Reciprocal insurance exchange is the formation of an association of entities, with each member of the association taking the risk of the other. Profits and losses are divided proportionally to the amount of insurance that a member has. This agreement is similar to a mutual insurance company, owned by the insured and puts the premium dollars received into a pool, which is used to pay the claims. Members of the reciprocal are called subscribers rather than policyholders.
The concept behind a reciprocal insurance company is that since all premium dollars collected from association members are used to pay for the losses suffered by association members, each member is both an insurer and an insured. All decisions are made in-house, without going through the board, and the association can decide its own direction without outside interference.
Back-and-forth exchanges first appeared more than a hundred years ago. Generally, they include groups of people who work in the same business, such as dry goods dealers, who have chosen to exchange insurance policies with each other instead of using a regular insurance company. Their main goal is to protect their business from fire damage. When one of the members suffers a loss, money will be collected from each subscriber in proportion to the amount of their personal contribution.
Reciprocal Exchange consists of two components: Reciprocal Interinsurance Exchange and Lawyer in Practice (AIF). An exchange is an actual insurance company that is managed by the Board of Governors and offers policies and procedures. The AIF is a separate legal entity selected by the Board of Governors and manages the day-to-day operations of its partners.
The advantages of reciprocal exchange are mainly related to the AIF. The AIF owner is not required to be the contract holder of the exchange, therefore, it does not bear any risks of the exchange. Because it is an entity separate from the exchange, it creates its own value based on the revenue stream it generates, minus operating costs, so it can increase its value by recruiting new members.
One disadvantage of back-and-forth exchanges is that it can be difficult to raise the funds needed to expand the business. In addition, because it consists of two separate units, the cost may be greater than the cost for only one company. Due to the nature of the business agreement, reciprocal parties tend to be more scrutinized by insurance regulators, and if the exchange is sold, it often requires a complete reorganization of the units.