The PM Insurance Model No One Talks About (But Should) with Nicolas Lares

. So like in the event, using, right, the FedEx example as a scenario here, yes, in the first 5 years, if you see an operator continuously have drivers who bump into poles, who make the same mistake over and over again, and it doesn't get corrected by year 5, guaranteed they're gonna continue to make those same mistakes years 10, 20, 30 down the line. But if you get an operator and shows, hey, they bumped into a lot of poles year 1, they made a change, they started coaching drivers how to deal with that. And after year 1, they no longer saw any polls being hit or claim activity for that specific, right, specific outcome. If you can find something like that in loss history, that is exactly what tells you that that's a good operator because they can deal with managing risk effectively. The goal is not to find somebody who can deal with a catastrophic claim if it happens once every 20 years. The goal is to find somebody when risk is presented at a minor scale, they can take the corrective action to prevent that from happening down the road.

Welcome back to Peter Lohmann's podcast. I'm here with Nicholas Lares. He's CEO and founder at InsurTech. Welcome to the show, Nicholas.

Yeah, thanks, Peter. Appreciate you having me on. Looking forward to, to chatting.

Yeah, I'm excited to get into conversation with you about insurance. If you hate insurance, You might as well just turn off the pod now because that's what we're talking about today. But this is going to be highly relevant.

Definitely going to want to hear that one.

Yeah, this will be highly relevant for anyone operating a property management business because Nicholas's specialty is working with rental owners and property managers to reduce their insurance costs, both on the rental owner insurance side as well as the tenant insurance renters insurance side. So we're going to get into all those details because you have a very unique and different model. Trust me, I did not just bring an insurance broker on the show to pitch, you know, his lines. This is a very unusual and relevant and differentiated offering that they have at InsurTech. Not endorsing these guys. I'm just really interested in what they're doing because I think it's something that's been on the radar of the big multifamily companies. For a long time, and I'm just starting to see some movement in our space, SFR, with these captive groups, which is really what it is. So, but before we get into all that, Nicholas, could you bring us up to speed on yourself, your background, and kind of how InsurTech came to be?

Yeah, yeah, totally appreciate the, the introduction. I got started in the insurance space really by accident. Coming to find out there's a lot of parallels in the property management space where people kind of don't wake up one day and say, hey, I want to be in this industry. Kind of just fall into it by accident. So I was right fresh outta college in December of, of 2019. My first job was working for a big IT company that was based in Miami where I'm originally from the Fort Lauderdale area. And I was hired pretty much March of 2020, 2 weeks before the first COVID case ended up hitting the US. So I was pretty much the first, you know, employee that was let go. Or furloughed from that, that firm. So I kind of was sitting around looking for something to do. And while the world was shut down, the only thing that seemed to be moving was stuff involved in, right, the cybersecurity space or Zoom or really Amazon. And a buddy of mine at the time, who's my best friend growing up, he and his family are third-generation insurance family. They tend to work with a lot of very large carriers when new and emerging markets are essentially coming up. They tend to rely on these deeply embedded relationships of brokers who know spaces well, who can interact with the customer base and essentially help the carrier build out an insurance product for that specific market. So it was right when the Amazon, what's called DSP market, where their logistics arm of, of last mile delivery vans was ramping up nationwide. And they were working with a few large carriers to essentially insure them across the country. So they're like, hey, we could use, you know, an extra person on the team to kind of help out with a lot of either automating or, building a lot of stuff behind the scenes to kind of make our jobs easier. So I was like, great, I've got nothing else to do. So jumped in 3 years later, insuring, I mean, almost $300 million worth of delivery vans across the US. One of the largest broker shops that we ended up building out, competing with the likes of like Aon, Marsh, all these really big, well-known insurance firms. And we were essentially Amazon's backend risk management team in a nutshell. So we were insuring their delivery logistics network, everything was going great. But then from one day to the next, the carriers we were working with said, hey guys, tested this market out for 3 years, it was a lot of fun, but we don't want to continue insuring this, this market, so we're gonna back out. So very similarly to what was going on right in the Florida, Texas, and California markets where a lot of traditional carriers said, hey, we can still be in this space if we wanted to keep charging people more, but it just doesn't make sense for us. So they backed out and I was there sitting with hundreds of customers that I had to pretty much tell, hey, I don't know if I'm gonna be able to insure you in 3 months. You may have to shut your business down, fire all your employees, and it was great while it lasted.

So who, who was the customer here? Was it like, 'cause I know FedEx, their routes are run by like, there's sort of a franchise thing. Is that how Amazon is?

Yep. They have the same structure, but Amazon has a bit more, I guess, uh, their thumb on the scale in terms of who their contracted providers can and can't use behind the scenes. So they were very strict and difficult when it came to the insurance placements. Most, if anybody's familiar with insurance, the general option if a traditional carrier backs out is for the ENS market to jump in, which is excess and surplus carriers, which are typically not regulated as much as a traditional carrier is. Amazon didn't allow that. So we had to pretty much come in and build a new insurance company from scratch so all of our customers can kind of band together and say, hey, we have enough purchasing volume where we can compete weight for weight with a standard insurance company itself, right? A $300 million of premium. It's a sizable book of business. So we essentially went to reinsurance markets, said, hey, we've got this risk. We want to build a program around it so they can be recognized as a federally regulated insurance company, but it's strictly going to be insuring this specific market. So that's what we did. We came out, we built that. And me as a—

can I pause you for a second? Yeah. So let me, I just wanna make sure I have this, cuz I think this is laying the groundwork for what we're gonna talk about. So, mm-hmm. The customer here who was the, the premium payors or payees, always mix those up, was, were, was like these individual franchise owners who were running these vans around. Is that right?

Yep.

That's correct. Okay. And the, the reinsurance provider. Who came back after 3 years and said, we're done. Or, or sorry, the, the, the, the original insurance provider. Yeah. The original insurance company. So after 3 years they said, we're out. Now what I wanna ask you is like, presumably they didn't leave because they were making money hand over fist. I'm, I'm intuiting, and you can tell me if I'm wrong, they left because they were losing money. Like the claims exceeded the premiums or, or they were close enough to the premiums that it wasn't worth the trouble? Is that— or maybe they didn't tell you. Yeah.

