Summary
A fronting policy is an insurance policy that is written to cover a specific risk, but the risk is transferred to a reinsurer. This type of arrangement is most commonly used when the organization wants to maintain complete control over the claims process. Fronting policies are often used to manage workers compensation risk, automobile liability risk, and product liability risk. When a fronting policy is used, the organization can write a policy to cover the specific risk, but then transfer that risk to a reinsurer. This type of arrangement is most commonly used when the organization wants to maintain complete control over the claims process. By having the reinsurer take on the entire policy risk, the organization can maintain complete control over the claims process. Fronting policies are a type of alternative risk transfer that is most commonly used by large organizations.
Players
Definitions
Fronting arrangements allow captives and self-insurers to meet financial responsibility laws in many states that require an admitted insurer's evidence of coverage, such as for automobile liability and workers compensation insurance. Fronting arrangements can also be used with other types of business contracts, like leases and construction contracts, where evidence of coverage from an admitted insurer is required.
When a company arranges for an admitted insurer to issue a policy on its behalf without the intention of transferring any of the risk, it is called fronting. The company doing this is called the fronting company. The risk of loss stays with the original organization or captive insurer through an indemnity or reinsurance agreement. However, if the self-insurer or captive fails to indemnify the fronting company, the fronting company would be responsible for honoring the policy obligations. Fronting companies usually charge a fee for their services, which is typically between 4 and 6 percent of gross written premium.
Fronting arrangement
A fronting arrangement is a type of reinsurance where an insurance company ("fronting company") agrees to issue an insurance policy on behalf of a captive insurance company. The risk is then transferred to the captive through a contractual agreement ("fronting agreement"). This allows the insured to receive a policy from the fronting company, but the risk is ultimately covered by the captive insurance company. When used in the context of automobile insurance, the fronting company would be an admitted carrier in the state where the insured is domiciled, and the captive would be based in another state. This allows the captive to take advantage of the state's insurance laws and regulations that are more favorable to insurers.
Captive insurer
Think of a captive insurer as an insurance company that is owned and controlled by its customers, and whose main purpose is to insure the risks of its owners. Customers in a captive choose to put their own money at risk, rather than using the traditional, regulated commercial insurance marketplace.
To issue policies, a captive insurer often contracts with a licensed insurer, even if the captive would prefer to be the main risk-bearer. This is because it is usually illegal for an unlicensed insurer to issue policies. The captive insurer is an unlicensed, non-admitted insurer except in its own domicile.
Fronting policies
A fronting policy is a way for an insurance company to manage risk by writing a policy to cover a specific risk, but then transferring that risk to a reinsurer. This type of alternative risk transfer is most commonly used by large organizations. By having the reinsurer take on the entire policy risk, the organization can maintain complete control over the claims process.
Fronting policies are often used to manage workers compensation risk, automobile liability risk, and product liability risk. In each of these cases, the organization can write a policy to cover the specific risk, but then transfer that risk to a reinsurer. This type of arrangement is most commonly used when the organization wants to maintain complete control over the claims process.
Friction with Fronters
Fronters are a great way for MGAs acting as captives to get off the ground running and launch a new product in a variety of states licensed by the fronting company. Fronters require a lot of information both upfront and on an ongoing basis including enough premium and loss data to produce bordereau’s. The fronters may wish for your company to integrate with their sometimes-manual processes and hold a lot of meetings all the while taking minimal to no risk. So, while fronters are a great resource to get off launched in multiple states with one or many products some MGAs may wish to outgrow their fronters and become licensed themselves.
Intended uses
Captive companies may choose to use a fronting arrangement to comply with state insurance laws, which require insurers to be licensed to sell policies. Since captives are not licensed, a fronting company can sell policies on their behalf.
Secondly, fronting arrangements can help captives save money on premium taxes. Licensed insurers are subject to premium taxes, while unlicensed insurers are not. Therefore, using a fronting company to sell policies can help captives avoid premium taxes.
Thirdly, fronting arrangements can reduce risk of insolvency by having the fronting company post a bond or other security on their behalf.
Lastly, fronting arrangements can help captives access capital markets by having the fronting company sell policies on their behalf. These benefits can come at a cost, as the fronting company typically charges a fee for their services, which can range from 4 to 10 percent of the premium.
Additional uses
Admitted coverages written (e.g., WC, Auto, employee benefits)
Many states require that an insurer have an admitted policy in place in order to provide certain types of coverage, such as workers compensation or automobile liability. A fronting arrangement allows the captive to comply with these requirements by having the fronting company sell the policy on its behalf. This type of coverage is typically written on a "first dollar" basis, meaning that the captive does not have to cover any deductible or self-insured retention.
Need for rated paper
In some cases, the captive may need to have its policy written on a "rated" basis in order to comply with state insurance laws or to meet the needs of its owners. A fronting arrangement allows the captive to have its policy written on a rated basis by having the fronting company sell the policy on its behalf. This type of coverage is typically written on a "quota share" basis, meaning that the fronting company and the captive share in the premiums and losses in a predetermined proportion. This simply means if the fronting company writes the policy on a 10% quota share basis, then it will retain 10% of the premiums and pay 10% of the losses. (Refer to reinsurance capacity article).
Policy issuance and claims handling services
When a fronting arrangement is used, the fronting company typically provides policy issuance and claims handling services to the captive. This can be a significant benefit to the captive, as it can free up time and resources that would otherwise be spent on these activities. How these services are provided will vary from one fronting company to another. Some fronting companies will provide these services for free, while others will charge a fee for them. In most cases, the fee is based on a percentage of the premium.
The fronting company typically has a broad range of in-house expertise, including tax, insurance, legal, and regulatory. This can be a significant benefit to the captive, as it can provide access to this expertise on an as-needed basis. This type of arrangement is typically used when the captive is new or when the owners of the captive are not insurance experts. A fronting company can also provide valuable assistance in the event of a dispute with a regulator or an insurance company.