An insurance premium, or the amount you pay for a policy, is based on several factors, such as the cost of basic coverage, operational expenses, and any additional endorsements or policy add-ons you choose. If your insurer is a reciprocal exchange, you may also see a surplus contribution fee on your insurance bill, in addition to your premium.
Surplus contributions, though small, play a vital role in your policy and the financial protection it provides. These fees do not generate any revenue for your insurer or its management company.
Still, these contributions do offer enhanced policy stability and reduce the company’s reliance on potentially more expensive external funding. This, in turn, enhances the company’s ability to provide protection and effectively settle claims, even during widespread incidents that affect many policyholders simultaneously.
How do surplus contributions work?
A surplus contribution is a small, often percentage-based fee added to your insurance premium. Insurers and their management companies do not generate revenue from the surplus contribution.
Instead, when collected from all policyholders, this small amount creates a much larger pool of financial resources that an insurer can rely on after large-scale events that may exceed the company’s operational budget.
For instance, surplus contributions allow insurers to meet claim payout obligations after catastrophic events like hurricanes, wildfires, and tornadoes. Because insurers with surplus contributions have less need for expensive external financing, these contributions can also help stabilize rates, potentially leading to lower premiums and long-term savings for you.
Surplus contributions and reciprocal exchanges
Not all insurance premiums include surplus contributions, but they are common in reciprocal exchanges.
A reciprocal exchange is an insurance model in which policyholders, also known as subscribers, maintain ownership in the company as long as they maintain a policy. Instead of being a traditional for-profit company, reciprocal exchanges are similar to cooperatives, where members agree to share insurance risks with each other.
When a customer purchases a policy, thus becoming a subscriber, they often pay a surplus contribution. Subscriber contributions are pooled and, as described above, enhance the reciprocal insurer’s financial strength, allowing it to better adapt and react to catastrophic coverage events.
Reciprocal exchanges are not corporations and don’t have shareholders. They are managed by an “attorney-in-fact” (AIF), an entity or individual hired to handle underwriting and administrative activities, such as billing and claims processing.
Benefits of a reciprocal exchange
Purchasing insurance from a reciprocal exchange can have many benefits, including:
-
Financial strength and stability. Surplus contributions help ensure the exchange has the funds to pay claims, even during a period of significant, unexpected loss.
-
Prioritization of policyholder interests. As a subscriber, you share in company ownership. As such, business operations and decisions are made to benefit the insured, not outside shareholders.
-
Potential for profit sharing. If a reciprocal exchange accumulates excess surplus over time due to favorable claims experience, the excess amount can be distributed to subscribers as dividends or future premium reductions.
-
Affordability and stability. In many cases, reciprocal exchanges are better positioned to weather industry volatility and can provide more affordable coverage while maintaining stability in the long run.
In addition to the benefits above, reciprocal exchanges are generally governed by a Subscribers’ Advisory Committee (SAC). A SAC is made up of a group of elected or appointed individuals who:
-
Ensure subscriber interests are met
-
Advise the attorney-in-fact on key decisions
-
Promote transparency
-
Ensures that funds are managed in accordance with fiduciary rules
As such, subscribers benefit from having an active voice and representation that is not dependent on or swayed by company profits.