What Are Fronting Policies?
A fronting policy is a risk management technique in which an insurer underwrites a policy to cover a specific risk, but then cedes the risk to a reinsurer. Fronting policies, which are a type of alternative risk transfer (ART), are most commonly used by large organizations. Because the reinsurer takes on the entire policy risk, it consequently maintains complete control over the claims process.
- A fronting policy is a risk management mechanism in which an insurer underwrites a policy to cover a specific risk or a set of risks, then cedes the risk(s) to a reinsurer.
- Fronting policies are most often used by large organizations that operate in multiple states.
- This technique is an example of an alternative risk transfer.
- The reinsurer is responsible for claims made against the policy it now controls.
- Other than underwriting and ceding the original policy, the insurance company’s only function is to ensure that the reinsurer has the financial means to pay its claims in a timely manner.
- The insurance itself company does not pay any of the claims a client makes.
- Fronting policies allow insurance companies to dabble in new areas of business, without taking in the typical risks of doing so.
Understanding Fronting Policies
The insurance company that underwrites the original policy is known as the fronting company. This entity receives a percentage of the premium despite ceding all of the risks to the reinsurer, which is responsible for all claims made against the policy it now effectively controls. The insurance company’s only function, other than underwriting and ceding the original policy, is to make sure that the reinsurer is in a fiscal position to pay off any claims that may come its way. To be clear: the insurance company itself never pays any of the claims in these types of arrangements.
Fronting policies are most commonly employed by large companies that conduct business across multiple regions or states. Not surprisingly, regulators have historically been dubious of fronting policies because companies may use them to circumvent state insurance regulations. This is due to the fact that the reinsurer taking on the entire risk underwritten by the fronting company is often unlicensed in a particular jurisdiction. In essence, the reinsurer acting as the insurer represents a regulatory loophole.
Strategy of Fronting Policy
For the primary insurance company, fronting is often used as a soft market strategy that provides income without incurring significant risk. This source of added capital can be used for staffing increases, systems upgrades, or any other expenses. Furthermore, the considerable financial and technical support of a reinsurer presents an easy way for a fronting company to explore a new insurance field on a gradual basis. Fronting can also provide a means to exit a new line of business, if it's not profitable for the fronting company, over the long term.
The cost of using a fronting company is always a function of a percentage of the gross amount of written premiums.