Reciprocals finding favour but not for everyone

With at least five reciprocal exchanges having launched this year, interest in the structures – especially in homeowners property – is at an all-time high, even as some observers question the model’s long-term success beyond major players such as USAA and Erie.

Reciprocals are again finding favour with a plethora of recent start-ups, largely in response to dislocation in the US property market, with the heavily reinsurance-backed vehicles proving particularly popular in southern coastal states.

Reciprocals have long operated in the US P&C industry, with early examples launched in the late 19th century.

While they are broadly similar to mutuals, reciprocals differ in that the policyholders within an exchange are both insurer and insured, and share in profits and losses in proportion to their premium payments.

Each reciprocal is managed by an attorney-in-fact (AIF) that operates the business in exchange for a pre-agreed fee.

It is hard to know precisely how many reciprocals are operating in the US. Alirt Insurance Research recently estimated 64 companies were operating as pure reciprocals at the end of 2023, while Insurance Advisory Partners managing partner and co-founder Tony Ursano told The Insurer TV earlier this year “there are approximately 100 reciprocal exchanges that exist in the US today”.

Despite that uncertainty, reciprocals are clearly once again in the spotlight given the number of launches in recent years.

The 64 reciprocals Alirt tallied collectively wrote $44bn of direct premiums written (DPW) in 2023, some 5 percent of total US DPW. The current market remains top heavy, with more than 70 percent of DPW generated by the five largest reciprocals – USAA, Farmers, Erie Insurance, Auto Club and CSAA.

Beyond that quintet, only four reciprocals wrote over $1bn in DPW last year, a group that included two Farmers subsidiaries, along with Privilege Underwriters Reciprocal Exchange, or PURE, which was acquired by Tokio Marine in 2020, and Texas Farm Bureau Underwriters.

The majority of reciprocals operating in the US – 70 percent – are focused on personal lines, with auto and homeowners the focus of those, while in commercial lines, multi-peril and commercial auto are the two major classes.

Alirt’s research shows that the current reciprocals market largely comprises companies founded over 20 years ago, with 40 of the 64 active entities it tracks having been established before 2000.

Between 1995 and 2010, 20 reciprocals were formed, and of those, eight have since ceased operations, Alirt said.

From 2009 to 2016, no new reciprocals formed, but since 2017 “there has been a slew of new entrants adopting the reciprocal model”.

Between 2017 and 2024, Alirt has recorded 21 new reciprocals being formed, of which 20 remain active.

The first of the recent spate of launches was Vault in 2017, which launched with $100mn of capital from Allied World and Hudson Structured Capital Management with a business plan focused on the fast-growing high-net-worth (HNW) market.

Following Vault’s formation, there has been a wave of other reciprocals formed by sponsors including Kin, Branch, SageSure, Marsh McLennan, Palomar and HCI, among many others.

The launch of the Kin Interinsurance Network in 2019 was, according to Alirt, the second reciprocal to be formed in the recent wave.

Many of the newer reciprocals have launched to address concerns around property coverage in the Gulf states and other high-risk states such as California.

The start-ups are often supported by capital infusions in the form of surplus notes, which are in turn backed in part by investors including private equity firms, hedge funds and ILS investors that, Alirt said, are banking on them to generate sufficient earnings over time to pay down their investments.

“The sustainability of this trend may well depend on the success of the RIEs that have formed in the last few years.

“If these insurers struggle, it may hinder the flow of capital to new entities, pressuring both policyholders and insurance companies in these coastal property markets,” Alirt said.

Reciprocals not a panacea

According to Kin CEO and founder Sean Harper, the reciprocal model, when run in a sustainable way by an AIF with both meaningful competitive differentiation and positive unit economics, “can result in very good outcomes for the consumers and a high-margin business for the management company”.

“Erie and PURE are firms with strong franchises and (presumably) significant differentiation that got them there,” said Harper in a recent series of social media posts.

“PURE entered the HNW market after it had consolidated to a single player and had a lot of pent-up demand for a second option.

“They executed well against that opportunity and were rewarded with a decent exit,” he added.

However, Harper said the reciprocal model is not a fix-all solution to struggling market segments.

“Converting to reciprocal exchanges has done little for the valuation of Kemper and Porch/Homeowners of America. I take that as evidence that investors are savvy to the idea that this structural change isn't a panacea,” he said.

“I actually think for many businesses, the reciprocal exchange is a pretty bad business model, because you are literally giving away the underwriting income and investment income to the customers,” Harper noted.

Alirt concern

Alirt also voiced concerns, and said reciprocals are largely based on the concept of “playing with other people’s money”.

“In short, with less investor/manager funds tied up in these insurers, there may be an incentive to opportunistically generate premium in difficult property insurance markets,” Alirt said.

“This is especially true where these interests are generating fees based, in part, on overall premium volume.”

And the research firm noted that, with many of the new entrants focused on catastrophe-prone states, they are vulnerable to the volatile results associated with underwriting in those regions while at the same time dealing with a hard reinsurance market.

The recent struggles of American Mobile Insurance Exchange – which launched in 2021 but then exited the Florida market in April this year – are a reminder of the potential risks facing this new crop of reciprocals, Alirt said.

Despite Harper’s note of caution about reciprocals not being for everyone, the model continues to generate plenty of interest.

Ursano in his interview with The Insurer TV said he expected up to 10 new exchanges in 2024 based on the mandates and interest his firm had seen.

Alirt’s research shows three have launched in 2024 – Manatee, Auros (the launch of which sister title Program Manager revealed) and Ovation Home – while in recent months, The Insurer’s stable of titles has reported on several others coming to market, or in the process of opening for business.

Those include the Maria Moller-led Trident Reciprocal Exchange – the ninth new property insurer in Florida since the Sunshine State’s far-reaching legislative reforms in 2023; Porch Group’s new Texas-based reciprocal to assume business from its Homeowners of America platform; auto insurtech Clearcover’s new exchange; and Star Vantage Reciprocal Exchange, which began taking on business in Mississippi and other coastal states from 1 July.