Tag Archives: underwritng

So Your Start-Up Will Sell Insurance?

Selling insurance is complicated. Not impenetrable, but complicated. The sales process is sort of like a tangled piece of string— it’s easy to see the beginning and end but hard to figure out what’s happening in the middle.

When you start untangling, you’ll find prospect lists, telemarketing, direct mail, traditional marketing and web-based lead generators uncovering and enticing potential customers. You’ll also find captive agents, independent agents or brokers, wholesalers, direct telephone sales, the Internet, affiliates, carriers and carrier-like entities selling various products.

Some of these strategies work in coordination or create feedback loops — a customer sees a TV ad, which prompts him to submit a form online, which adds him to a direct mail list, which points him to an online aggregator, which puts him in touch with an independent agent selling insurance on behalf of a managing general agency… as you can see, the number of distribution permutations is considerable.

However, at American Family Ventures, we appreciate simplicity. We classify insurance distribution start-ups using four groupings: lead generation, agency/brokerage, managing general agency (MGA) and carrier.


As pictured above, the primary distinctions between participants in each group arise from the amount of insurance risk they bear and their control over certain aspects of the insurance transaction (for example, the authority to bind and underwrite insurance policies).

However, many other tradeoffs await insurance start-ups navigating among these four groups. If you consider the evolution of digital customer acquisition, including new channels like mobile-first agencies and incidental channels, choosing a niche becomes even more complicated.

In this post, I’ll discuss some of the key attributes of each group, touching on topics relevant for start-ups new to the insurance ecosystem. Please note, in the interest of time and readability, this post is an overview. In addition, any thoughts on regulatory issues are focused on the U.S. and are not legal advice.


Lead generation refers to the marketing process of building and capturing interest in a product to create a sales pipeline. In the insurance context, because of the high-touch sales process, this historically meant passing interested customers to agents or call-center employees. Today, lead-generation operators sell to a variety of third parties, including online agencies and digital sales platforms.

Let’s consider a few key attributes of lead-generation providers:

Revenue model — There are a variety of lead-selling methods, but the most common is “pay per lead,” where the downstream lead buyer (carrier or channel partner) pays a fixed price for each lead received. When pricing leads, quality plays a big role. Things like customer profile, lead content/data, exclusivity, delivery and volume all affect lead quality, which frequently drives the buyer’s price-sensitivity. As a lead-generation provider, you’ll generally make less per customer than others in the distribution chain, but you’ll also assume less responsibility and risk.

Product breadth — With the Internet and enough money, you can generate leads for just about anything. Ask people who buy keywords for class action lawsuits. However, start-ups should consider which insurance products generate leads at acceptable volumes and margins before committing to the lead-generation model. Some products are highly competitive, like auto insurance, and others might be too obscure for the lead model to scale, like alien abduction insurance (which, unbelievably, is a real thing). Start-ups should also consider whether they possess information about customers or have built a trusted relationship with them — the former is often better-suited to lead generation, and the latter can facilitate an easier transition to agency/brokerage.

Required capabilities (partnerships) — Lead-generation providers need companies to buy their data/leads. Their customers are usually the other distribution groups in this post. Sometimes, they sell information to larger data aggregators, like Axciom, that consolidate lead data for larger buyers. Generators need to show lead quality, volume and uniqueness to secure relationships with lead purchasers, but beyond that they don’t typically require any special partnerships or capabilities.

Regulation — While I won’t go into detail here, lead-generation operators are subject to a variety of consumer protection laws.


Entities in the agency/brokerage group (also called “producers”) come in a variety of forms, including independent agents, brokers, captive agents and wholesale brokers. Of note, most of these forms exist online and offline.

Independent agents represent a number of insurance carriers and can sell a variety of products. Brokerages are very similar to independent agents in their ability to sell a variety of products, but with a legal distinction — they represent the buyer’s interests, whereas agents represent the carriers they work for. Captive agents, as the name suggests, sell products for only one insurer. While this might seem limiting, captive agents can have increased knowledge of products and the minutiae of policies. Finally, some brokers provide services to other agents/brokers that sell directly to customers. These “wholesale brokers” place business brought to them by “retail agents” with carriers, often specializing in unique or difficult placements.

