Whether you are negotiating a fronting fee with an insurance company for the first time since you have a “start up” captive insurance company, or you want to renegotiate a “renewal” captive company fronting fee, you will be dealing with your insurance education to live.
The cost of “fronting” is going up precisely because there is a shortage of insurance companies willing to be “fronting”. The insurance market is losing companies like Quanta Capital, Alea, etc. thus reducing the options available. Where do the new insurance companies come from? Hurricanes Katrina, Rita and Wilma have wreaked havoc on property inmates where we see fronting costs up to 15%. The new Bermudian companies will adopt platforms from US insurance companies and will be the insurers of the future.
Captive insurance company owners should realize that “fronting” insurance companies should be approached at different levels of management, preferably involving senior management early in the negotiation process.
Underwriting departments play a greater role in captive fronting, where the finance departments look closely at the credit risk of the parent transaction. For example, several years ago, construction companies capitalized on captive insurance companies just to insure the deductible excess under their Owner Contractor Insurance programs. Now “fronting” insurance companies examine the financial statements of the same construction companies to make sure they can retain ownership of the captive insurance companies. Interestingly enough, captive owners should continue to monitor their fronting insurer’s financial statements and keep abreast of potential rating downgrades by the rating agencies. Insurance company management has traditionally tended to “not disclose” negative results.
Fronting insurers play a greater role in the choice of domicile of the captive insurer. Domestic versus offshore domicile remains up for debate. Even ashore, like New York State, with its 35 captive insurance companies, they are trying to expand the captive concept by lowering the $100 million parent net worth threshold to $25 million parent net worth in captives. The New York captive initiative needs more advertising.
Most experienced insurance companies have shown the ability and expertise to “front” prisoners from the residences in Vermont to the residences in Hawaii and from Barbados to Bermuda. The focus has been on continuously reducing overhead costs and the sites that do this are attracting all new captive formations.
Interestingly, inland captive housing did not lead in the 2005 formations, with Bermuda and the Cayman Islands accounting for 134 captive formations. Vermont led the United States with 37 captive formations.
The pricing of insurance companies for the risks of captives is subject to scrutiny by the actuarial department. Captive owners have come to recognize that they need their own actuarial support when they disagree with the insurance company’s assessments of what is the right price for the risk. Whether you are a California residential contractor or a Florida nursing home, your inmate needs adequate pricing performed by the leading insurer. We will see more lawsuits between captive owners and their front insurance companies in the future as the disagreements over pricing continue with each renewal.
Captive owners want their front insurance companies to come up with independent pricing for each risk, and that concept continues to be a problem with the front company. When it is allowed, and must use their deposited rates. Market behavior reports from insurance companies will expose front carriers that they are violating their rate statements when writing primary insurance products reinsured to the captive insurance company.
The more mature captive insurance company, with a financial history of more than five years, should have a committee of its Board of Directors carefully review the entire fronting fee cost structure. This would be a good excuse for captive board members to understand these important transaction costs.
What are the detailed components of the fronting fee? How are they controlled by the prisoner owner? When was the last time a new fronting company was asked to quote about the prisoner? Once the captive board gets this training, the boards will not be “stamps” and will exercise more judgment when making insurance decisions.
More and more adult inmates want to get their directors liability insurance in their inmate. The front insurance company writes the traditional D and O form, and that risk is then returned to the captive, which acts as the reinsurer. The exclusions in the traditional D&O policy are then covered by a direct sourcing policy from the captive, eliminating the need for the front end. Pricing for the direct purchase policy should be verified by the captive owner. In some ways, a captive writing direct insurance policies in the United States should apply for an AM Best rating. Remembering that captives are a long-term investment and getting an “A” rating from Best’s makes the captive a substantial asset.
Reciprocity between captive owners may be another way to eliminate the “fronting” fee. Each owner uses the “A” rated captive for each other’s risks and purchases an advanced reinsurance program behind both captive insurance companies. As fronting fees approach the double digits, it’s imperative for captive owners to look for alternatives to “fronts.” Creative solutions must be implemented and proprietary companies’ budgets must have the financial resources to explore alternatives.
Finding “fronts” for contractor pollution liability insurance is another area that is getting a lot of attention. General contractors, residential or commercial, trade contractors, carpentry and plumbing, specialty contractors, foundation and pipeline contractors, and remediation contractors, are all candidate candidates and need “fronts” in the early years. Captives can significantly reduce the insurance costs of traditional pollution coverage for contractors, especially when stratification of policy limits is introduced above captive retention. The usual pricing above captive retention follows the simplistic approach that the lower tiers of liability are priced higher than the upper tiers, again giving the captive owner a “price” discount.
The identification of the “fronting” carriers has not changed drastically in recent years:
3. Old Republic
5. Freedom Mutual
6. Discover Re
The negotiation process with any of these carriers has always been challenging for captive owners. Insurance company “fronts” are a dynamic group and with people constantly changing positions, it is required that you pay close attention to your fronting carrier to continuously provide beneficial relationships and eliminate misunderstandings. When was the last time you asked your fronting carrier how my program is doing instead of responding to their letter saying they are going to cancel your “fronting” relationship because they are returning from that particular insurance product line.
There have been a number of studies into what the “fronting fee” entails or should include. The amount of these fees keeps changing, but the general concept remains the same. Focus and concentrated efforts are required to keep this “fee” economically effective.
Recent fronting fees include:
1. State premium taxes (non-negotiable);
2. Federal Excise (non-negotiable);
3. Government schemes (non-negotiable, but try to find out how they come about);
4. TRIA rates (usually non-negotiable);
5. Joint protection (negotiable, look at the concept to take this yourself from outside the structure); and
6. Profit margin for carrier/fronter (negotiable).
If loss rates are attractively low for your captive insurance company, you should do everything you can to get a lower fronting fee. Insurance companies are always looking for companies with a low loss ratio, even as a ‘front’. If you can, try to influence the decision maker. Many “fronting fees” renew as they are when they are relatively high in maturity, and it is in the carrier’s best interest to renew as they are, as there is little additional cost to doing renewals. It is the “lifeblood” of the insurance company.
Based on the fear of regulators and rating agencies, “fronting” airlines have made a conscious effort to require and significantly increase the collateral requirements they request from captive owners. This is a subject of negotiation and as many owners of agent-owned captive insurance companies have discovered, collateralized programs result in the agent’s inability to fund the letter of credit and so the “front” cancels the program.
Captive Owners should know that overfunded collateral is another way a “front” company can access additional capital for growth. You must understand the true components of the required collateral:
1. Loss Reserves (Schedule F – Loss Reserves Plus Unearned Premium Reserves and Accrued But Unreported Losses)… IBNR deserves the most attention as these are estimates, and will pay the Captive Owner for an independent actuarial study for the loss payout pattern and full development.
2. Many “front” companies want financing, including letter of credit financing equivalent to high loss ratios, despite pricing on the “fronted” policy. Owners must have the expertise to challenge the pricing methodology.
In conclusion, “fronting” insurance companies offer “licensed paper”, which is asset value; they provide regulatory compliance and finally support services. Remember if fronting costs are above 5%, and usually in the 6-10% range. If you go over 10%, it is imperative that you look for another option.