So the, the formal reasoning was that they were actually profitable. So most carriers work off of what's called, right, a loss ratio, which is pretty much a way to dictate, hey, how much are we paying out in claims versus what premium we collect? Carriers usually will tap out or not make money at a 60% loss ratio or higher, generally because their fixed costs of running an insurance company ranges between 40 to 50%. And then if you add, right, some investment income, you have some additional margin on top of the 100% of premium collected. The carriers we were working with were running at a loss ratio about 56%. So they were profitable, but they just weren't profitable enough. They weren't making enough money to stay in the business.

So they're kind of right on the edge once you factor in all the overhead and everything else.

Yeah. But if you take that, right, a 4% profit margin on $300 million, I mean, it's a significant amount of money when you divvy it up amongst the individuals themselves who are paying for it, right? It might not be to an insurance company who's insuring trillions of globally, but for that specific market, it's still decent, decent enough amount of money where, hey, it, it's still enough room, right? Where we're making money, it's still profitable, and it can carry on and self-sustain itself, if you will. Right? They weren't losing 12% every year like State Farm is on their personal auto insurance policies, right? Where their personal auto insurance policies take a loss for State Farm, but the homeowners and other lines essentially generate a profit so they can kind of balance it out and State Farm as a whole. Can still operate profitably.

And also famously, they, they, they invest the float and make a return on that. There's a whole Berkshire story with GEICO and all that. So yeah, so in theory, if these, these franchise owners just self-insured or like did a captive essentially, which is probably where you're going with this.

Yep.

And they had $0 of expense to run the program, which isn't true, but let's just pretend. And their claims ratio stayed the same, then they would basically get back— what's 100 minus 46? 34 cents of every dollar. Did I do that math right?

I don't think I did. 1 minus 46 would be 54.

Yeah, 54 cents back of every dollar they paid in premiums if the program was free to run and everything else stayed the same. So you basically looked at this and you're like, hey, there's something here. Let me talk to some reinsurance company. And for anyone listening who doesn't know what reinsurance is, reinsurance is like your insurance company's insurance company, is like the way to put it. So in the event of a catastrophic, you know, non-local event that bankrupts your insurance company, or would, the reinsurance company steps in and covers them. And Warren Buffett famously loves reinsurance companies and like insuring highly unpredictable and expensive events. But anyway, yep. Sorry. So no, I think I just wanna make sure I had all that.

Yeah. But no, that's, that's kind of what, what pushed me into the, you know, the captive space. And a big question that most people ask me when I first introduced them to this concept, they, they always ask me and say, hey, how come no one's ever done this before? How come this is the first time I'm hearing about what is called a captive? And me as, right, an insurance broker at the time, I had no idea about it until my company was essentially forced to deliver a solution for it, right? So if you look at the traditional insurance market, it's a very profitable, very lucrative, very, right, rinse and repeat system where everything's renewal-based. It's all based off of relationships where most brokers don't have an incentive or a need to create what's called a captive around their specific market. They have relationships with carriers. The carriers sell an insurance product to the customers who pay for it, and if everything goes according to plan, why, why change it if it's not broken, right? So they just keep renewing every year. No questions need to be asked. Great. What's the cheapest option?

I mean, the insurance broker's paid by the insurance company, right? They get a commission.

Exactly.

Yeah. And of course they're never going to— they wouldn't even know about it, how would they? Yeah.

And they have no incentive to change. Right. Which is essentially where I'm getting at, where I didn't know about this option, right? The general population doesn't know that there is an alternative to being insured by State Farm and all these big insurance companies. No one knows that exists. Everybody thinks there should be something that exists, or everybody finds that, you know, traditional insurance relationships are very one-sided to the carrier, that it's very unfair, that it's really just, hey, I can only actually use a product that I pay for every year until something bad happens.

Well, if it ever does, there's no— Okay. So, all right. So, gotta push back on that. This is where we— this is where you and I are gonna disagree. It's like, yeah, that's insurance. Of course. How could it not be the case that you don't get your claims back in the years when you don't— that you don't file, that you don't get your premiums back in the years when you don't file? Of course, that's how it works. Because in that year, somebody else who's insured by that same company did have a claim. Money needs to exist to pay that person out in the same way that you could sign up for a new insurance policy on January 1st and have a catastrophic event on January 2nd, having paid essentially no claims or 1% of your annual claims, and they will pay it out in full. How is that fair to the insurance company?

Yeah, that's, you know, that's what they want you to think, right? But assuming, assuming you take a short-term event and you can extend it out into a decade's, right, evaluation period, a lot of catastrophic claims, what we call smooth out in the industry, over a 30-year time period, right? So The goal of insurance companies is not to be profitable within a year, it's to be profitable for centuries. It's to exist as long as they can. So, right, a lot of companies or insurance companies are built to withstand catastrophic events every decade if it happens, right?

And thank God they are, because if they weren't, that would be horrible for their customers.

Exactly. But what I— essentially my issue with traditional insurance companies, once I found out that, right, captives were an option, I, I really did a deep dive into the history of how insurance was created and came to be. And if you think about the origin story of insurance, right, you have shipping and marine cargo, which was really the first insurance product ever built. That was to ensure voyages across, you know, the Atlantic Ocean when European settlers were expanding and, and checking out other, right, continents to expand to. Property insurance was developed actually in London. Right, in the 1600s when people lived in buildings made out of wood and there was no fire, right, department system to essentially put fires out should somebody's house burn down. So insurance was created as a way for communities and people in London to essentially pool their own money together in the event that a fire would come through and burn down their home. They wouldn't have to essentially pay for it from scratch, right? So everybody would put their money together in a bank account. They'd say, hey, my house, right, all of our houses collectively together are worth, you know, say a million dollars. If it's 10 of them on average, it's about $100,000 per home. So I'm going to put $10,000 aside every year, right? All of us collectively. So if one of our homes burned down, nobody has to pay for it from scratch and there's money in a bank account for us to rebuild it, right? So that's how insurance got started. But there was never a third-party insurance company that said, hey, great, I'll help you maintain the same structure, give me your money. But in the event that somebody's house doesn't burn down, And all that money you guys put, put in, right? The $100,000. If nothing happens, it goes to my bank account. I transfer it out of your bank account and we reset from zero every year. It was always just, hey, if we each funded the insurance bank account for $100,000 and no one's house burned down, technically next year we don't need to pay any more money because in the event anything happens, it's fully funded and all of our properties are protected. So it was always a shared risk. It was never supposed to be transferred to a third-party entity who would reset the cards back to zero every year and say, great, I'm keeping the difference. Bank account resets to zero and everybody repays in. So going back to how and understanding how insurance works, captives are really just going back to how it was essentially built in the first place, right? The only difference is now there's not an entity or a third-party carrier who, if there's a surplus generated every short-term year, to wipe it clean, start from zero, and everybody goes again. Does that make sense?

