A reciprocal inter-insurance exchange is an unincorporated association in which policyholders exchange insurance policies to spread around risk by pooling their money together. In the reciprocal setup, the carrier is owned by policyholders, but managed by an attorney-in-fact. Policyholders of a reciprocal insurance exchange can be individuals, partnerships or businesses and are referred to as subscribers. A reciprocal inter-insurance exchange is not a "mutual insurance company," which is generally an incorporated entity; rather it is an unincorporated association of subscribing members who exchange contracts of indemnity with each other.
History
Reciprocals began in 1881 when dry-good merchants in New York were discontent with their experience overpaying insurance companies to insure their buildings. They decided to pool their money together and self-insure each other instead. Those store owners had well-maintained buildings, but they were all charged premiums that did not correspond to the potential losses for these buildings and only reflected the way risk was broadly classified in their era. Because the merchants were well-capitalized and could absorb certain losses, they decided to self-insure to lower their insurance costs. Subscribers were able to indemnify each other when a member suffered some type of loss, but that led to delays in resolving claims and issuing payments to affected members. Reciprocals then began in the form of insurance organizations to address this problem.
Principles
A reciprocal insurance carrier consists of two separate legal entities: a reciprocal inter-insurance exchange and an attorney-in-fact. The reciprocal is used to allow subscribers to exchange indemnity contracts among themselves, through the medium of a common attorney-in-fact, which allows them to spread risk around. The attorney-in-fact holds a power of attorney status over the reciprocal and is authorized to administer the reciprocal exchange and run the day-to-day operations of the carrier, including issuing policies, managing investments and handling claims. The attorney-in-fact may be an individual, partnership or corporate entity. The attorney-in-fact receives payment from commissions and fees. The AIF may be owned by the reciprocal or contracted from a third party. A reciprocal insurance exchange is managed by a board of governors that is responsible for choosing and monitoring the attorney-in-fact, approving rates and overseeing the reciprocal exchange. Reciprocal insurance policies are typically nonassessable, keeping the policyholder from being charged an additional amount of money if the cost of operating the reciprocal exchange is higher than expected. Reciprocals also issue assessable policies.
Capital
Capital in an unincorporated reciprocal inter-insurance exchange is provided by the subscribing members' current payments which are not called "premium" but rather "premium deposits".
The McCarran–Ferguson Act, 15 U.S.C. 20, mandates that U.S. insurance companies may only be regulated by the individual states. There is a considerable variation in how state law refers to reciprocal exchanges. Some states have specific laws governing reciprocal exchanges, while others subsume regulation of reciprocal exchanges under the regulations governing "captive insurers".
Creation of an exchange
A reciprocal inter-insurance exchange may be operated directly by its policyholders. In theory, a small group of individuals could band together to "cross insure" each other on an informal basis. A group of 20 stock-car racers, for example, could agree to cross-indemnify each other for damage to each of the 20 cars owned by the individual racing members: at the end of each race, the racers would have agreed to pass the hat to fund the repairs of the car damaged in that race. Such an arrangement might be unlawful under some state insurance codes.
