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Retro vs. Re-insurance: Which Suits Your Needs?

By Don E. Ray

Retro vs. Re-insurance: Which Suits Your Needs?

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I was recently asked by an industry friend, who is a dealership buy/sell consultant (broker), for my estimation of the net pretax proceeds from a retrospective commission (retro) F&I program verses a reinsurance program.  My friend, we’ll call him Sherlock, was asked by his client about the monetary value of a retro program verses a reinsurance program. As Sherlock performed his investigation, he called me. Sherlock had been previously told that there was about a 15% monetary benefit to a reinsurance program.  Knowing that was low, I discussed with Sherlock a comparison that I had made for dealership group in the Midwest. My comparison showed a much greater reinsurance advantage. This 13-store dealership group was currently receiving about $500,000 per year in retro payments.  Using exactly the same volume history, I estimated that this group would receive an underwriting profit (premiums received, less claims paid, less administrative costs) of almost $2,000,000 per year.  That’s almost 4 times more than the amount historically being received from the dealer group’s current retro structure!

Ok that sounds great but let’s back up to make sure that our understanding of these terms, retro and reinsurance are consistent.  First a retro:

As noted above these payments received are retrospective commissions paid by the F&I providers typically directly to the dealership.  Underwriting profits are calculated and paid to the dealership on an earned basis (sometimes with investment income). Or these commissions are paid in advance with future offset and payback liability.

The good news is that as a result in the changes in the income tax rates by the 2017 Tax Cuts and Jobs Act, retros received by the dealer’s corporation will likely result in less income tax than in the past.  However, the disadvantages of this structure remain in place. These include reduced profit participation (see above), reduced investment earnings, higher administration fees. Better tax rates on a bad structure is still a bad structure.

Now let’s consider a reinsurance structure (there are several):

A Non-Controlled Foreign Corporation (NCFC) has been historically beneficial to dealers, especially very large dealership groups.  However, the aforementioned 2017 Tax Cuts and Jobs Act made significate changes in the eligibility of this structure.  The effect of these changes on a dealership F&I type reinsurance structure has not been clarified by the IRS.  The IRS has yet not issued a timeline for any clarification pronouncements. That being said, there is new risk in this type of structure.

A Dealer Owned Warranty Company (DOWC) can be an effective alternative to an NCFC for very large dealership groups.  It is more effective in some states than others and was not significantly impacted by the 2017 Tax Cuts and Jobs Act.

The reinsurance structure that is most attractive to the majority of auto dealers is the Affiliated Reinsurance Company (sometimes referred to as Allied Risk Company or ARC).  This structure provides very friendly tax benefits and dependent on the policies of the administrator, other ARC benefits can include:

  • Dealer control of the investments
  • Ability for loans to be made from unearned premium
  • Service tie-back for customer retention and which drives fixed operations
  • Funding to the ARC done weekly
  • No exit fees or penalties in run-off
  • Simple and transparent reporting
  • Fully disclosed fees and without hidden costs
  • New product innovation
  • Customized coverage, terms, rates to meet local market needs

Irrespective of whether you choose a retro or a reinsurance program, without effective and compliant sales processes at the dealership, you will never get the maximum compensation available to you.  It is a must for all such programs to include F&I Income Development either In-House or by a Qualified Agent. These essential requirements include Recruiting, Training, Compliance, Performance Reviews and the Ability to Enhance Dealership Profitability.

So, Sherlock where does your informed investigation take you now?