Yeah, but it makes sense, but like, I feel like you're only telling one side of the story because the insurance companies— like, first of all, if insurance companies were that great and that profitable, you can go invest, you can go buy stock in those companies, or you could start one if you wanted, if you really think it's that easy and profitable and fun and unfair to the people who are paying premiums. Yeah, the other point is like The, the, the function of the insurance company is way more than just collecting premiums— collecting premiums and, and paying out claims. They have to adjudicate those claims, they have to deal with fraud, they have to protect the money and presumably invest it, they have to administer the plan and people paying. And people— what happens if someone doesn't pay their premium? And what happens if the company gets sued? What happens if someone takes their case all the way up to state Supreme Court or whatever because they feel like they didn't get their fair share of what they're owed. I mean, there's a million. And we talked about like the loss ratio, the money that the other side of that loss ratio, which you said is like 40 to 50%, it costs that company to run that, run the insurance. Like, that's real cost. And so, you know, I feel like in some of your framing of your LinkedIn posts, you make it sound like insurance companies is like a scam. And I just don't buy that framing. I'm not saying that there's not an interesting alternative, and I'm excited to talk about those details, but what these insurance companies are doing is not nefarious. It's not unfair. It's just what would make sense. It's just like in the same way that like I could go out and grow all my own food. 100%. I could do that, but it's a lot easier to just go to the grocery store because they kind of specialize in doing that and they have a wide variety. And presumably anytime I need food, I can go there and they have it. So I don't know, like, and I, what, what's kind of your, your, what would be your response to that?

Yeah, I mean, I think the, the main thing that you're trying to point out is, is really the, I mean, the fraud and litigation is really where carriers end up in hot water if they end up ever, you know, losing money any year or inevitably, right, going out of business because of what are called, the term is like, you know, catastrophic claim., but it's, you know, somebody spills coffee, all right, on their lap at the McDonald's drive-through, they get burned, and then they're suing McDonald's for tens of millions of dollars. It, in those structures, it's usually a person suing, right, an insurance company for an uncapped potential amount of money, right? There's no limit on what that essentially would look like. And the term is called nuclear verdict, right? If you're looking at the commercial space and dealing with like physical property, or an actual asset that has a fixed cost, whether it's the replacement cost of it or the actual cash value, there is no unknown number where an insurance company get, gets sued to oblivion over the price or what it costs to repair something, right? There's a fixed cost. There's not an unknown number where an attorney can sway a jury and have the insurance company go bankrupt because their client now has a terrified approach or can no longer go to a drive-through anymore because of nightmares. Right? If you can carve out those two separate markets, yes, I would not want anybody to do or create a captive insurance company that is pure liability where anybody can sue them up to oblivion for any arbitrary amount. But anything involving like property, hard physical assets themselves, I think everybody should entertain a captive. And if you're not in a captive, I just think you're in an inferior risk capital allocation strategy. Where, you know, yes, insurance companies have a place, they serve a market, but do I think they should be generating 10, 20, 30% profit margins year over year just because their customers don't know how much their fixed costs are? You know, that's questionable. That's questionable. And I think that's something that if people are presented with an alternative, you know, 10 times outta 10, they would rather go the option where, hey, I'd rather pay the same amount of money for the same contract that says we will pay out for XY up to Z, but one has an option at the end of the year where they can see a return and the other one is just a pure fixed cost with no option return. I just think it's a better alternative. It's a better product at the end of the day, right? That's all essentially what we're trying to do is just offer a better product to what's existing in the market. Not to say that the insurance companies don't have a good product, they do serve a purpose, but I just think this is a better product for that same service offering.

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Habitation dwelling.

Yep. And then, and then also on the renter's insurance side as well, renters can shop around for their own insurance. In our space, a lot of us are using master renter's insurance programs through companies like Second Nature or Foxen or others. I think technically Foxen's like a, like a tenant legal liability only, but in any case, that's traditional insurance. All of those things fall under traditional insurance. What you're describing is something pretty radically different from that, which is called a captive program, and they exist for both the rental dwelling policies. And a lot of times you see this on these big multifamily properties, but I think you work with scattered site as well. And then you also have a program for renters insurance. So share a little bit about what even is captive insurance and how does it work? How is it similar or different from traditional insurance?

Yeah, totally. So I like to phrase it as either, you know, co-owned insurance structures. A lot of people like to liken them to a mutual insurance company where we're taking, you know, to visualize a linear transaction where you as a customer pay an insurance company, and then the money just goes right from your bank account to theirs and sticks in their bank account. Where what captives and things like risk retention groups, co-owned self-insurance structures, they are ways to essentially create a circular loop between the customer who pays the insurance company and the customer simultaneously owns that insurance company on a pro rata basis of the premium they, they paid it. So it's a way to essentially say, hey, insurance company, you're not publicly traded. On Wall Street. You're not owned by private shareholders that are not also the customers who pay for the company. So it's a way where in the event, you know, yes, if the insurance company's goal is to generate a surplus, generate a profit, and that profit is distributed to their shareholders annually, why not just make the people who pay that, that insurance company, their customers, the shareholders simultaneously? And that's essentially what all, all forms of profit-sharing-based insurance products create, right? So we do anything that touches real estate. We do obviously, right, the renter's insurance, and it's any insurance product that can flow through a residential asset, right? So most people like to focus on just what's required, you know, hey, every resident needs a $100,000 limited liability policy to move in as part of their lease, right? That's one thing. There are also security deposit alternatives, right? Pet liability is up and coming as an alternative to pet rent. Now you've got the— exactly, benefit kits like Second Nature. You also have, right, property insurance. One thing that we also do too is employee health insurance, right? Any insurance product that you can think of that you as a real estate owner, operator, investor, manager, any insurance dollar that flows through your business can essentially be placed in a profit-sharing-based insurance product. And that's essentially what InsurTech is doing. We're, we're going out to the market. We don't build our own captives or risk retention groups. We essentially source them from the market directly and we place portfolios depending on their size, their geographic location, even their risk appetite. They should be in different captive structures behind the scenes. And that's essentially what, what me and InsurTech is, is doing for real estate industry as a whole.

