What is 'Fronting Policy'
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 are most commonly used by large organizations, and is a type of alternative risk transfer (ART). Because the reinsurer takes on the entire policy risk, it has complete control of the claims process.
BREAKING DOWN 'Fronting Policy'
The insurance company that underwrites the original policy is called the fronting company. The fronting company receives a percentage of the premium despite ceding all of the risks to the reinsurer. By issuing the insurance policy, the fronting company appears to be the insurer, though in reality it transfers all risk to the reinsurer.
In a fronting policy, the deductible is the same as the liability. The reinsurer is responsible for all claims made against the policy that it now controls. The insurance company’s only function, other than underwriting and ceding the original policy, is to ensure that the reinsurer can pay its claims. It does not, however, pay any of the claims.
Large companies are the most likely candidates for using a fronting policy, especially if they have operations in multiple states. Rather than employing multiple insurance policies to cover risks in different jurisdictions, the company will have insurance companies underwrite policies, and then takes over the risks in those policies, thus allowing it to centralize claims management for a specific type of risk.
Regulators have historically been wary of fronting policies, as companies may use them as a way of circumventing state insurance regulations. The reinsurer that takes on the entire risk underwritten by the fronting company is often unlicensed in the jurisdiction. This means that the fronting company, which is licensed to do business in the jurisdiction, is ultimately handing the policy over to a reinsurance company that is not regulated by the state. The reinsurer thus acts like an insurer.
Strategy of Fronting Policy
For the primary insurance company, fronting is often used as a soft market strategy that provides income without significant risk. This income may serve to pay for certain support staff when not fully utilized. It also gives the primary company an opportunity to test the waters of new business lines. The considerable financial and technical support of a reinsurer then presents an easy way for an insurance company to enter a new insurance field gradually. Fronting can also provide a means to exit a field if necessary.