Everything You Should Know About Reciprocal Insurance Exchanges
Updated June 4, 2021
Reading time: 7 minutes
When searching for a new insurance provider, most homeowners will look into policy options, insurance coverage amounts, and annual premiums. This makes sense; there’s a lot to look for when researching new policies, and making sure you have enough coverage at a reasonable cost is important. But many people don’t realize that the structure of an insurance provider can also affect insurance policies, especially when it comes to coverage and costs.
Sorting through stock insurance companies, mutual insurance companies, and reciprocal insurance exchanges can be confusing. Each of these types of insurance organizations offers similar insurance policies but with various benefits and levels of involvement for policyholders. The insurer you choose depends on factors like your insurance needs and whether you prefer to have a stake in your insurance provider’s operations.
Feeling overwhelmed already? That’s why Insurify is here to help. We’ll walk you through the basics of reciprocal insurance exchanges. Then you can use Insurify’s homeowners insurance comparison tools to find the best insurance policy, price, and provider for you in just minutes.
Before we get into the basics of reciprocal insurance exchanges, let’s talk about the difference in insurance company structures. The primary difference between these structures is who owns the insurance company, but this difference can greatly affect how an insurance organization is run and who it’s run for.
Even if you’re new to navigating the insurance market, you’re probably familiar with (or have at least heard about) the main types of insurance structures: stock insurance companies and mutual insurance companies.
Stock insurance companies are owned by—you guessed it—stockholders. These companies are either privately or publicly shared, meaning that stock in the company is either limited to being purchased by select companies and individuals or shared openly for anyone to buy-in. Stockholders keep these insurance companies up and running, providing funds that help ensure policyholders are covered when filing insurance claims and covering the costs of running the organizations. Because of this, stock insurance companies are run with the primary intention of gaining profit for stockholders. Still, most companies will try to offer policies that appeal to customers in order to stay competitive with other insurance providers so they can increase their number of policyholders and, therefore, profits. Insurers owned by stockholders include Allstate, Progressive, and MetLife. These companies are often well-known for their reliability due to the stockholders’ funding.
Mutual insurance carriers are the next most common type of insurance provider. These companies are owned by policyholders rather than stockholders. The main reason policyholders own these companies is because policyholders are actually the ones who create these companies. Individuals and businesses with similar insurance needs (like healthcare workers or legal professionals) will come together to create mutual insurance companies that can adequately serve their shared, unique needs. Compared to how stock insurance companies seek to make profits for their stockholders, mutual insurance companies seek to minimize insurance costs for policyholders. This is possible because policyholders own the company and vote for board of directors members. From there, the board will choose managers, and the managers and board run the company on behalf of the policyholders. Mutual insurance companies take any profits (known in the insurance industry as dividends) they make and either save the dividends to be used when policyholders file insurance claims or distribute the profits annually among policyholders. Mutual insurance companies include State Farm and Liberty Mutual.
Reciprocal insurance exchanges—also known as reciprocal inter-insurance exchanges—are simply another way to structure insurance organizations. Similarly to how mutual insurance companies work, policyholders own reciprocal insurance exchanges. Multiple reciprocal insurance exchange characteristics differentiate the organizations from mutual insurance providers, including the fact that reciprocals aren’t always built on shared interests or needs. The nature of reciprocal insurers’ insurance contracts is one of the most unique aspects of the structure. Reciprocal insurance exchanges are, quite literally, exchanges of insurance contracts between policyholders, who are referred to as subscribers. When a subscriber purchases a policy, they are exchanging contracts with other subscribers, which means they simultaneously receive insurance coverage and become a partial owner of the organization. Essentially, each subscriber is both the insurer (in providing insurance coverage for other subscribers) and the insured (in receiving coverage from the group). In this exchange, each policyholder covers the others, pooling together resources if a subscriber faces perils. Reciprocal insurers include Farmers Insurance and USAA.
Reciprocal inter-insurance exchanges are unincorporated associations, meaning that they do not go through the legal process to become companies and are not legally separated from their owners. This makes sense since subscribers are both the customers and owners of the exchange. This also means that legally speaking, reciprocals are not considered reciprocal insurance companies—they are simply exchanges of insurance contracts between members.
Similarly to mutual insurance policyholders, subscribers will choose the organization’s board of governors, which acts as an advisory committee. Since subscribers both own and are served by the reciprocal insurance exchange, reciprocals need a third party to sign contracts and act as an underwriter. The board of governors is then in charge of choosing an attorney-in-fact (AIF), an individual or corporation paid to handle these day-to-day operations of the exchange. This means that the AIF is in charge of issuing policies, handling claims, and managing the underwriting (price-setting) process. Attorneys-in-fact have power of attorney through the inter-insurance exchange. And AIFs may either be owned by the reciprocal insurer, known as proprietary reciprocals or contracted through a third party, known as non-proprietary reciprocals.