An important difference between the lead-generation group and the agency/brokerage group is the ability to sell and bind policies. Unlike the former, the latter sells insurance directly to the consumer, and in some cases issue binders — temporary coverage that provides protection as the actual policy is finalized and issued.

Some attributes of agencies and brokerages:

Revenue model — Agencies and brokerages generally make money through commissions paid for both new business and on a recurring basis for renewals. The amount you earn in commissions depends on the volume and variety of insurance products you sell. Commission rates vary by product, typically based on the difficulty of making a sale and the value (profitability) of the risk to the insurance carrier. Start-ups should expect to start on the lower end of many commission scales before they can provide evidence of volume and risk quality. Agents and brokers can also be fee-only (paid for service directly and receive no commission), but that’s rare.

Product breadth — Agencies and brokerages sell a variety of products. As a rule, the more complex the product, the more likely the intermediary will include a person (rather than only software). Start-ups should also consider tradeoffs between volume and specialization. For example, personal auto insurance is a large product line, but carriers looking to appoint agents (more detail below) in this category usually have numerous options, including brick and mortar and online/mobile entities. Contrast this with a smaller line like cyber insurance, where carriers may find fewer, specialist distributors who understand unique customer needs and coverages.

Required capabilities (partnerships) — Agencies and brokerages are appointed by carriers. This process is often challenging, particularly for start-ups, which are non-traditional applicants. Expect the appointment process to take a while if the carrier isn’t familiar with your acquisition strategy or business model. Start-ups trying to accelerate the appointment process can start in smaller product markets (e.g. non-standard auto) or seek appointment as a sub-producer. Sub-producers leverage the existing appointments of a independent agency or wholesaler in exchange for sharing commissions. You could also apply for membership in an agency network or cluster — a group of agents/brokers forming a joint venture or association to create collective volume and buying power.

Regulation — Agencies and carriers need a license to sell insurance. Each state has its own licensing requirements, but most involve some coursework, an exam and an application. As we’ve recently seen with Zenefits, most states have a minimum number of study hours required. There are typically separate licenses for property, casualty, life and health insurance. Once you have a license, many states have a streamlined non-resident licensing process, allowing agencies to scale more quickly.


A managing general agent (MGA) is a special type of insurance agent/broker. Unlike traditional agents/brokers, MGAs have underwriting authority. This means that MGAs are (to an extent) allowed to select which parties/risks they will insure. They also can perform other functions ordinarily handled by carriers, like appointing producers/sub-producers and settling claims.

Start-ups often consider setting up an MGA when they possess data or analytical expertise that gives them an underwriting advantage vs. traditional carriers. The MGA structure allows the start-up more control over the underwriting process, participation in the upside of selecting good risks and influence over the entire insurance experience, e.g. service and claims.

We’ve recently witnessed MGAs used for two diverging use cases. The first type of MGA exists for a traditional use case — specialty coverages. They are used by carriers that want to insure a specific risk or entity but don’t own the requisite underwriting expertise. For example, if an insurer saw an opportunity in coverage for assisted living facilities but hadn’t written those policies before, it could partner with an MGA that specializes in that category and deeply understands its exposures and risks. These specialist MGAs often partner closely with the carrier to establish underwriting guidelines and roles in the customer experience. Risk and responsibilities for claims, service, etc. are shared between the two parties.

The second type of MGA is a “quasi-carrier,” set up through a fronting program. In this scenario, an insurance carrier (the fronting partner) offers the MGA access to its regulatory licenses and capital reserves to meet the statutory requirements for selling insurance. In exchange, the fronting partner will often take a fee (percentage of premium) and very little (or no) share of the insurance risk. The MGA often has full responsibility for product design and pricing and looks and feels like a carrier. It underwrites, quotes, binds and services policies up to a specific amount of written authority. These MGAs are often set up when a startup wants to control as much of the insurance experience as possible but doesn’t have the time or capital to establish itself as an admitted carrier.

