Captive and ART Review Article of the Month - Fronting Up
And not a great deal has changed. The number of fronting carriers in the market has fallen, leaving many captives, particularly group and association captives or those writing creative risks, left with little choice but to settle for unsatisfactory arrangements.
Often cited in past Captive Insurance Companies Association (CICA) annual fronting surveys as the biggest challenge faced by captive owners, fronting still remains a serious challenge, second only to security (20%) as the biggest challenge they face, with 19% of the vote, according to this year's poll.
Fronting is seen by some as a necessary evil, with most fronting arrangements in place for compliance reasons - either to comply with local regulatory legislation, statutory purposes for certain risks such as employers liability or contracts with third-parties that require AM Best or Standard & Poor's (S&P) rated paper or proof of insurance.
The market is still dominated by international players such as ACE and AIG, which also offer bundled services, although most countries will have their own smaller indigenous fronting market offering limited local services. Although many captives are satisfied with the role their fronting carrier plays, those that are unhappy are usually most disturbed by pricing and collateral requirements.
Captive fronting collateral is usually presented in the form of letters of credit (LoCs). However, the CICA 2007 Fronting Survey found that the number of captive respondents required to use LoCs as collateral for fronting fell significantly to 50% from 70% in 2006. A combination of LoC/trust accounts as collateral was up to 21%, cash was used by 12% of respondents and surety by 9%Fronting carriers request collateral using a variety of evaluations (aggregate limits, expected claims or each and every loss, for example) and for new captives or those with creative risks will usually calculate collateral on a worst case scenario basis. Fronting carriers far prefer dealing with the predictable exposures typically seen in the traditional market such as property, workers' comp and general liability. The subsequently high collateral demands put an instant roadblock in front of many captives looking to set up a fronting arrangement.
Pricing typically varies between 4% and 7% of written premium, which can be affected by whether the carrier has a network of partnerships to help reduce costs. However, CICA's survey found that almost one in ten captives was paying between 10% and 15% of premium in fronting fees. And it seems quality of service varies as wildly as price when it comes to what fronting carriers offer for their fee. According to Jonathan Groves, leader of Marsh UK's captive practice, good value for money can manifest in a number of ways.
"If your fronting carrier is able to issue policies within a guaranteed timeline of say naught to 60 days, agrees to move premium to the captive on a speedy basis within 15 to 20 clays from receipt of premium, is going to involve the captive in settlement of claims and is going to be flexible on how policy wording is drafted, then 4% to 7% represents value," says Groves.
"It becomes an issue when you get charged 7% or 8% and the carrier is very tardy when moving premiums, it doesn't want to involve the captive in any claims, it has draconian collateral requirements and the policy wordings are only standard wordings. That is not good value.
"You might find some fronting carriers that charge a slightly higher fee but are willing to reduce their collateral requirements, so it's a trade off," he adds.
Groves estimates 50% of captive owners are unsatisfied with the service they receive from their individual fronting carriers. However, he believes that fronting carriers' pricing may be justifiable as they do incur costs behind the scenes, such as capital charges relevant to reinsuring unrated insurers (most captives).
Hidden costs
Most captives are unaware of these costs, which heightens the perception of overcharging. Moreover, Ken Riegler, executive vice president and director of business development and client relations for ACE Risk Management, argues that fronting pricing is fair anyway, considering the underwriting risk and quality of paper the carriers provide.
One thing that is certain is that with the fronting supply and demand ratio the way it is right now, captives have to like or lump fronting fees, whether they believe them to be fair or not. In the meantime, captives should do what they can to ensure they are getting the best from their carriers for their buck.
Riegler breaks down what to expect from a good fronting company:
■Underwriting: If the carrier is willing to share the risk it is likely to have underwriting capabilities and industry expertise
■Reinsurance: Captive owners should look for fronting carriers with a broad, solid base of reinsurers that are highly rated by AM Best or S&P. Using a B+ reinsurer implies a lack of diligence in how they evaluate their reinsurers.
■Compliance: The carrier must have a good understanding of regulations in relevant countries, not only to ensure compliance but also to secure the most advantageous rates and to keep abreast of legislative change.
■Claims practice: The carrier has a fiduciary responsibility to properly report the loss to the excess carrier. Captive owners should understand the carrier's reporting process, adopting a collaborative approach.
■Fund flow: Captive owners should make sure the carrier is efficient at moving funds by looking at. A carrier that holds onto funds defeats the purpose
Riegler believes these expectations are partially met in the current fronting market, but it is up to the buyers to evaluate what kind of fronting carrier they need. While some carriers offer open dialogue and flexibility, others may be stripped down and offer the captive no say in the fronting arrangement, he says. Varied approach
Equally, there are variations in the approaches of the buyers themselves.
"Some captive owners jump into fronting for the first time and are totally rushing the situation. Others are fully committed to the ART arena, so they have vetted these things out to evaluate the strength of a fronting company," says Riegler.
Riegler recommends using the help of a broker with specialist knowledge in the captive's particular risks or in structuring fronting arrangements.
Groves outlines the steps captive owners can take themselves prior to engaging in a fronting arrangement to ensure they get the best from potential fronting carriers:
■Identify what their specific requirements are: lines of business, which countries, what limits are acceptable, what quality of policy wording is desired
■Set up internal measurement standards on how quickly they realistically expect money to be moved, how quickly they intend to pay premiums and how they can encourage divisions in various countries to pay
■Go to the market with a request for proposal (RFP) reflecting these points, asking the markets to provide their quotes around their requirements
Once the captive owner has received interest from the markets Groves says it should:
■Tie the fronting fees into its specific measurable standards
■Ask to see the fronting carrier's IT systems to ensure that it has the capability to physically deliver its guaranteed level of service Naturally, few captive owners are doing this at present, often approaching fronting carriers a matter of weeks before renewal and with no stipulations or clearly stated service expectations.
"Many captive owners don't think - about what they want initially, or about what limits and clauses are relevant in certain countries. Therefore, carriers often come back to them offering standard wordings in those countries, saying 'these are the carriers and this is what we think the premium we can extract from them is'. But the captive owner does not go back and interrogate enough," says Groves.
"While most captive owners talk about their placement strategy five months out from renewal, they often talk about their fronting strategy five or six weeks out, or sometimes five days out," he adds.
Gloomy outlook
Riegler thinks that, barring any unforeseen economic disasters, the fronting environment will remain similar for captives over the next two years. However.Groves is concerned that the risk-hungry fronting market will become even more restrictive for captives.
"I think it will get harder for captives because there are fewer carriers willing to do stand alone fronting without any participation in the risk itself," says Groves.
"Two or three years ago there were companies willing to fronting on a standalone basis, whereas now the carrier always wants to retain some of the risk, [f the carrier docs not cede 100% of the risk it makes it harder because it becomes difficult to get fronting for peculiar risks.
"The market won't retain any of the risk, whilst on the other side they won't engage in a full fronting programme because it doesn't fit in with current guidelines."
Captives requiring a front for long-tail or unusual risks may subsequently be in for a tricky time and may be forced to accept unfavourable terms in order to secure any sort of front at all.
Looks like fronting will continue to be grumbled about for a while yet.
