What You Need to Know about Your Investment Policy Statement

One of the most overlooked — and least understood — aspects of auto dealer reinsurance is the investment policy statement (IPS). It may seem like dry, legalistic fine print, but it’s actually the one document that will most affect how well your reinsurance company meets your needs.

And just as it’s important to understand any contract you sign, knowing the ways an IPS limits your options before you sign can make enormous differences in your financial picture. Here are four essential things to understand about your IPS:

1. It defines your options for how your reinsurance funds are invested. The IPS is prepared by the trustee of your reinsurance company, and aims to ensure that there will be sufficient funds to cover any claims made against warrantees you’ve sold to customers. In a worst-case scenario, you could have insufficient funds to honor your warranty obligations if your portfolio declines in value. As a result, IPS documents tend to be fairly conservative by nature, seeking to reduce volatility in order to protect required reserves. However, there are some trustees who allow a dealer’s financial advisor to invest the money more aggressively.

2. Once you’ve agreed to the IPS, you have to live by its terms. Once the dealer signs the IPS, the dealer and his/her financial advisor must comply with its investment guidelines. If you want more control over how you can invest your reserves, it is important to work with a reinsurance administrator whose IPS provides you with as much investment flexibility as possible from the outset. Remember that you can choose to work with a different agent or reinsurance program if you’re not satisfied with the terms originally offered to you. It’s imperative that you understand and negotiate the terms of your IPS so it meets your needs. It’s a good idea to consult with your financial advisor before signing the IPS.

3. Until recently, most providers didn’t let you control your investments, but now some of them do. One of the reasons many dealers find the investment aspect of reinsurance confusing is that the rules have changed over time. Until recently, a reinsurance company’s trustees were required to meet two essential goals regarding company funds: to generate a positive rate of return, and to beat inflation. Consequently, the only viable strategy was to invest the funds in cash, cash equivalents or in certain cases, bonds — but there were no options to invest in equities. The fact that some trustees now allow portions of reinsurance funds to be invested in equities represents a significant change. If you want to invest a portion of your reserves in equities, you must ensure that your investment policy statement allows it.

4. It’s easy to get distracted by less important details of an IPS, and miss the most important things. It’s smart to take time to understand details like the administrative fees your provider will charge — but in doing so, make sure you don’t neglect the important details specifying how you may invest your money. If your only goal in having your own reinsurance company is to ensure that you have sufficient funds to cover warranty claims, an IPS that limits you to investing in cash, cash equivalents or bonds may be all you need. But for dealers who can afford and accept the risk of investing in equities, including mutual funds and even specific stocks, an IPS that features greater flexibility around investments may be the better solution. If you are in this category, it’s even more important to speak with your agent and financial advisor to discuss an appropriate investment strategy. That strategy should consider the specific ways and timeframes in which you envision using your reinsurance funds.

Your IPS: a decision worth taking your time on

Today, most IPS guidelines regarding investment approaches remain fairly conservative, but there are definitely options to consider. If possible, ask to receive the IPS paperwork at least a few days before you need to sign, and then share it with your financial advisor. You and your advisor can discuss how the proposed IPS’ terms could impact your ability to meet your financial goals — and ultimately help you decide whether the proposed IPS is suitable for you.

Even though some dealers may regard signing an investment policy statement as a no-brainer, there is actually a lot riding on its terms. Potentially, there could be major differences in the rates of return you can earn on your funds, not only in the immediate future, but for years to come. Creating and running your own reinsurance company could be one of the best decisions you ever make for your dealership — and that’s why it’s so important to know exactly what you’re getting into.