In the past, if your vehicle manufacturer ran what is known as a retro account (which some people confuse with actual reinsurance), they paid you a certain amount for each warranty you sold. You received that money as ordinary income, either at the dealership or personal level, and it was taxed accordingly. Essentially, all you needed to do was sell the warranties, and the manufacturer paid you commissions.
In comparison, when you own a reinsurance company, those same premiums go into your reinsurance account in a tax-advantaged way. You only pay income tax as you earn investment income (including realized gains, dividends, and interest income) and when you take a dividend from the earned premium. The timing of taxable dividends from earned premium is within your control. When you decide to take a dividend from your reinsurance company, you’re taxed at what’s called the qualified dividend rate, which is currently the same as the long-term capital gain rate. Under this tax structure, more of your premiums can be invested.
Once you decide to manage your own reinsurance company, you may face a bit of a learning curve. There will be new types of decisions you’ll need to start making to protect your interests and ensure a smooth-running program. You’ll also need an overarching financial and reinsurance strategy that treats your reinsurance company as a key financial resource that can help you in the immediate future, as customers file claims against their warranties. It will also help you far into the future, when the money is earned out and is yours to withdraw and use as you choose.
Another change is that when you run your own reinsurance company, it’s your money, and you’re in control of it. It’s up to you, your agent and your financial advisor as to how to manage it so that it coordinates with your broader financial strategy. Your agent can continue to serve as your consultant, not only helping to train your F&I department on the new system, but also helping you keep your reinsurance company operating properly by going over all its nuances on a quarterly basis. Your financial advisor, meanwhile, will be focused on understanding your broader financial and investment needs, and configuring your reinsurance account to accommodate your needs, risk tolerance, and so on.
It’s very important for you, your agent and your financial advisor to have a good working relationship, and the ability to collaborate on the various financial decisions that affect your dealership, your reinsurance company, and your own financial position. This coordination of advice about your reinsurance strategy is critical to the company’s financial success. For example, if you know that in six months you’re going to need to borrow $500,000 for a major expansion, you would want the advisor and agent to coordinate your cash flow so that assets are allocated properly.
One of your first encounters with your new-found responsibility as owner of your own reinsurance company is when you’re going through your quarterly reviews, or cession statements. Typically, you’re looking at each of your specific line items and products that you’re selling. Ideally, each is connected to a brokerage account holding the reinsurance funds, with corresponding investment income.
You’re also reviewing loss ratios for each, and making appropriate adjustments. For example, you might decide you need to raise prices on a particular warranty in order to make it profitable at the loss ratio that you want to maintain. Suppose you’ve been charging $1,400 for a five-year, 100,000 mile GM powertrain warranty. If your loss ratio should be 38%, but it’s coming in at 65%, you might need to raise the premium to, say, $1,500.
Best of all, with the funds in your reinsurance company properly managed, the returns on your investments could potentially pay for claims made against the warranties you’ve sold, all while investing the premiums in a tax-efficient manner.
Making the decision to establish your own reinsurance company might seem a little overwhelming, but by working carefully with your agent and financial advisor, it’s extremely doable. It can provide significant improvements in the financial picture of not only your dealership, but in your and your family’s personal finances as well.