Some important characteristics:

Revenue model: MGAs often get paid commissions, like standard agencies/brokerages, but also participate in the upside or downside of underwriting profit/loss. Participation can come in the form of direct risk sharing (obligation to pay claims) or profit sharing. This risk sharing functions as “skin in the game,” preventing an MGA from relaxing underwriting standards to increase commissions, which are a function of premiums, at the expense of profitability, which is a function of risk quality.

Product breadth: MGAs of either type often provide specialized insurance products, at least at first. The specialization they offer is the reason why customers (and fronting partners) agree to work with them instead of a traditional provider. That said, you might also find an MGA that sells standard products but takes the MGA form because it has a unique channel or customers and wants to share in the resulting profits.

Required capabilities/partnerships: Setting up an MGA generally requires more time and effort than setting up an agency/brokerage. This is because the carrier vests important authority in the MGA, and therefore must work with it to build trust, set guidelines, determine objectives and decide on limits to that authority. Start-ups looking to set up an MGA should be ready to provide evidence they can underwrite uniquely and successfully or have a proprietary channel filled with profitable risks. Fronting often requires a different process, and the setup time required varies based on risk participation or obligations of the program partner. Start-ups should also carefully consider the costs and benefits of being an agency vs. MGA — appointment process difficulty vs. profit sharing, long-term goals for risk assumption, etc.

Regulation: MGAs, like carriers, are regulated by state law. They are often required to be licensed producers. Start-ups should engage experienced legal counsel before attempting to set up an MGA relationship.


Insurance carriers build, sell and service insurance products. To do this, they often vertically integrate a number of business functions, including some we’ve discussed above — product development, underwriting, sales, marketing, claims, finance/investment, etc.

Carriers come in a variety of forms. For example, they can be admitted or non-admitted. Admitted carriers are licensed in each state of operation; non-admitted carriers are not. Often, non-admitted carriers exist to insure complex risks that conventional insurance marketplaces avoid. Carriers can also be “captives” — essentially a form of self-insurance where the insurer is wholly owned by the insured. Explaining captives could fill a separate post, but if you’re interested in the model you can start your research here.

Attributes to consider:

Revenue Model: Insurance carrier economics can be complicated, but the basic concepts are straightforward. Insurers collect premium payments from insureds, which they generally expect to cover the costs of any claims (referred to as “losses”). In doing so, they profit in two ways. The first is pricing coverage so the total premiums received are greater than the amount of claims paid, though there are regulations and market pressures that dictate profitability. The second is investing premiums. Because insurance carriers collect premiums before they pay claims, they often have a large pool of capital available, called the “float,” which they invest for their own benefit. Warren Buffett’s annual letters to Berkshire shareholders are a great source of knowledge for anyone looking to understand insurance economics. Albert Wenger of USV also recently posted an interesting series that breaks down insurance fundamentals.

Product breadth: Carriers have few limitations on which products they can offer. However, the products you sell affect regulatory requirements, required infrastructure and profitability.

Required capabilities/partnerships: Carriers can market and sell their products using any or all of the intermediaries in this post. While carriers are often the primary risk-bearing entity — they absorb the profits and losses from underwriting — in many cases they partner with reinsurers to hedge against unexpected losses or underperformance. There are a variety of reinsurance structures, but two common ones are excess of loss (reinsurer takes over all payment obligations after the carrier pays a certain amount of losses) and quota share (reinsurer pays a fixed percentage of every loss).

Regulation: I’ll touch on a few concepts, but carrier regulation is another complex topic I won’t cover comprehensively in this post. Carriers must secure the appropriate licenses to operate in each country/state (even non-admitted carriers, which still have some regulatory obligations). They also have to ensure any capital requirements issued by regulators are met. This means keeping enough money on the balance sheet (reserves/surplus) to ensure solvency and liquidity, i.e. maintaining an ability to pay claims. Carriers also generally have to prove their pricing is adequate, not excessive, and not unfairly discriminatory by filing rates (their pricing models) with state commissioners. Rate filings can be “file and use” (pre-approval not required to sell policies), or “prior approval” (rates must be approved before you can sell policies).


