You may have heard much about the alternative market. But can you as an agent profit from it? Some agents think that the alternative market is only for big brokers placing large risks. However, commercial lines agencies of all sizes can participate and profit because the alternative market today is as diverse as the traditional market.

What is the alternative market? No one has come up with the best definition, but everyone agrees it includes self-insurance vehicles such as captives, risk retention groups and self-insured groups. These vehicles serve risks of all sizes, from small nonprofits to Fortune 500 companies and everything in between. Captive companies have been formed for all types of liability and property insurance, and for workers' compensation.

There may be myths about the alternative market because it did start as a mechanism for big companies to cover their liability risks. Large companies formed captive insurers in Bermuda and other offshore domiciles in the 1960s and '70s.

Vermont passed enabling legislation in 1981 that allowed it to become the first domestic domicile that could compete with offshore locales. The driving force behind the law was an agent: H. Lincoln Miller, Jr., owner of an independent agency on Long Island and a summer resident of Vermont.

Following Vermont, several other states passed laws enabling captives. Today, other U.S. domiciles include Hawaii, Colorado, Illinois and Tennessee.

The alternative market took off during the 1980s. First, in 1985, the hard market hit, driving up the demand for alternatives to commercial insurance. The following year, federal tax legislation curtailed the tax advantages of offshore captives. That put domestic captives on a level playing field.

A pivotal federal law made the alternative market available to the mass of American businesses and nonprofits. Congress passed the Liability Risk Retention Act of 1986 to help businesses obtain affordable liability insurance.

Under that law, business of the same type can join together to cooperatively insure their liabilities. A new type of alternative market, the risk retention group (RRG), was born. Once chartered in any one state, the RRG can offer insurance in all other states without having to obtain individual state licenses.

Today, thousands of small and medium-sized organizations-and even a few large ones-buy their liability coverages through RRGs. There are risk retention groups that insure ski areas, nonprofits, dentists and chemical specialties firms, to name just a few. RRG members run the gamut from large companies with sales of $50 million, to medium-sized firms, to professionals like CPAs, to small nonprofits with only part-time employees.

RRGs are varied. Some have as few as four or five members. At least one, an RRG that insures nonprofits, has more than 2,000 members.

Since RRGs can underwrite only liability insurance, most have formed alliances with traditional insurers that offer property coverage to their members.

Most, though not all, RRGs are open to agents and brokers and pay competitive commissions. Most will do business with any licensed agent; a contract isn't required.

Properly run risk retention groups offer many advantages to both their members and agents.

RRGs fit in perfectly with niche-marketing strategies, since, by definition, each RRG serves a single industry.

Prices are stable. As a member-owned entity, an RRG does not have to follow the fluctuating market price.

Overhead is usually lower than for an ordinary insurance company. RRGs are usually managed by cost-conscious outside management firms that vie for RRG business. The cost savings can be passed on to the members through lower premiums or dividends. Specialized underwriting is another plus. Underwriters serving risk retention groups become experts in one industry.

Similarly, specialized coverage is also intrinsic to RRGs, as their policies are tailor-made to meet the needs of one industry.

RRG members must put up capital to join, so most stay with the RRG for the long haul. As a result, agents usually do not have to get competitive quotes at renewal. Easier renewals and a high retention rate mean agents can spend more of their time getting new business. The high renewal rate should also reduce the RRG's expenses, which boosts its bottom line.

Because the insureds own and control the RRG, they feel much differently about it than an ordinary insurer. The broker can benefit from that goodwill through referrals. Some RRGs are sponsored by trade associations, which may give selected agents access to their members.

Most RRGs accept only well-run companies committed to controlling their losses. Once admitted, members have a strong incentive to operate safely.

Overall, RRGs may have had a good financial record, and many carry Best's ratings. There have been few insolvencies. Agents should, however, conduct due diligence on RRGs they are thinking of representing. Well-run RRGs are well-reinsured, which limits the risk they face.

For most agents, the simplest course is to locate some top-quality RRGs and place business with them. Some agents use RRGs as their primary market for certain types of businesses, while others use them simply as another choice.