Got it. So you are working with property managers and rental owners, understanding their insurance needs, their, their appetite risk, how big they are, and we're, and, and some, in some cases pulling them up with others and, and placing them in a captive, or I'm, I'm guessing some of these companies are big enough that they create their own captive with the help of some third party that can facilitate this.

Yep, exactly. Generally, rule of thumb is, you know, hey, anything that's over, you know, 5,000 units collectively and more, you can float the idea of, hey, we have enough volume where between our residents, our own premium, we can, we have enough volume where we can self-insure. You've got the option where if you want reinsurance backing a piece of it, you can pay an increased, what is called a fixed expense to have that backstop. Or if you say, hey, I don't want any backstop, I know I, I'm gonna be profitable for decades, I don't want that fixed expense. I just want my pure premium going straight to pay claims with nobody backstopping me. Yes, right? You, you retain some risk by doing that, but at the same time you're increasing your profit margin potential because reinsurance is really the biggest cost when it comes to an insurance company, which, you know, ranges from 25 to 35%. So, if you're a real, really large portfolio and you say, hey, my tenants are safe, I'm in Class A properties, I haven't had a single claim filed from a resident in 10 years, and the most that essentially they could pay out is $100,000 of payment, that's fine, right? I'd rather collect $1 million and keep that money than lose 35% of it every year to a reinsurance company when I don't need backing there, right? So we can get very creative and kind of customize. A lot of people like to think of it as like, It's kind of like a white labelable version or like a Build-A-Bear Workshop for kind of building your own insurance toolkit for your portfolio and essentially just maximizing those dollars to where they stick on your balance sheet instead of ending up on somebody else's balance sheet at the end of the year.

Now the captive programs, is the case with all of them that the premium payers are, are pro rata owners as well, or is that not required? Can you still get a refund without being an owner?

Well, there wouldn't be a scenario where you would pay in premium and not translate to an owner.

Okay, got it. So, so in all these captive programs, you end up being like a pro rata owner based on your premiums paid.

Yeah.

Yeah.

Okay. Yeah. In all, in all structures, that's how they're essentially set up.

Yeah.

The goal, I mean, if you want to say, hey, I want my own premium dollars essentially to go to my own insurance company, not to be pooled with other owner operators, it really boils down to how well you can manage risk, right? How, how, how low of a risk operator owner you are. If you think it all depends on pooled risk, right? If you perform better than the pool that you're in, you're technically then subsidizing everybody else who's in that pool. So if you say, hey, I'm the best of the best in this pool, I want to essentially retain as much as possible and be rewarded for that, then we're going to put you in your own pool. Because if you think you're performing better and the data shows that you are, then there's the capacity for you to essentially go on your own and be your own pool.

Yeah, I mean, this really strikes me as like the surveying people to ask how good of a driver they are problem, where it's like everyone thinks they're an above-average driver. I've never met a real estate operator who's like, yeah, my claims are probably like average to below average, or, you know, you know, my risk is, is, is higher than average, right? Every single real estate operator I've ever met you know, across thousands of people, they all say, oh no, we run a great ship here. We've never had a claim. We place great tenants, we run great properties. They're very safe. We've never had a fire, blah, blah, blah. And I'm like, yeah, of course. Like, these things are rare events. Like, this is not— it's, it's not like every other operator is having fires every other year. Of course you've never had a fire. It would be statistically weird if it were any other case. So, you know, this idea that like, well, we've had 4 or 5 years with no claims, blah, blah, blah. It's like, Yeah, that's most people, but that doesn't mean your risk is any different than it was in the first year. And it doesn't mean your risk is any different than any other operator. It just means most properties don't have a fire every year. So yeah, I don't know, like part of me just resents this idea that there's these people who think they're better than everybody else and they're just going to like remove themselves from the pooled and like the whole idea of insurance. It only works if everybody participates. If everyone like carves off into all these little small pools, we're losing the value of pooling the risk.

Yeah. I mean, I, my only pushback on that is that you'll, you can account for the catastrophic claim with different captive structures and different reinsurance placements depending on your captive. But I will say, and one of the things that I saw in the, when insuring Amazon, is, you know, high-risk operators, whether people think they are or not. The data shows typically within 5 years, you know how somebody is going to perform for the rest of their career.

Yeah, I can see that for Amazon drivers though, because these guys are nuts. I mean, I talked to a buddy, a good friend of mine ran FedEx routes. He owned a business doing this for years, and the horror stories he would tell me was unbelievable. I mean, these guys are running into fence posts. They're knocking over— they're getting their, you know, they're the data you get from a moving vehicle operated by some random guy delivering packages. You're getting tons of data. You're getting like speed data, you're getting GPS data, you're getting traffic, you're getting like speeding tickets data, you're getting customer complaints. There's Ring videos, right? So like, it's, it's— that would totally make sense to me that like you could probably predict within a year or less, you know, how somebody's going to perform as a driver, and then you can infer, you know, about the owner-operator of that specific company. But the problem with these property, you know, property insurance and renters insurance is the claims are so rare. Like, it's super rare. I've never made a claim on— I've been in— I've owned rental property since 2008, multiple properties. I've never made a claim on any of my single-family rental insurance policies. And most people haven't either. I'm not an exception. Is, you know, getting back to what I was saying earlier. So like, I, I don't know that I fully agree that you can get a great risk profile off an operator within a few years because isn't it the case that 99% are not gonna file a claim within the first few years anyway? So how do you differentiate among these operators and how do you, how do you get a sense of their risk?