In this overview, I did not address a number of other interesting topics, including tradeoffs between group choices. For example, you should also consider things like exit/liquidity expectations, barriers to entry and creating unfair advantages before starting an insurance business. Perhaps I’ll address these in a future post. However, I hope this brief summary sparks questions and new considerations for start-ups entering the insurance distribution value chain.

I’m looking forward to watching thoughtful founders create companies in each of the groups above. If you’re one of these founders, please feel free to reach out!

Section 831(b) Captives – Where is the Common Sense?

A captive insurance company that qualifies for the tax exemption found in section 831(b) of the Internal Revenue Code is a time-tested and useful risk management mechanism that offers the entrepreneur excellent tax and financial planning benefits.

It looks simple — form a small insurance company and pay no more than $1,200,000 in annual premiums to it, which are fully tax-deductible and then later remove the profits of the captive at more favorable dividend (for now) or capital gains rates.

But it is not so simple. There are many pitfalls. Aggressive captive providers have proliferated recently who are ignoring common sense risk management and taxation issues to the potential peril of their clients. And they hide behind actuarial opinions and regulatory acceptance arguing that their plans and pricing are perfectly acceptable.

The problem is that actuarial opinions are only as good as the assumptions that the actuaries are given. And regulators examine different issues than the IRS when they are approving a captive’s license. The existence of an actuarial opinion or a license does not assure the client that their captive is truly compliant with the complicated tax issues that are involved.

There are two current “hot buttons” that anyone contemplating forming a captive should consider:

Pricing of Risk: Once the types of risks to be transferred to the captive are identified, the next challenge is to properly calculate the premium for such risk. Underwriting is as much an art as it is a science, with factors such as coverage details, loss history, limits, deductibles, exclusions and the financial strength of the issuing insurance company all coming into play along with sound actuarial practices.

Given these variables, it is easy for different people to offer diverse opinions on what an appropriate premium may be. But common sense must prevail. For tax purposes, the IRS will only allow a deduction for premiums that are reasonable in amount. The starting point for “reasonable” is the market rates for the coverages in question. However, market rates are not the end point for small captives, but they absolutely do create a benchmark. If a taxpayer is considering paying premiums that are vastly beyond that benchmark, they had better have very strong and well documented arguments for doing so.

Let’s take an actual case in point. A captive provider suggested that a client’s captive issue a $3,000,000 excess policy for Employment Practices Liability for a premium of over $250,000. Yet the client already had a $3,000,000 primary layer for this type of coverage for which he had paid less than $12,000.

Given that the primary layer would have to pay out full limits of $3,000,000 in order to trigger a loss on the excess layer, insurance companies would normally charge less than the premium paid for the primary layer of the same size. And when we compared what actual clients paid for this type of excess coverage, we found a rate of about $3.00 per employee. The suggested premium for the captive, however, equated to $808.50 per employee. A review of the actual excess policy language did not reveal any special provisions that could possibly justify such a high premium.

While it is true that a small insurance company may need to charge more than market rates because it has a very low capital base, common sense (and the IRS) would never accept a premium that is 269 times the market rate as in any way “reasonable.” [When presented with this argument, the captive provider in question simply stated that they felt that they could defend the premium in the event of an audit. The client was not comforted.]

Terrorism insurance is another area of controversy in the small captive market. It is a coverage that can legitimately be placed in a captive insurance company, but pricing is a serious issue. Given the fact that TRIA does not cover loss of income from a terrorist attack and that such coverage is not easily available in the domestic market, some captive providers have suggested that small captives can charge $500,000 to $600,000 for a $5,000,000 limit of such coverage.

