Should I Reinsure My CPI Program?
Should you reinsure your Collateral Protection Insurance program?
If you purchase Collateral Protection Insurance for your finance or lease portfolio and you’re wondering whether to reinsure the risk, the short answer is Heck YES (the caps tell you I’m shouting at you over the internet). Of course, there is a more nuanced answer, that socks up a few more words. Bear with me for a few hundred words while I try to make my point.
Reinsurance is an excellent way to take ownership of the underwriting results of your insurance program. This is all the more true with products like CPI, that tend to have stable, predictable results over time. Yes, it requires the fortitude to choke down the occasional bad month or quarter, but underwriting losses – even short-term losses - are the rare exceptions that prove the rule: CPI is a profitable line of coverage.
What is reinsurance?
If you are new to reinsurance, think of it as a way to transfer risk from one insurance company to another. It’s “insurance for insurers.” A reinsurer assumes the contractual obligations of an insurance policy issued by the insurer, and in exchange receives a premium payment from the insurer. Under the most basic type of reinsurance agreement – the type used with CPI – the reinsurer takes over 100% of the insurer’s policy liability in return for 100% of the original premium, minus a ceding fee retained by the insurer. The ceding fee compensates the insurer for its role in the process, which in most is one the reinsurer may not legally undertake. More on that later
Most reinsurance companies (at least those in the auto F&I space) are formed in Turks and Caicos Islands. Depending on your personality type, this may sound exciting or nauseatingly risky. It’s neither. Despite the Caribbean address, these companies are no more exotic than that 529 college savings plan you’ve been meaning to open for your niece. They file U.S. federal tax returns and bank on Main Street, USA. The popularity of Turks & Caicos has nothing to do with secretive offshore wealth accumulation and everything to do with the British territory’s rock solid insurance regulatory infrastructure and its attractively low capital requirements for reinsurance companies. Everything you can do in Turks and Caicos you can do in several U.S. states. It will just cost a lot more to do it. And the weather is probably better in Turks.
The formation and management of reinsurance companies is a topic that deserves more attention than is available here. A number of excellent firms specialize this niche. Berkshire Risk is not among them, but we are always happy to make an introduction. It pays to use an expert. If your accountant brother-in-law claims he can save you some money because “how hard can it be?” politely change the subject.
How a reinsured CPI program operates
They say a picture is worth a thousand words, and we’ve used up a lot of words already, so we’ll try a picture in the interest of conservation. The chart below depicts the risk transfers as they occur in Berkshire Risk’s reinsured CPI program.
1. Insurance relationship – The dealer/FiCo pays premium to the insurer and the insurer pays covered claims, all of this managed by Berkshire Risk.
2. Reinsurance relationship #1: Reinsurance Treaty – The insurer transfers the policy liability and premium to Tallgrass per a master reinsurance treaty, with underwriting profit/loss settled monthly based on claims activity.
3. Reinsurance relationship #2: Retrocession – Tallgrass settles underwriting profit/loss with dealer/FiCo reinsurance company.
Why do you need the insurance company?
If your reinsurance company is taking all the risk, do you really need the insurer? The answer is yes, you do, and there a few reasons why this is so. For starters, insurance and reinsurance are different lines of business with different regulatory oversight. A reinsurance license does not authorize the licensee to issue a policy. State insurance codes deliver endless additional complications. The unavoidable reality is that the company issuing the CPI policy must be an insurer licensed to do so by your state insurance department.
If this post raised as many questions as it answered, it means you’ve paying attention. At Berkshire Risk Services, we love to talk about this stuff. Call or email with your questions, thoughts, and adoring calls for more posts on the exciting world of insurance.
