Direct Writer Captive Part 2: Fee Loads

This week we continue our three-part series on the Direct Writer Captive. Today's conversation addresses the fee loads generally associated with a Direct Writer.

Before we get into this, let's have a quick refresher. If a captive issues one policy, it can either be a reinsurance captive or a direct writer captive. It can't be both, but if the captive is issuing multiple policies, it can be both because a commercial carrier may reinsure some policies.

For this example, let's assume that it is one policy type being issued to the insured, and in this arrangement, the captive is in a 90/10 quota share arrangement with the fronting carrier.

So now, let's assume that the premium collected is $1,000,000.

The fronting carrier is going to be holding that million dollars. Then the captive will purchase excess coverage for an infrequent, large claim. Let's assume that the policy premium is $200,000. Generally, the excess carrier is also the fronting carrier, which leaves $800,000 of net premium.

Now let's break down the fees.

Let's assume that their fronting fee is 8% of $1,000,000 - $80,000.

Remember, if the quota share is 100/0, the fronting fee will be higher. If it's 60/40, the fronting fee is going to be lower, and such fees will be reported on the bordereau report.

Now let's talk about overall coverage. What is that? That's the captive "sleep well at night" coverage. The overall coverage usually covers the captive against catastrophic overall losses. For example, this policy will kick in if the captive members collectively have a 110-130% loss ratio.

These fees and the excess fees are expressed on the bordereau report because the fronting carrier controls the bordereau report.

Next is the captive management fee. Let's assume the captive management fee is 5% of $1,000,000 - $50,000.

SGA (sales, general and administrative costs) fees are also assessed and this could be fees to cover yearly audit, pro forma financials, and statement of actuarial opinion.

There are other service providers engaged in the affairs of the captive. These fees will not be expressed on the bordereau report. They will be expressed on the financial statements of the captive.

So, when you start with $1,000,000 and take out all the expenses, you're left with $395,000, which translates into an expense load. For every dollar of premium, the captive collects, 60￠ goes out for expenses.

I'll let you judge whether that's good or bad.

With $395,000 left, let's assume there are $300,000 losses, and the fronting carrier absorbs 10% - $30,000. So the captive isn't paying $300,000 - they're paying $270,000.

That leaves the captive with $125,000 of underwriting profit, but the fronting carrier takes 10% - $12,500. The fronting carrier walks away with $460,000. The captive walks away with $112,000.

The direct writer, with $1,000,000 premium collected and $200,000 of excess reinsurance, is a bit different of an analysis. There is no fronting or quota share fees, but the captive manager's duties are more intensive, so their percentage is a bit higher, around 10-11%. The SGA costs are the same. That leaves $595,000, a 40% expense, and leaves $295,000 of underwriting profits - the captive keeps all of it. That's a $182,000 delta between the two models.

Now people will say we're buying coverage in the reinsurance model but not in the direct writer model. Well, you're right. These coverages are an expense. I also suggest that if you're purchasing overall coverage, it's not the same as if it were in the direct writer model.

So I'll let you judge which model might be a better fit for your clients. Next week, we'll talk about cash flow and risk flow.

If you missed last week's video on the Roles and Responsibilities of the Direct Writer Captive, catch up here: https://youtu.be/HBVoaBm-DZs