Investment Mistakes that Dealers Make in the Reinsurance Process

Creating your own reinsurance company involves several players, including your agent, reinsurance program administrator, and financial advisor. The stakes are high and the reinsurance process is somewhat complicated, so it pays to be aware of the common mistakes other dealers make  — and avoid repeating them.

Not understanding your investment policy statement (IPS)

One of the most common mistakes dealers make is signing an investment policy statement (IPS) without really understanding what they’re agreeing to. The IPS contains specific rules and limitations regarding how the required reserves in your reinsurance account can be invested. For example, some IPS documents limit the percentage of funds in your account that can be invested in equity markets, where the potential for earnings is greatest.

The IPS can also govern whether or not you are able to open up a surplus account into which the administrator can sweep your earned reserves, where you could have greater control over how they are invested. The IPS may also specify other investment vehicles that limit your options, such as a fund-held structure, where the administrator of the program holds your money and pays you a T-bill rate (significantly lower than the return you could historically expect from having funds invested in equities). Dealers who have signed off on such details are often surprised when they realize that they’ve agreed to an arrangement that isn’t as flexible as they expected.

Your financial advisor can still advise and help you in the reinsurance process, but they will always be limited by what your IPS says. So my advice is to carefully read your IPS, understand it, and make sure it’s suitable for your needs — and only then should you sign it.

Assuming that any financial advisor can provide you the help you need

There are many aspects of reinsurance investment that require both an advisor with direct experience, and a capable reinsurance program administrator. I’ve heard too many stories of dealers who have given the go-ahead to their investment advisor to initiate the process of setting up the reinsurance company, only to learn that the broker-dealer they were using was unfamiliar with the process and related paperwork. This can delay action for weeks or even months — and every week that passes, the dealer is missing out on the opportunity for investment returns.

In selecting a financial advisor, it’s important to ask whether he/she has specific experience in reinsurance investment strategy. Many dealers focus instead on such questions as what the advisor’s fees will be and what the expected rate of return is. In my experience, those questions should come later in the process, after you have vetted the advisor and determined that he/she has the experience needed to handle your investment strategy and set-up.

At a minimum, the advisor should ask to see your IPS and review it with you to understand what limitations there are in terms of your investment options. In addition, the advisor should ask you the types of questions that investment advisors ask all of their clients, such as: your objectives for the money; how and when you expect to use it; your risk tolerance; and your overall financial situation and investing experience.

Managing your reinsurance without adequate strategy and planning

Many dealers who are new to having the reinsurance process face a learning curve in terms of how to use their money. When we work with new clients, we always ask how and when they plan to access the funds — and whether it’s to purchase another dealership, build a new parking lot, or other purposes. The answers will govern how we recommend the money be invested.

For example, if a dealer is going to need to access significant funds in the immediate future, we would avoid putting them at risk by investing in the stock market. Other strategic decisions include if and when to open a surplus account, or evaluating the ratio of earned to under premiums, and adjusting investment allocations accordingly.

Learn from others’ mistakes, and proceed with confidence

Despite the potential pitfalls described here, there are many compelling business reasons for auto dealers to create their own reinsurance company, including more control over their money, the potential for significantly higher returns, and greater financial leverage that can help them improve their business or address personal financial needs.