Yeah. What, what carriers will typically look at are what are called just repeated activity.. So like in the event using, right, the FedEx example as a scenario here, yes, in the first 5 years, if you see an operator continuously have drivers who bump into poles, who make the same mistake over and over again, and it doesn't get corrected by year 5, guaranteed they're gonna continue to make those same mistakes years 10, 20, 30 down the line. But if you get an operator and shows, hey, they bumped into a lot of poles year 1, they made a change, they started coaching drivers how to deal with that. And after year 1, they no longer saw any poles being hit or claim activity for that specific, right, specific outcome. If you can find something like that in loss history, that is exactly what tells you that that's a good operator because they can deal with managing risk effectively. The goal is not to find somebody who can deal with a catastrophic claim if it happens once every 20 years. The goal is to find somebody when risk is presented at a minor scale, they can take the corrective action. To prevent that from happening down the road, right? So that's essentially what can be shown within 5 years where, hey, if we see a property and they consistently claim, right, deposit insurance because they're not screening residents accordingly, we're going to be able to find that out within the first 5 years of that asset essentially being operated by that company, right? So, and if we see, hey, the first 2 years they had a lot of deposit alternative claim activity, they added a better, right? A screening company in place and all of their deposit insurance claims dropped off from that day onwards.

Mm-hmm.

Right? That's a good risk when it comes to essentially applying that business model too. So, you know, and, and also something to take into consideration is a lot of these captives, yes, you know, we, we don't want to bring in people who are low-risk operators, but we can always ask them to leave, right? In the event that, hey, We brought somebody in, their loss history showed that they were super clean first 5 years, and then all of a sudden they took a turn for the worse and started performing negatively. Captives, just like any other traditional insurance companies, can non-renew their customer base. So in the event that somebody comes out that, hey, this was right, the data did not accurately predict, right, their future claim experience, they can be non-renewed and the traditional market will always be an option for them to essentially divert back to. So that's always something that, that is like, it's constantly evolving as well. It's not just to set it and forget it and you're in forever, right? The metrics are always re-underwritten. The claim activity is always investigated and inspected. So there are always these, these checks and balances and these fail-safes to make sure, again, 'cause as a captive insurance company, your goal is to be profitable forever and to be around forever. So that's, that's something that goes into account when it, when it comes to underwriting the risk pool. Forever, you know, every year that goes by.

Okay, a little bit more of the technical stuff is like somebody still has to administer these things. So how are these captives administered and how much does that cost and how are they paid?

Yeah, so most, you know, most insurance companies really are good at outsourcing a lot of the actual operational load when it comes to running an insurance company, right? Claims is obviously the one most people think about Whereas every insurance company out there does not have an independent adjuster in every single city that they write an insurance policy in. There are what are called third-party claims administrators or public adjusters who are in every city that insurance companies will contract with, right? In the event that a claim would happen, they know the local market, they know the area better than an insurance company that's headquartered in a separate city and state. So all of these insurance companies rely on these adjuster networks to actually fulfill and deliver on claims. When they arise in certain markets. So all these captives work with that same network. Most of them are corporations, right? So Cedric is one that most people are familiar with that a lot of large insurance companies will, will deal with claims as a TPA for. There's a lot of up-and-coming other networks that are out there. Maverick is one. But everybody, you know, all the captives we work with essentially outsource the actual claim fulfillment too. But what's good about the captive structure is since you're involved, and the money still technically belongs to you, there are a lot of scenarios when, hey, this is a clean, right, a clean activity or clean accident. We know exactly what happened. It's proven. There's footage or whatever you have at record showing exactly what happened and how much it is to essentially pay out for. A lot of captives will essentially just remit money to you without even really asking additional questions or doing further due diligence if it can be proven with enough information up front where, hey, this happened. It was verified and confirmed. This is an accurate estimate. Here's money 72 hours later. Go fix it yourself. Which is also some, something I like to liken to, right? Property managers and owners are really good at owning and managing properties. Insurance companies, on the other hand, might not have the talent or the staff that is as low to the ground, has their boots at every property that you own or manage. Who can tell you better than yourself what it takes to cost to fix something, what you need to get it done for the cheapest amount possible. So if you can align the incentive where the people who manage and own these buildings probably can do a better job than anybody else at fixing something when it goes wrong, right? Captives are a vehicle to essentially enable you to remove any lag times, to remove any delays, and give you what is needed to essentially get that fixed and resolved as soon as possible, which is really just the financial part of paying for the claim itself.

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Yeah, I would say that would be your only incentive if you didn't have a long tail potential reward on the back end, because I think it does change the psychology. But yes, you're right. I mean, and all claims are still have to be approved. By third-party administrator, right? It's not just, oh, somebody submitted a claim and we're sending them a, um, right, the, the money without even verifying all the information, but just the speed to verify and essentially ensure that any claim activity is real and not fraudulent is essentially expedited in terms of dealing with the right TPA, with the right people in place to be able to help handle that, which some insurance companies just frankly aren't, right? And that's even in some scenarios where you have an insurance company where Right? Damage happened, you need to get it fixed right away, but you can't wait on them to send out an investigator, an adjuster, generate an invoice where every day that goes by, you're not only losing more money, but potentially causing more damage. And that structure, you're right, a lot of companies will say, hey, well pay for it yourself and then we'll reimburse you. Well, when that reimbursement takes a year before they can finally, right, verify and, and rectify all the issues that you submitted, you know, that's coming outta your cash flow, that's coming outta your NOI at the end of the year. Whereas a lot of insurance companies, they're not incentivized to speed up and expedite that process because again, that is a disaligned incentive to them and their shareholders, which doesn't exist in, in, you know, a self-owned or co-owned captive or insurance structure.

Got it. Okay. What about the case of like one of the participants in the program believes that their, so their, their claim is denied., right? And they say, this is crap, you know, this is a legitimate claim. And so they begin an adversarial process against the captive, which they themselves are part owner of. Like, how is, how is that handled? Like, you know, because the, the way when you first hear about this program, it sounds amazing. You're just, you're imagining just a bank account, like you talked about a bank account, like you put money in and you take money out. It's like, great. But the reality is there, there need to be employees. There need to be claims process, there needs to be an adversarial process sometimes. There's, you know, there's all kinds of things that, that, like, again, coming back to the OG insurance companies, there's a reason that 40 to 50% of their expenses don't go toward paying out claims. It's because there's real costs with operating a business. So how is some of that handled with these captives?