Some agents have taken the next step: serving as a catalyst for a new RRG. Let's say that you happen to write many contractors, and there is a pricing and/or coverage problem with the E&O cover. You could talk to your clients, explain the RRG concept and see if there is interest in starting a group. The prospective members probably would have to provide at least $1 million of total start-up capital. However, it doesn't have to be all cash; a letter of credit can be used for all or part of it. Raising capital is usually the biggest hurdle in starting a risk retention group. But if the capital can be raised, the members can derive RRG benefits as stated above.

The alternative market is a growing force in workers' compensation. There are many creative alternatives to traditional insurance.

One is the self-insured group, or SIG. SIGs let businesses band together to insure their workers' compensation risks, offering cost savings to participants. Most pay commissions and thus offer opportunities to agents.

SIGs provide the benefits of self-insurance at small and medium-sized businesses. Some states allow only homogeneous groups , where all members are in the same industry. Others allow heterogeneous groups, which are open to all businesses that meet underwriting guidelines. Some states to do not permit SIGs.

Self-insured groups let small and medium-sized businesses get almost the same cost savings as big companies that individually self-insure. In most states, SIGs at first must charge the state-mandated rates. However, if their losses and expenses are low, they can pay higher dividends or grant larger premium credits. Another SIG advantages is that they're exempt from residual market loads, or RMLs. In states with large residual markets, RMLs can boost premiums by 15 percent or more.

SIGs, however, do have some disadvantages. One is joint-and-several liability. Members are liable for the losses of other group members and can be forced to pay assessments. To limit their risks, SIGs should buy reinsurance for catastrophic losses.

Another disadvantage is that SIGs are chartered to operate in only one state. To operate elsewhere, they must requalify in each additional state. And they usually offer only workers' compensation and must offer traditional programs in other lines.

Because of disadvantages of self-insured groups, many trade associations are turning to other workers' compensation alternatives.

Under one new alternative arrangement, a traditional insurer issues the policy. A national carrier's name on the paper solves the regulatory problems associated with SIGs. Behind the scenes, however, is a risk-sharing mechanism: a captive.

This mechanism lets the sponsoring association and members share in underwriting profits and investment income. A major advantage is that there is no joint-and-several liability. Thus, the risks are more limited, but the potential upside can be as great.

Such a program offers associations a range of alternative-market approaches, from a traditional sponsored program to risk participation in a rent-a-captive facility to an association-owned captive. As the group's needs change, it can move to a different option. Even large individual members can move among the options.

One local example of such an approach is the Connecticut Chamber of Commerce's new workers' compensation program for its members. Travelers issues the policies, while our company, USA Risk Group, serves at the program manager.

So far, we've been talking about the alternative market as another option for placing business. But there is another, entirely different, opportunity for agents.

An agency captive is a captive insurance company owned by an insurance agency. Its purpose is to give the agency a bigger share of the profits from good business it places in the traditional market.

Agency captives must be domiciled offshore, since they are entrepreneurial captives. U.S. domiciles allow only nonentrepreneurial (policyholder-owned) captives. Most agency captives are domiciled in Bermuda, Barbados or the Caymans.

To make a captive work, you need a large profitable book of commercial business that is concentrated in a particular industry; for instance you may specialize in insuring printers or veterinarians. All the business in this niche should be with one insurer.

Your agency captive would reinsure part of the risk on a quota-share basis. For instance, the captive might take on 20 percent of the risk from the carrier – that is pay 20 percent of the losses – and in return receive a 20 percent share of the premiums, minus the ceding commission. Some agency captives take as little as a 10 percent shares, others as much as 40 percent.

Just like the carrier, the agency captive can make a profit from underwriting gains and investment income. If the business remains profitable, an agency can make far more than it could with any traditional profit-sharing agreement.

On the other hand, if the business goes sour and produces unanticipated losses, the captive can lose money. If you have received good historical loss information and the insurer underwrites conservatively, you should probably profit handsomely. But profits are not guaranteed.

Only agencies with a large book of specialized business can make a captive work. It takes a minimum of about $3 million to $4 million in eligible annual premiums. (The captive will get only about 20 percent to 40 percent of these premiums.) This level is required to offset ongoing administrative and captive management fees.

The alternative market today is vast, diverse and growing. All agents should know what is available and the benefits of captives, risk retention groups and SIGs, since they too can benefit from that market.