You are sure to have the best insurance education of your life, whether you’re negotiating a fronting charge with an insurance company the first time you do it, or if you want to renew a “renewal”, captive company fronting fees.
Because there are fewer insurance companies that will “front,” the cost of “fronting’ goes up. Insurance market losses companies such as Quanta Capital, Alea and others. This reduces the number of options. Where will the new fronting insurers come from? The property captives have been hit hard by Hurricanes Katrina and Rita. Fronting fees are expected to rise to 15%. The “fronting” insurers for the future will be the new Bermuda companies that will purchase U.S. insurance company platform platforms.
Captive insurance company owners must recognize that the “fronting” of insurance companies requires that they be approached at all levels of management. Senior management should get involved in the decision-making process as early as possible.
Captive fronting is becoming more complex with financial departments closely monitoring the credit risk associated with parent transactions. In order to insure their self-insurance deductibles under their Owner Contractor Insurance programs, many construction companies used to capitalize captive insurance companies several years ago. To ensure that the captive insurance companies can be sustained, “fronting” insurers are now reviewing the financial statements of those same construction companies. It is important that captive owners continue to monitor their fronting insurer’s financial statements and keep abreast of any possible rating downgrades by rating agencies. The tendency to “failure disclosure” of negative results by insurance company management has been a hallmark of the past.
In the selection of the domicile, fronting insurance companies play a larger role. The debate continues about whether to choose a domestic or offshore domicile. New York State with its 35 captive insurers is trying to expand the concept of a captive. They have reduced the threshold from $100 million to $25 million to increase the number of captives. The New York captive program needs more advertising.
Many of the most experienced fronting insurance companies have demonstrated the ability to “front” captives in all 50 states, from Vermont to Hawaii, Barbados to Bermuda. It has been the goal to reduce overhead costs and attract all new captive formations.
Surprisingly, the United States did not have any domestic captive domiciles in 2005 formations. The Cayman Islands and Bermuda accounted for 134 of these captive formations. The United States was led by Vermont, which had 37 captive formations.
The actuarial profession is taking a closer look at the pricing of captive risks by fronting insurance companies. When they disagree with an insurance company’s assessment of the right price for the risk, captive owners are realizing that they require their own actuarial support. Your captive needs to be priced correctly by the fronting insurance company, regardless of whether you are a residential contractor or nursery home in California. As the price disputes between captive owners, their front insurance companies and their front insurers continue to exist, we will see more litigation.
The front company continues to have problems with this concept. Once it is admitted, it must use the filed rates. Reports on market conduct by insurance companies will expose front carriers who are not following their rate filings while writing primary insurance products that are then reinsured back to the captive insurer company.
A committee of directors from a mature captive insurance company with more than five years of financial history should examine the cost structure of the fronting fees. This would give the members of the captive board a reason to examine this crucial transactional cost.
What are the components of the fronting fees? How is the captive owner able to monitor them? What was the last time that a new fronting company was asked for a quote on the captive? After this training is completed, the Boards won’t be “rubber stamps” anymore and will exercise greater judgment in making insurance decisions.
Captives that are older than their counterparts are increasingly looking to insure their Directors and Officers Liability Insurance. The traditional D and O form is written by the front insurance company. This risk is then transferred back to the captive acting as reinsurer. A direct procurement policy from the captive covers the exclusions in the D and O policies, thus eliminating the need to have the front. The owner of the captive should control the pricing for the direct procurement policies. A captive that writes direct insurance policies in the United States should be eligible for an A.M. Best rating. Captives can be a long-term investment. A Best’s rating of “A” makes them a significant asset.
Reciprocity between captive owners is another way to eliminate the “fronting fee.” Each owner purchases sophisticated reinsurance programs behind the captive insurance companies and uses the captive that is “A” rated. Captive owners need to look for alternatives to fronting fees when they approach the double-digits. Captive company budgets must be able to afford to explore other options and come up with creative solutions.
Another area of interest is finding “fronts” to Contractors Pollution Insurance Insurance. Captives are available to general contractors, residential and commercial contractors, trade contractors and carpentry and plumber, specialty contractors and foundation and pipeline contractors, as well as remediation contractors. Captives can significantly reduce traditional pollution coverage costs for contractors, particularly when policy limits are added above the captive retention. The standard pricing for captives is based on the simple principle that lower liability layers are priced at a higher price than the upper layers. This gives the captive owner a discount.
In the past few years, the identification of “fronting” carriers did not change much.
1. AIG
2. ACE
3. Old Republic
4. Zurich
5. Liberty Mutual
6. Find out More
7. Chubb
8. Hartford
9. Arch
Captive owners have always had to negotiate with these carriers. Insurance company “fronts” can be dynamic and change frequently. It is important to pay close attention to your fronting carrier in order to maintain positive relationships and avoid misunderstandings. How was your last interaction with your fronting carrier? Instead of reacting to their letter stating that they will cancel your “fronting” arrangement because they have returned from that particular insurance product, ask them how your program is going.
A number of studies have been done to determine what the “fronting fees” should or should not include. While the exact amount of these fees may change, the concept is the same. This “fee”, while changing in amount, requires focused efforts to remain economically efficient.
The following are some of the most recent “fronting fees”.
1. State Premium Taxes (not negotiable);
2. Federal Excise taxes (not negotiable).
3. Government schemes (not negotiable but you can try to get how they were arrived at).
4. TRIA fees (often not negotiable)
5. Aggregate Protection (negotiable; look at the idea of buying this yourself from outside the structure);
6. Margin for profit carrier/fronter (negotiable).
Your captive insurance company may be able to offer a lower “fronting” fee if your loss ratios are low. Low loss ratio business is a key goal for insurance companies. Try to influence the decision-maker if you can. Many fronting fees are renewed when they are relatively high in mature. It is in the best interest of the carrier to renew as-is because renewals have very little cost. It is the lifeblood of an insurance company.
Due to regulatory and rating agency fears, “fronting” carrier have made an effort to significantly increase the collateral requirements they ask for from captive owners. This area is subject to negotiation. Unfortunately, many Agent Owned Captive Insurance Company owners have discovered that collateralized programs can lead to inability to fund the letter credit, and thus the “front” cancels it.
Captive owners need to be aware that collateral with excess funds can also allow a company to access capital for growth. It is important to fully understand the components of collateral.
1. Loss Reserves (Schedule F-loss reserves plus unearned Premium reserves and Incurred but Not Reported loss)… IBNR is the most important because these are estimates. Does the Captive Owner wish to pay an independent actuarial analysis for the loss payout pattern and its full development?
2. Many “front” companies would like funding that would include funding the letter credit equal to high losses ratios. This is despite the fact that they set the pricing for the “fronted” policy. The pricing methodology must be challenged by the owners.