Reciprocal insurance exchanges most often issue what are known as nonassessable policies. These insurance policies ensure that if the reciprocal’s operating costs end up being higher than expected, subscribers will not be charged more to offset these costs. (While some reciprocals will issue assessable policies, they are far less common.)
A subscriber’s insurance policy through a reciprocal insurance exchange determines more than just the amount of insurance coverage they have. The cost of a subscriber’s insurance premium—known by reciprocals as a premium deposit—will affect the subscriber’s amount of coverage, how much they receive in annual dividends (if distributed), and even how much they are subject to lose when another subscriber files an insurance claim.
Another major difference between mutual insurance companies and reciprocals is who—or what entity—takes on risks. In mutual companies, the insurance company takes on any risks or losses caused by policyholders’ insurance claims. But since reciprocal insurance exchanges are meant to divide risk management and indemnity among subscribers in case of potential losses, each subscriber protects the others, meaning that the risk is on the subscribers. This also means that when one subscriber takes a hit and has to file an insurance claim, the other subscribers pay for this loss through the cost of their premium deposit.
The first reciprocal inter-insurance exchange started in 1881 in New York. A group of dry-good merchants were not satisfied with their one-size-fits-all insurance policies and felt like they were overpaying for insurance coverage that they didn’t need. So the six business owners decided to pool their risks and exchange insurance contracts among themselves. This allowed the merchants to rid themselves of costly insurance premiums while insuring themselves and one another through their subscribers’ agreements.
It’s clear why a small group of merchants would choose to insure one another and risk-taking on the others’ potential losses for lower rates in the 1800s. But how can you know if a reciprocal inter-insurance exchange is right for you? And what does becoming a subscriber entail nearly 140 years after the creation of the first reciprocal insurance exchange?
First, it’s important to note that the main purpose of reciprocal insurance exchanges still stands true today: to save subscribers money on costly premiums.
When comparing reciprocals with stock or mutual insurance companies, one main difference to consider is the insurer’s reason for providing insurance. With a reciprocal insurance exchange, subscribers are the insurers, but they insure others to receive protection in return, not to receive profits for themselves. In stock insurance companies, on the other hand, the insurers are providing coverage in order to make a profit. While this may not directly affect the quality of your insurance coverage, it may be reflected in your annual premiums.
Another benefit of becoming a reciprocal subscriber is that you are a partial owner of the company, so your opinion can help make a difference in the way the reciprocal is run. Still, subscribers in 2021 won’t see as much responsibility as the founders of reciprocal insurance exchanges had. Liability for reciprocal subscribers is limited, meaning you are protected from being held responsible for other subscribers’ insurance claims, and you can generally rest assured that you won’t need to be concerned with powers of attorney like reciprocal subscribers in 1881.
But every rose has its thorns, and it’s important to do your research before jumping headfirst into a policy with a reciprocal insurance exchange.
Newer reciprocals can face more setbacks than new stock insurance companies, for example. This is primarily because a reciprocal’s net worth is dependent on the number of subscribers it has. A new reciprocal with few subscribers may not be able to support its subscribers’ coverage needs.
Another reason reciprocals can be riskier options is that they are made up of two entities, the reciprocal insurance exchange (owned by subscribers, managed by a board of governors) and the attorney-in-fact. This means that reciprocals need to cover the cost of insuring subscribers, running an organization, and the cost of the reciprocal’s AIF. These costs, along with the risk of not having enough subscribers to insure everyone, can leave reciprocals posing more risks for subscribers than rewards.
Still, some long-standing reciprocal insurance exchanges, like Farmers Insurance, are just as reliable as any other mutual or stock insurance provider. The best way to judge the financial reliability of an insurer is to check its A.M. Best rating. That way, you can know whether a certain reciprocal insurance exchange is well equipped to provide for your insurance needs.
Looking into your insurance provider’s structure can be confusing. That’s why Insurify answered some of the most frequently asked questions about reciprocal insurance exchanges to help you find some clarity in the chaotic insurance industry.
The primary risk of being an inter-insurance exchange subscriber is the structure’s pooled losses. If you’re a subscriber to a well established reciprocal, you likely won’t feel the hit of these losses. But subscribers of smaller reciprocals will face the brunt of their fellow subscribers’ insurance claims. This can leave subscribers feeling the high-risk nature of reciprocals and can leave the reciprocal drained of resources for future insurance claims. The best way to mitigate the risks associated with reciprocals is to research insurers before purchasing an insurance policy.
Yes, just like any other insurance provider—regardless of the organization’s structure—all reciprocals are required to follow insurance laws, along with local and state laws regarding insurers. Some states even have specific regulations for reciprocal insurance exchanges, so the laws each reciprocal is required to follow can change from state to state.
Yes, it just depends on the reciprocal. Some reciprocals, like Farmers Insurance, offer life insurance policies, among others. But other reciprocals, like PURE Insurance, offer various insurance policies excluding life insurance.