In fact, such a policy is available from Lloyds of London at rates significantly lower than those used by these captive providers. For example, one of our clients, a $100 million (revenues) company in Dallas, Texas was recently quoted a price of $10,000 for $5,000,000 of terrorism coverage that includes loss of income as a result of a terrorist attack anywhere in the United States, not just in Dallas. Lloyds obviously has the financial strength to price risks lower than the average captive, but the disparity between the real market price and the pricing quoted by captive providers with little or no insurance experience once again defies common sense.

One of the basic tenets of risk management is that if the risk of loss is severe, and coverage can be purchased at a low price from the third-party market, it is not a sound business decision to self-insure that exposure. If a client is truly concerned about a terrorism related loss, it therefore would make more sense to buy the coverage from Lloyds rather than self-insure it in their own captive. Except, of course, for the tax benefits of doing so. Thus, the decision to form and fund such a captive clearly indicates a lack of economic substance and is motivated primarily by tax considerations. Such a captive would most likely fail an audit by the IRS.

Of course, even Lloyds might not have the ability to pay a claim in the event of an enormous terrorist event, which could be a reason to self-insure this risk in a captive. But pricing the premium at a “worst case plus” rate is not sensible and would likely not survive an IRS audit.

Finally, terrorism quotes in the captive market rarely take into account individual risk characteristics. If the client is located in a “target rich” area, such as near a nuclear facility, some higher rates certainly can be justified, but common sense says that such a rate is not applicable to everyone, particularly in lower exposure areas.

What about an actuarial opinion? Certainly an opinion that is specific to the actual policy coverages in question and to the client’s unique risk characteristics can go a long way to justifying the given premium. But clients must be careful that a proffered opinion truly relates specifically to them and not just to the type of coverage in general. When it comes to terrorism insurance, however, we submit that there can be no such “coverage in general” that makes economic or common sense.

Life Insurance: Whole life insurance can be an acceptable part of a captive’s investment portfolio. But that statement has opened the door to abuses — abuses that the IRS is well aware of and is determined to quash. A captive must be formed first and foremost for risk management purposes. The tax benefits that follow are wonderful, but must be secondary, and the investment portfolio then ranks third.

Some life insurance agents (who likely know nothing about property & casualty risk management) are touting the formation of a captive for (effectively) the benefit of purchasing life insurance with the premiums received by the captive. This, in effect, allows life insurance to be purchased with pre-tax dollars. Not only does this approach likely violate section 264 of the Internal Revenue Code (that disallows the deduction, directly or indirectly, of premiums paid for life insurance), it violates the economic substance doctrine.

Again, common sense would show that if the primary purpose of forming a captive insurance company is to buy life insurance with pre-tax dollars, that would not constitute a valid reason to become involved with what is, first and foremost, a risk management vehicle.

It is our understanding that the Internal Revenue Service has a specific internal mandate to find and close captives that are marketed in this manner.

To avoid this issue, we suggest the following: (a) do not purchase a captive from anyone promoting it as a vehicle for the purchase of life insurance, particularly an immediate purchase; (b) make any life insurance decisions a part of an overall investment strategy; (c) do not use any unearned premium to purchase life insurance (which means no purchases in the first year); and, (d) do not use more than 50% of the captive’s premiums in such an investment.

These issues of pricing and the use of life insurance are particularly important to the CPAs who are being asked to sign the client’s tax return showing deductions to a captive. CPAs now have a higher financial and professional risk when signing a tax return and must be acutely aware of these potential issues with respect to their clients’ captives.

Historically, many good business ideas that have tax benefits have been abused and distorted by greedy promoters and unsuspecting taxpayers. The end result is often a complete closure of the benefit by Congress or the IRS. We hope that the few “bad actors” in the 831(b) space do not cause the same result with this excellent risk management and financial planning tool.

James Landis collaborated with Rick Eldridge in writing this article. Rick Eldridge is the President & CEO of Intuitive Insurance Corporation and, along with James Landis, a Managing Partner of Intuitive Captive Solutions, LLC.