What Is a Back-to-Back Deductible?

In the insurance industry, the term “back-to-back deductible” refers to an insurance policy in which the deductible is equal to the full amount of the policy. 

Insurance contracts with these kinds of deductibles are referred to as “fronting policies”—that is, policies issued by an insurance company for the purposes of allowing the policyholder to self-insure. The insured party would then be responsible for covering any damages that might occur under the contract, even though they are technically covered by an insurer.

Key Takeaways

  • A back-to-back deductible is an insurance policy for which the deductible is equal to the full amount of the policy. 
  • Insurance contracts with these kinds of deductibles are referred to as “fronting policies”—that is, policies issued by an insurance company for the purposes of allowing the policyholder to self-insure. 
  • The insured party is then responsible for covering any damages that might occur under the contract, even though they are technically covered by an insurer.
  • One of the main areas in which back-to-back deductibles are used is in relation to captive insurance companies, which are wholly owned subsidiaries of a larger parent organization and are often tasked with fulfilling the insurance needs of the parent company. 
  • Using captive insurance companies in order to self-insure can benefit parent companies in terms of taxes, as the premiums paid by the parent company to its captive insurer are often tax-deductible.

Understanding Back-to-Back Deductibles

Deductibles are a normal feature of most insurance contracts, particularly for health insurance, auto insurance, and property and casualty insurance policies. These deductibles are the out-of-pocket expenses that the policyholder must pay when they file a claim.

For example, if a policyholder files a $4,000 claim and has a $1,000 deductible, they would need to pay $1,000 out of pocket and their claim would only cover the remaining balance of $3,000. All else being equal, higher deductibles lead to lower insurance premiums, and vice-versa.

In essence, a back-to-back deductible is simply an insurance contract in which the deductible is equal to the full coverage amount. In our earlier example, the policy would have a back-to-back deductible if the deductible was $4,000 rather than $1,000. In that scenario, the policyholder would need to pay for the full claim out of pocket despite technically having purchased insurance.

At face value, it may seem strange that anyone would choose to purchase insurance with a back-to-back deductible. However, there are circumstances where doing so can make economic sense. To begin with, when someone takes out an insurance policy with a back-to-back deductible, the insurance carrier—also known as a fronting company—underwrites the insurance contract and ensures the policyholder’s ability to pay any claims.

This means that the policyholder can benefit from the risk analysis performed by the insurance company. In other cases, back-to-back deductibles are used when dealing with captive insurance companies.

Real-World Example of a Back-to-Back Deductible

One of the main areas in which back-to-back deductibles are used is in relation to captive insurance companies. These insurers are wholly owned subsidiaries of a larger parent organization and are often tasked with fulfilling the insurance needs of their parent company. The parent firm is willing to put their own capital at risk, and may simply use the captive insurance company as a way to self-insure in a manner that complies with their state insurance regulations.

For example, rather than simply putting aside cash as a rainy day fund, a parent company might take out an insurance policy with its captive insurance firm and include a back-to-back deductible in the policy. That way, the firm has technically received insurance from a third party, without transferring any financial risk to the captive insurance firm.

Using captive insurance companies in order to self-insure can also benefit parent companies in terms of their taxes. For one thing, the premiums paid by the parent company to its captive insurer are often tax-deductible. But beyond that, these captive insurance companies are often established in overseas tax havens in which profits are taxed at a much lower rate than would be possible domestically.