulators, through the National Association of Insurance Commissioners (NAIC), recognize several types of captives. A dealer-owned reinsurance company is one narrow, specialized use of the idea.

Where it fits in a service contract program

A service contract program has several players. Here is the basic chain:

1. The customer buys an optional contract from your store.
2. The obligor is the company legally responsible for paying covered repairs under that contract.
3. The administrator handles the paperwork, claims and cancellations.
4. The insurer issues a policy that backs the obligor. If the obligor cannot pay, the insurer steps in. This is often called a contractual liability policy.
5. Your reinsurance company takes on the insurer’s risk for the contracts your store sold, under a written reinsurance agreement.

The insurer in step 4 issues the policy but passes the risk to your company. The industry calls this “fronting.” According to IRMI’s glossary, the fronting insurer charges a fee for this role. It also stays responsible on the policy if the reinsurer fails to pay its share.

Because of that, the insurer wants security. The money that backs your company’s share of the risk is typically held in a trust account. A trust account is a separate account, held by an independent trustee, that the reinsurer cannot simply withdraw from. The NAIC’s Credit for Reinsurance Model Regulation sets out rules for trusts that secure reinsurance, including who may act as trustee and what kinds of assets may be held.

What the customer sees

Nothing changes for the customer. The contract, the claims process and the insurer backing stay the same. The customer never deals with your reinsurance company.

The products also stay optional. The CFPB says a lender or dealer generally cannot require a customer to buy an extended warranty to get an auto loan. Owning a reinsurance company should not change how your F&I office presents products.

Why some dealers look at owning one

The underwriting result follows the risk

“Underwriting result” means the premium earned on the contracts, minus the claims and expenses paid on them. It can be a gain or a loss.

Without your own company, that result belongs to whoever carries the risk. With your own company, it belongs to your company. Mercer Capital describes the difference between reserves and claims paid as the underwriting profit when results are good. The same logic means your company absorbs the loss when results are bad.

You see your own numbers

A reinsurance company gets regular reports on the contracts it backs. That means you see your own claims, cancellations and product mix. That information can inform decisions about reconditioning, inventory and which products you offer.

It is a separate company you own

Mercer Capital’s second article looks at how a dealer’s reinsurance company can matter in valuation and estate planning. It is a separate legal entity. How it fits into a sale of the dealership or a family transition depends on how it is set up.

The honest trade-offs

A dealer-owned reinsurance company is not right for every store. Before going further, weigh these points:

• Real risk of loss. If claims run higher than expected, your company pays its share. A bad claims year can wipe out a good one.
• Money is tied up for years. Premium sits in reserves until the coverage it pays for has been provided. A multi-year contract keeps money in reserve for its whole term.
• Paperwork and ongoing costs. The company has its own books, records, board decisions, regulator or insurer reports and annual statements. Someone has to do that work every year.
• It may not fit smaller stores. Mercer Capital cautions that reinsurance adds complexity and risk, and may not suit smaller single-point stores or dealers with limited management bandwidth.

How it differs from a “retro” program

Some programs offer a “retro,” short for retrospective commission. In a retro, the program provider keeps the risk and the company. If your contracts perform well, the provider pays you a share of the results after the fact.

A retro involves less paperwork and less risk for the dealer. But the provider sets the terms, holds the money and controls the timing. With your own reinsurance company, you own the company and carry the risk directly. Neither option is right for everyone.

Names you may hear

You may hear several labels for the same idea: “dealer reinsurance,” “dealer-owned reinsurance company,” “DORC” or simply “your own reinsurance company.” These are trade labels, not legal categories. The exact legal form depends on where the company is formed and how the program is built.

Where Quantum Re fits

Quantum Re is a captive management and consulting company. We help dealers form their own reinsurance company, set up the trust account, and run the company afterward. That includes keeping its books and records and preparing and filing its annual statements.

Quantum Re is not an insurer and not an obligor. It does not pay claims, and it does not sell, place or broker insurance. The reinsurance company belongs to the dealer.

Key takeaways

• A dealer-owned reinsurance company is a separate company you own that takes on the claims risk on the products your store sells.
• The products are still backed by an insurer, and the customer’s contract does not change.
• Your company’s share of the money is typically held in a trust account to secure its obligations.
• The underwriting result, gain or loss, belongs to your company. So does the risk.
• It takes years, reserves and paperwork, and it is not the right fit for every store.