Yeah, there is, there is verbiage in most of the contracts where if there is a disputed claim, it's generally not over if coverage existed, but usually on what the payout amount is where there's, right, arbitration and mediation clauses that the captive and both the customer or the arbitrating party can file in court to have that resolved. But for the most part, you know, the, the key word there, the biggest differentiating factor is it's usually over the payout amount, not what coverage, if it's denied or not, right? So a lot of times litigation costs will, will really run up in the event that somebody thinks that they have coverage, they don't, or they do have coverage and they sue to have more of an amount that the coverage allows them to have, right? Again, that always comes with usually the liability side. It's rarely on the property side, or if it is, the property can be evaluated and a firm number can be agreed upon in court. So the litigation costs when it comes to pure property or non-nuclear potential liability claims, A lot of those litigation costs are a lot cheaper and easier to resolve than the alternative, which, which traditional captives again usually carve out or don't offer to the general market because we're not serving the personal insurance space, we're serving the commercial space, which is a lot easier and predictable.

Got it. Okay. What about large, expensive, unpredictable events? So apartment building burns down or a guest slips and falls and sues for millions of dollars, or spills hot coffee on themselves in the welcome guest area, or like, I mean, there's still scary expensive things that can happen that, that could easily exceed the cost of the property itself or the replacement value of the property. So what happens then when you only have a year and a half of reserves like built up?

Yeah, I mean, the carrier, you know, most captives will have litigation teams that already they have pre-selected, most like, you know, traditional insurance companies do. So there will be in most cases, you know, defense lined up to essentially represent you and the captive itself in the event that that should happen. But yeah, I mean, obviously your people think, oh, I'm a year in, what happens? It depends on your captive structure. If you entered into a captive where you opted out of, you know, not having reinsurance and you're in a pure, you know, bank account, if you will, that doesn't have a backstop. Yeah, if your first year you paid in, you know, $100,000, but then you get hit with a million-dollar claim, technically the $900,000 difference is coming out of your pocket. And most times there is a, right, a payment plan, or it's built into added premium at a future expense moving forward if you want to stick with the captive. But in the reinsurance position, if you're in a group captive that has backing, you know, yes, that's technically on the reinsurance company who's taking on that risk. And right, again, a lot of these captives have been around and been in operation for several years where there is enough money in the fund where they can cover those claims if they were to happen for somebody who got hit with a, you know, a catastrophic claim before they really fully funded their own bank account upfront, if you will. So, right, there are reinsurance placements to deal with that scenario, and reinsurance companies are aware of that risk and take on that responsibility either way.

Got it. Okay. I'm just trying to think if we've really covered what the program is, how it works. It sounds like this historically, I mean, my understanding was historically this was available for, you know, these big multifamily guys, but it sounds like now it's becoming more and more a thing for SFR. So for our world, talk a little bit about what are the programs and options available for a scattered site third-party manager like myself?

Yeah. Yeah, so I mean, the first pushback I get from a lot of people are like, hey, you know, I thought this was for REITs and institutional funds to have, you know, 10,000 units plus. That has been the case historically where those are all pretty much purely independent self-captives. But over, yes, the past 10 years, group captives, rented captives have been more prevalent and what I call just accessible to smaller portfolios, including, right, smaller SFR managers and owners. So we can really insure anything as long as there is a lease landlord relationship in place where it's not somebody who personally owns the home that's in their name that they also live in it. Yeah. As long as there is an owner that owns the property and there's a different resident living in it and it's in an LLC name, we can really insure at the property level anything from a single townhouse up to, you know, 10,000-unit scattered site portfolio. So there's really no limitations on the property side. On the resident side, same thing. We can really bring anybody on. There's no limitations just because The different options that are created and in existence today for the market are vast and can fit any portfolio at any size. So we can deal right in the single family, scattered site. We tend to help a lot with centralizing their risk, if you will, where instead of each site having a different insurance that's debacking it and insuring it with a different claims process across the board, a lot of single family rental, scattered site communities or managers like working with a single insurance provider, having one right process to go to in the event that something does go wrong. And again, right, if there is upside profit margin potential, it sticks with them back at the management level, or they can divert it back to each individual property if there is one, which we can also assist with, right, on the accounting side to show what each property generated each year depending on, on the policy opted in for. And everything's à la carte, right? You don't have to do everything or nothing. If you say, hey, I just want to do the property, I just want to do, you know, the renter's insurance side, you can pick and choose exactly what it is. There's no right or wrong answer. The goal is really just to evaluate the options, see what's on the table, and then from there we can put a game plan together to put you in the right pool.

Yeah, I mean, a friend of mine is dipping his toe in the water with a renter's insurance captive and reporting success, early success. It's early days, but he was telling me that, you know, the claims on renters insurance is like very, very, very low. So the $8, $10, whatever it is a month that renters are paying, you create a captive, they pay into that, you pay out claims from that, and most of it is profit. He's telling me now, again, it's early days and I remain skeptical. Like, of course they're going to look profitable most years, but one big event can wipe out many, many, many years of of profit. That's the nature of insurance as rare, expensive events. So what are you seeing on, on the renters insurance captive stuff?

Yeah, I mean, before we, before captives even spin up, they do what are called feasibility analysis studies or actuarial studies to see if that product is profitable. Every insurance company has to technically report their right premiums collected, claims paid out to you, whether it's the S&P 500 or certain accounting bodies. Where if you Google, you know, hey, historically, what is renters insurance, you know, profit margin for insurance companies for decades, it's been in the range between 40 to 60% going back. I think it's to like 1970s or 1980s. So right there is over 40 years of history on that specific product where captives can accurately predict and say, hey, for every $100 your renter pays for renters insurance policy, Somebody is probably generating, right, $40 to $60 a year off of that policy, and it's either you or it's not you right now. You have the option to pick and choose if you want it to be you, but all of these products have historical records, right? Insurance is a highly regulated product with a lot of accounting going behind the scenes, being posted to a lot of rating bureaus. So all of these products have historical records of performance. And yes, right? If an insurance company comes and says, hey, we can on average predict, you know, 20% return every year, give it 10 years. And yes, there may be one year where the insurance company doesn't make any money at all, but there may be years where they make 35%, 40%. Some years they make 5 to 10%, where averaged out over the course of 10 years, it equates to, right, a 20% return or profit margin potential over a long enough time horizon, right? So, Yes, you know, just want people to be aware, just because a captive is, is, you know, projecting or estimating returns doesn't mean every year you will get that. But if you're in it for the long term, it will average out to that, you know, given historical performance over the past 40, 50, 60 years that this insurance product has been around. And that's the beauty of this thing. It's like I came from an emerging risk market where there was not a lot of historical data on how to show how much or how profitable a specific insurance policy is. But dealing with real estate property, renters insurance, they're well-known established products that have been around for decades, which is why captives are becoming so popular is because people are starting to wake up and realize, you know, hey, there's enough data where we feel comfortable of essentially retaining that risk and, and profit ourselves for the next 20 years in business now that we've already been in business, right, for 20 years.

