Reciprocal Insurance Exchange

Reciprocal insurance exchanges are a form of insurance organization in which individuals and businesses exchange insurance contracts and spread the risks associated with those contracts among themselves. Policyholders of a reciprocal insurance exchange are referred to as subscribers.

A reciprocal insurance exchange is formed by bringing together two separate entities: a reciprocal inter-insurance exchange and an attorney-in-fact (AIF). The reciprocal inter-insurance exchange is used to allow subscribers to exchange policies through the attorney-in-fact, which allows them to spread around risk. The attorney-in-fact is authorized to perform business transactions on behalf of another entity, which, in this case, is the reciprocal insurance company. The AIF runs the day-to-day operations of the reciprocal and is provided with a power of attorney status by the reciprocal. The AIF may be owned by the reciprocal, referred to as a proprietary reciprocal, or may be contracted from a third party, referred to as a non-proprietary reciprocal.

A board of governors manages a reciprocal insurance company. The board is responsible for choosing and monitoring the attorney-in-fact, approving rates, and providing oversight of the operations of the reciprocal. Surpluses from premiums are held in separate surplus accounts devoted to a specific purpose, though the accounts can be commingled and used to pay claims against the policies.

Reciprocal insurance companies can issue both assessable and non-assessable policies, with the latter being the most common policy issued. A non-assessable policy keeps the policyholder from being charged additional amount of money if the cost of operating the reciprocal is higher than expected. This means that the financial liabilities of the policyholder are limited to the cost of the policy.

A reciprocal insurance exchange is different than a mutual insurance company, in which individuals and businesses with similar insurance needs, such as doctors, come together to pool risks and obtain better rates.

Reciprocal insurance exchanges got their start in 1881, when six dry-good merchants in New York agreed to indemnify each other because of their shared discontent with insurance companies. This group's members all had buildings of superior construction and maintained them well, but they were all charged premiums that did not correspond to the potential losses for similar commercial buildings. At the time, insurance companies applied broad strokes in their classification of risk; modern rate-setting techniques hadn't quite been developed yet. Able to absorb certain losses, the merchants had the incentive and ability to “self-insure” to lower their costs.