Why Captives Often Put on a Front

Fronting is the term used to describe a proven strategy that allows insurers, including captives, to meet state regulatory requirements and provides the capability to participate in risks that they otherwise would be unable to assume. It is a long-used risk-handling mechanism through which underwritten risk exposure is transferred within the insurance and reinsurance sector. For example, a captive insurance company may partner with a traditional insurance carrier who will underwrite an insurance policy and pass most or all of the inherent underwriting risk to the captive. The carrier, in this example, is known as the fronting company and receives an agreed-upon percentage of the policy’s premium as a fronting fee. Beyond the underwriting process, the fronting carrier’s responsibilities will include quoting, binding coverage and issuing policies. Their duties may extend to claims handling and management, but there is the opportunity for this service to be unbundled and contracted with a third-party administrator (TPA).

Carriers and captives may also turn to fronting as a way to write controlled coverages, such as commercial auto, in states where they are not approved to do so. Fronting allows them to essentially “rent” the carrier’s services to issue policies in those jurisdictions by paying a fronting fee to carriers who already have a legal presence and satisfy regulatory requirements. Fronting carriers embrace the strategy because it generates income without taking on commensurate levels of underwriting risk.

Captive owners often explore fronting as a way to facilitate their risk assumption goals. They turn to the fronting market to handle everything from underwriting to policy issuance to generating the documentation verifying they’ve satisfied regulatory and contractual requirements, where required. The carrier may also function as a reinsurer wrapping around the captive, ensuring that total coverage is afforded by the program.

Additionally, many organizations are under contractual obligations, such as commercial property owners and developers, for which a mortgage lender requires proof of insurance coverage from a carrier with an AM Best rating, such as A- or better. If a company wishes to establish a captive to provide property or general liability coverage associated with those properties—but is unable to evidence the required rating on its own— fronting allows it to meet the obligation.

An illustration of the combination of captive and fronting strategies might involve a property management company also engaged in building and owning facilities it manages. The property insurance marketplace may be hesitant to provide coverage for risks associated with this business sector so that the management company may face prohibitively expensive insurance premiums or a shortage of insurance capacity. By establishing a captive, the company, via their captive, assumes the first layer of risk, which reduces the premium costs paid to the carrier; this saving is utilized to fund the captive to pay losses, therefore satisfying the captive's obligations. The fronting carrier issues the policy and agrees to assume losses above that first layer. The captive will take care of losses related to their exposure and rely on the fronting carrier and its reinsurers to handle severe and catastrophic events. As previously mentioned, it’s an arrangement that also satisfies lenders’ contractual requirements.

The market for fronting has grown exponentially over the past decade from just a handful of carriers that were willing to serve this role. Entrepreneurially-minded insurance executives recognized that fronting could allow them to offer policies without taking on underwriting risk (although they still faced credit risk and the remote possibility a reinsurer would be unable to perform as promised). As a result, there are a number of insurance companies that are happy to serve as fronting carriers for captives.

Exploring the use of captives and fronting is especially appealing in some of today’s hardest insurance markets, particularly property coverage in regions that have experienced catastrophic climate-related incidents such as flooding and wildfires. As with any effort involving captives, talking with a knowledgeable consultant in the early stages will help organizations better understand whether it’s a viable approach before they begin what might be a cumbersome process.

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.