Yeah, I mean, I feel like what the day— the data shows is that an insurance company that's well run over a long time horizon runs a— I think you said like 10, 15, 20% profit margin after accounting for claims paid out and administrative and operating overhead.

Yep.

I have to say, I'm okay with that. Like as a business owner myself who runs about those same profit margins, I'm okay with that. Like, I'm— I don't feel kind of this moral outrage knowing that an insurance company is only paying out X percent of premiums collected. I feel like— I mean, isn't that the case for every business? Like, I look at like the plumbing companies and the roofing companies and the flooring companies that we hire to, to do work at our properties, they're also running 10-20% profit margins. Does that mean I want to be in the roofing business or the flooring business? No, I don't. I want to focus on what I'm good at and let these people do what they're good at, and I'm happy for them to earn a profit in the process. So like, is the juice worth the squeeze here? I feel like this is— you're taking on a newer type of product. There's question marks around like the, like the longevity of this program and the risk profile compared to just like a traditional insurance? Maybe a, maybe a better question to ask is like, what am I— what have I not asked about? What are the risks? What are the things— if you were to do like an honest comparison between traditional insurance and captives, like, what are some of the things that people should— let's pretend they were like shopping one of your competitors, right? What would you want them to be asking about?

I mean, the biggest thing when it comes to captives are, you know, really understanding what the fixed expenses are. Just because, right, if you're going to, you know, to your point of owning a roofing company, you know, technically if you had the option to own a roofing company without having to manage and operate it yourself, you would refer a lot of business to that roofing company in the event one of your own properties had to, right, have a roof repaired or replaced. There's really no difference, right, in a captive structure versus a traditional insurance company where it's, hey, if If somebody's paying for this, it might as well be to a company that I have some type of a stake or equity in to, right, just benefit it because the money's gotta be spent. Somebody's gonna make it. It might as well be me. In the risk of the captive cells, I mean, most of them are really, the risk is being brought on by the reinsurance company. So most people ask me, you know, hey, in worst case scenario, if a building falls down in every city at the same time that this captive's insuring, What is my risk? You know, one, if that does happen, something seriously wrong is going on underneath the scenes where there's going to be more questions being asked. But if that does happen, right, reinsurance companies, given we're all, right, these caps are federally regulated insurance products, there has to be enough reinsurance backing to pay out for a claim in the event that everybody with all policies at the same time file a maximum claim at once. So in the event that a catastrophic event happens where buildings are falling down all over the country, the reinsurance company has enough money to pay out for all of those claims.

Oh yeah.

But I mean, they might not be around.

That's, yeah. Right. A year from now. That's a, that's a silly concern that these people are coming to you with. I mean, these reinsurance companies are, they're solid. The risk is not that the reinsurance company isn't gonna pay out. They are gonna pay out. The risk is that the reinsurance company doesn't renew. That's what I've seen with a lot of these programs. Not, not these programs, other— not, not captives, other different types of novel insurance that pops up every few years. They come out, they're all excited. Oh, this is great, you know? And you're like, wow, how is that really working? Because like, I'm running the math and I'm not seeing how that work—

how that—

how those numbers are playing out. Well, the reinsurance company happily collects premiums for the first couple years and then just drops them as a customer. And they're left with no reinsurance and they're not able to operate anymore. So I think a better question to ask would be like, what's gonna happen to my captive if my reinsurance doesn't renew?

Yeah, the options are to find alternative reinsurance placements, which in the event that a reinsurance company non-renews, your costs are probably gonna go up to source alternative reinsurance placement. Most of them, right, are obviously out of London or Switzerland, but in the event that something like that happens, if you can't find reinsurance backing and a captive ends up saying, hey, Hey, we're closing up shop. Your options are to either find another captive if you are, you know, proving that your performance has been good in the previous one, or you can always go back to the traditional market, right? The traditional market is always going to be around. That's not going to be something that there's never going to be an option. The only difference, right, is just, hey, in the time of my business being operational or me owning real estate, just what structure do I want to be in, right? And it's, you know, again, like you said, 10% is not going to drive the needle every year., but 10% over a 50, 60, right? 70-year investing career that compounds and adds to actually a lot of money over time.

Yeah.

Right. So that's, that's really where the true benefit is and where insurance companies really make their money. It's not in the first 10 years, it's over decades where it really starts to compound and add up. And that's, that's exactly what captives essentially deliver back to customers at the end of the day. The compounded returns is where the value comes in. And then if you multiply that over, every insurance product that flows through a real estate company, you know, do 10 to 20% of renters insurance, property insurance, workers' compensation, group health and benefits, right? All of them stacked together start to really add up to where you're now looking at, you know, could be 20, 30, 40, 50% profit margins across the board. I mean, you know, when insurance— Warren Buffett, is notorious, even Amazon, they're notorious for acquiring company, looking at the expense items, and then going and acquiring the top 3 to 5 expense items that that company operates under, right? And then they just build a portfolio of interlinked products and services where their expenses then generate profit for them at a future, right? Level. So that's exactly right. The main value of being vertically integrated in real estate, right? If, Yes, you own, you also operate, you also have a development and construction arm, right? All of those different margins from zero to finished product add up when stacked right over across each other, which is exactly just an option, right? Insurance is now available for people to be able to essentially vertically integrate.

So just one last sort of technical question on how these things work. So I pay premiums every year. And I get a, in, in good years I get a percentage of those premiums back. So the money, like, do, do I have to start by funding like a large reserve or how do we, how do we kind of kickstart this whole thing? Like, and like how does that work?

Yeah, so it depends on which, which captive structure, you know, you want to enter into. All independent cells or non-reinsured captives all have pretty much an upfront investment or, you know, what's called like a deposit. Where you do have to pre-fund the account where in the event a claim happens in the first 6 months, there's money there to be tapped into, right? Usually that money still belongs to you. So although it's recognized like as an expense or a capital expenditure, it's still since an account that you own. So technically it's not a lost or sunk expense, it's just a deferred, right, down payment if you will, to spin up the insurance company, but it still belongs to you.

