Share the Risk, Share the Wealth.

Agency rent-a-captives can help good businesses keep insurance affordable.

Just months ago, most of us were confident that the long-awaited firming market was finally here. But the Sept. 11 terrorist attacks have rapidly exacerbated normal market forces, and businesses now are facing the fallout that these attacks will have on insurance.

Insurers also are dealing with what many across the nation are experiencing--the loss of family, friends and business associates, as well as the loss of a general sense of security. Each day continues to bring its own issues that require immediate attention. But we know that the American psyche is strong, and we are preparing now for the rebuilding that will emerge from this difficult time.

A few years ago, the industry suffered from too much capital chasing too few business opportunities. The result was a very soft property/casualty market with prices dropping below loss costs. In the wake of the terrorist attacks, many are anticipating a reduction in capacity and pressure on prices. And this is likely to accelerate the hardening of the market.

One way to add more capacity and reap the benefits of better underwriting is to allow agents to share in the rewards of good risk evaluation. An agency rent-a-captive program would do this and more.

In an agency rent-a-captive, an insurance company and an agent work as partners, with the agency putting up some of the capital and sharing in the program's loss experience. The insurer usually provides most of the expertise, but both parties are closely involved in the program's risk selection, underwriting and pricing. While large brokers might opt to set up their own captives, most agencies will find that using an existing rent-a-captive facility can save them up to 75% in costs.

An agency rent-a-captive also can help keep insurance costs to a more affordable level. With this arrangement, an account's individual risk characteristics are reflected in more precise pricing, tailored coverage and responsive services than if it were handled on a more traditional basis. Thus, a better-than-average business in a tough class could be rewarded by paying rates more closely tied to its own performance rather than to the industry in which it does business.

While captives and rent-a-captives may seem mysterious and complicated, they're actually straightforward business arrangements that have been around for years. Agencies assume a share of the financial risk, but gain an opportunity to earn revenue far greater than normally available to them under a traditional contingency program. The greater the agency's risk assumption, the greater the potential reward. A preferred book of business in a good program can bring the agency as much as 50% or more revenue from underwriting profit and investment income.

Captives can involve almost any coverage, but usually involve frequency-driven commercial casualty coverages such as workers' compensation, general liability, auto liability and other niche coverages.

Agency captives generally are established in four steps:

* The agency identifies a preferred book of business and an insurance company partner willing to share the insurance results. This could include homogeneous or heterogeneous accounts, or both. Together, they must outline a program selection and administration plan that meets the requirements of policyholders, the agency and the carrier. For added stability, most captive programs generally have annual written premiums in excess of $3 million.

* The agency next determines how much risk it is willing to assume, taking into account its current business needs and its risk-reward appetite. Many programs allow an agency to reevaluate this decision each year to reflect its current business needs. Agency risk is generally limited through a combination of specific and aggregate reinsurance purchases.

* The agent must provide the capital required to support the premium-to-surplus requirement of the captive or rent-a-captive. Options include cash, letters of credit or paying a percentage to borrow surplus in a rent-a-captive.

* Finally, the agency provides collateral for its risk in the program, referred to as the "program gap." This is the difference between the captive's loss fund and the aggregate insurance trigger. Each subsequent program year also will have a gap established, requiring additional collateral. As losses are known, collateral posted for prior years is reduced.

In coming months, many carriers could take a tough, comprehensive approach to risk selection, pricing and renewal terms and conditions. Agents may find less distinction being made between profitable and unprofitable business. In some circumstances, a rent-a-captive can offer the best option for minimizing the effects of the hardening market on profitable businesses.

Judith A. Blades, a Best's Review columnist, is president of business insurance at The Hartford Financial Services Group, Hartford, Conn.