What Is a Back-To-Back Deductible?
The term back-to-back deductible refers to the feature of an insurance policy where the deductible equals the actual amount of the policy. Insurance contracts with these deductibles are considered fronting policies—policies issued by a licensed insurance company while allowing an entity to self-insure. This means the insured party is the one who covers any damages, relieving the insurer of any risk.
How Back-To-Back Deductibles Work
Deductibles are a common part of the insurance industry, especially for health, auto, casualty, and property insurance insurance. Policy deductibles are the out-of-pocket expenses that the insured party has to pay when a claim is filed. For instance, an individual is responsible to cover their $1,000 deductible when a $4,000 claim is filed after a car crash while the insurer covers the remaining $3,000. The higher the deductible, the lower the premium paid to the insurer.
A back-to-back deductible allows a policyholder to essentially self-insure with the assistance of a licensed insurance provider. This type of deductible may also be called a matching deductible. It allows the policyholder a chance to get insurance coverage without passing on any risk to the insurance company. Since the deductible is identical to the value of the policy, the policyholder assumes the burden of covering any claims that a third-party may file against them.
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. The carrier generally does not expect to pay any damages on behalf of the insured.
- A back-to-back deductible is a deductible that is equal to the actual amount of the policy.
- Insurance contracts with back-to-back deductibles are issued by licensed insurance companies while allowing the insured party to self-insure.
- The insured party is the one who covers the costs of any damages, relieving the insurer of any risk if and when a claim is filed.
It may seem a little strange that a policyholder pays an insurance company even though it doesn't take on any of the risks associated with a policy. And the fronting arrangement may appear to skirt state insurance regulations, particularly because the true liability lies with an unlicensed and unregulated entity. In most cases, courts have allowed fronting arrangements to exist because the licensed fronting company is ultimately responsible for the insured company’s ability to cover claims and losses.
Even though they don't pay out any claims, insurance providers are responsible to underwrite the policyholder's ability to pay for any claims and losses.
Back-to-Back Deductibles vs. Captive Insurance
A deductible which equals the value of a policy can also be a feature of a captive insurance agreement. A captive insurance provider is owned and operated by its own clients. This is similar to a mutual insurance company—except that in the mutual insurance arrangement, policyholders do not exercise control over the insurance business. Participants in a mutual insurance organization also receive dividends from any profits that the insurance may produce.
In practice, a captive insurer typically has only one client. A large corporation seeking to manage insurance requirements and tax liabilities across multiple jurisdictions will often establish a captive insurer as a wholly-owned subsidiary to address these issues. These firms are willing to put their own capital at risk. They choose to do this because it ideally allows them to reap the benefits of not exposing themselves to the costs of the traditional commercial insurance marketplace.
To do so, a company establishes a captive insurer with a two-part tax benefit. First, the premiums paid by the company to its own captive insurer are often tax-deductible. Second, these subsidiaries are often established in overseas tax havens where profits are taxed at a much lower rate than they would be at home.
A back-to-back deductible is an indication of either a fronting policy or a captive insurance arrangement. Both are legal examples of an alternative risk transfer (ART)—the management of risk outside of the traditional commercial insurance marketplace. In both cases, the back-to-back deductible model results in a company's election to self-insure against claims or losses that would normally be handled by a wholly separate insurance carrier.