But if there was an— there— but if there was a claim, it would turn into an expense presumably because it would be used to pay out a claim. Yeah.

Yeah, yeah, that's correct. But all group cell captives, they're all pretty much pre-funded and the costs to essentially become an owner is really just the cost of what the premium is for you to pay in. So there's no upfront capital expenditure, there's no additional capital calls in the event, right, if reinsurance is tapped into, you know, you're not gonna be asked to fork over additional, you know, money to pay for any additional claim activity if it should arise. It's just, it reads, the policies read the same way a traditional insurance company was, and so does the value and economics. Or, hey, I paid all my premiums and you're just, you owe me for whatever happens and that's it. There's no additional gotchas or, you know, additional money that you're gonna have to fork up in the event of a bad claim year.

Okay. Now are, are there, are any of the groups that are kind of in our space, like Foxen and Second Nature and like there's, there's Beagle and like, are these— are any of those groups doing this? Or like, how did— how do— how does— how do they fit into what we've been talking about?

Yeah, I mean, there's a— there's a bunch of different, you know, product options out there in the captive space. They all do something very similar. At the end of the day, what I've noticed in terms of product differentiation is product availability. So what products does this captive offer, right? There are some resident-only insurance captives where they say, hey, all we do is tenant liability. If you want deposit alternatives, if you want pet liability, sorry, we can't help you. We're not able to do that. So the number one is product differentiation in terms of what's available for your residents to purchase. On the property side, it works the same way, right? Some captives just do property, some captives just do general liability, some captives do both. It really depends on what, right, what you want to take on and what you want to leave to the traditional market. So when you're looking at captives, first question is, you know, hey, do I want a different captive insuring different products or do I want, right, all of it just going to one company just to make it easy, centralized, and efficient? And then number 2 is essentially what, right, what's the profit margin? What are the fixed expense of each captive? So when you're evaluating captives, the, the one thing I, as right, as a, a broker would recommend is to essentially say, hey, for every premium dollar paid in, What is my retention potential? Right? So for every dollar paid in, if assuming zero claims happen, how much sticks to the captive? Is it 70%? Is it 60%? Is it 50%? A lot of times the fixed costs are right, the big differentiator to most, most property managers and owners. They want to retain as much money as possible at the end of the day, right? Everyone's in business to make money. So when you're evaluating captive,. If you want one that's all-encompassing, that has every product available and the highest profit margin potential, that's pretty much where I'd recommend people go.

Got it. So your company, InsurTech, is not itself a captive. You are a broker, or how would you describe your company?

Yeah, technically I, I'd like to call it like a captive syndication or market platform where everybody can essentially come have a conversation, right, with me and then say, hey, These are all of the insurance items I'm responsible for. What captives are available for me to enter into based off of everything that flows through my company today? Right? So some people have, you know, W-2 employees. Some people have 1099s where a group health captive might not be an option for you, but resident and property would be. Some people just say, hey, I just deal with, right, just the property and the residents. What options are available for a captive based off of my portfolio size, et cetera? Because a lot of times where I think a lot of the industry has a pre-known like awareness of, it's like, hey, I'm a smaller operator. I talk to this captive program manager, but they only work with, right, 1,000 units or more and I can't enter into that. So you spend all that time talking to somebody evaluating if captive was right for you and then come to find out the person you talk to can't even help you and you just wasted your time and you're stuck in the traditional market, right? So on my end, I go and do all the research. I pre-find captives as they're being generated and spun up. I let them know exactly all my, right, customer base and potential. And then if anybody comes to me and says, hey, I want to be in a captive, help me find the right one. That's where essentially I come in. And then I have essentially agreements on the backend with the reinsurers that are backing most of these captives where the money I get is based off of their performance, not the captive's performance itself. So that way I'm rewarded more of a fair structure instead of just, hey, throwing on 10, 20% on top of what you're already paying and that coming, kind of coming to me at the end of the day. So that's kind of where I, I make my cut where most people will ask. You know, hey, what's in it for you?

Yeah, that was gonna be our next question. So, so, so you, you get some sort of a compensation from the reinsurance companies behind these captives?

Yeah. Or if they don't have reinsurance placement, right, there's often, you know, a, a admin fee for placing the services, right? Finding the TPA, putting the actuarial team in. But generally that's like less than 2% of the total cost. So it's, it's nothing really that's gonna like drive the needle for your profit margin potential. But yeah, it's all very minimal and a lot of it, again, it's all really performative. So I'm putting myself in a position where like, right, I'm putting my money where my mouth is and saying, I want people in this, in these groups that are gonna be profitable because my income also relies on, on them being profitable as well. Right. Backing with the reinsurance behind them. Got it. So it's just more fair lines. It's just a lot, a lot of insurance is just misaligned incentives. And my favorite part about captives, it just, it really takes all those opposing incentives and just aligns them all together. Which I think is just really cool.

Yeah. Well, Nicholas, we're at an hour. I appreciate you coming on the show. For people who want to learn more about InsurTech or you, just kind of follow along. First, I need to recommend that you follow Nicholas on LinkedIn because he puts some pretty spicy takes and I get in there and kind of argue with him sometimes, which is fun. And anywhere else that people should kind of follow along or check you out?

Yeah, I'm starting to get more active, you know, on all the social media channels. I'm starting to diversify the spiciness. But yeah, just, you know, Nicholas Laris on LinkedIn. My website is really helpful, you know, InsurTech, insur3tech.com has a lot of information. Got a blog on there, post some case studies. But yeah, anywhere you can find me, reach out. I'm pretty active and available online. Also go and hang out, you know, at a lot of events in the space as well. I'm trying to go to the, you know, NARPM owner-operator conference next year as well. So that's some stuff I'm looking forward to. So yeah, I'll always be around at events as well. At any— try to go once a month at least.

Cool. All right. Well, thanks again, Nicholas, and maybe I'll see you at a conference.

Yeah, I'll see you around, Peter. Thanks again.

Thanks. I hope you have enjoyed this episode. If you like the show and want to get connected to the community, you can follow me on Twitter @PSLOHMANN and subscribe to my email newsletter on my website, peterlohmann.com. I try to share as much valuable property management content as I can on a regular basis. Thanks again for listening and have a great week.