Answer: A fronting fee in insurance is a charge paid by a captive insurance company or self-insured entity to a traditional, licensed insurance company for the use of its paper. This arrangement allows the captive or self-insured entity to operate in jurisdictions where it is not licensed, and the fronting company accepts the risk on paper but then cedes the risk back to the captive or self-insured entity.
Understanding the Concept of Fronting in Insurance
Definition of Fronting
In the insurance world, fronting refers to an arrangement in which a licensed, admitted insurer underwrites a policy for a certain risk but then immediately passes all that risk to a reinsurer. This allows companies that are self-insured or have their own captive insurance company to operate in jurisdictions where they are not licensed.
The “fronting” insurance company, in essence, lends its paper — i.e., its policy documents and insurance license — to the captive or self-insured entity. It might also handle claims administration and other services.
Why Use Fronting in Insurance?
Companies choose to use fronting arrangements for several reasons:
- Regulatory Compliance: A captive insurer may not be licensed to write insurance in all jurisdictions where its parent operates. A fronting arrangement allows the captive to provide coverage in those jurisdictions by using the licenses of the fronting insurer.
- Risk Transfer: While the fronting insurer initially accepts the risk, it transfers that risk to the captive insurer via a reinsurance agreement. The captive insurer then retains the risk.
- Access to Market: It gives companies with captive insurers access to insurance markets that they might not otherwise have, including admitted markets and surplus lines markets.
Role and Responsibilities in a Fronting Arrangement
The Role of the Fronting Company
The fronting company plays a crucial role in a fronting arrangement. It provides its paper — i.e., its insurance policies and license — and it also often provides administrative services. These services can include policy issuance, premium collection, regulatory reporting, and claims handling.
The Role of the Captive or Self-Insured Entity
The captive or self-insured entity pays the fronting fee and takes on the insurance risk. It reimburses the fronting company for claims, and it might also provide collateral to the fronting company to protect against the risk of loss.
The Fronting Fee: What Is It and How Is It Calculated?
What Is a Fronting Fee?
A fronting fee is a charge that the captive or self-insured entity pays to the fronting insurer. This fee is for the use of the fronting insurer’s paper and for the administrative services it provides.
How Is a Fronting Fee Calculated?
The fronting fee is typically a percentage of the premiums written under the fronted policies. The percentage can vary based on several factors, including the nature of the risk being insured, the amount of risk being transferred, and the services the fronting insurer provides.
Examples and Implications of Fronting Fees in Insurance
Let’s take a look at some examples of how fronting fees work in the insurance world:
Example of a Fronting Fee
Suppose a U.S.-based multinational corporation has a captive insurer in Bermuda. The corporation has operations in multiple states, but the captive is not licensed to write insurance in all of those states. So, the corporation arranges for a U.S.-based insurer to issue insurance policies to its operations in those states.
The U.S. insurer, in turn, cedes all the risk back to the captive insurer through a reinsurance agreement. The captive insurer pays a fronting fee to the U.S. insurer for its services and the use of its paper.
Implications of Fronting Fees
While a fronting arrangement provides benefits, it also comes with costs. The fronting fee can add to the cost of insurance, and the captive or self-insured entity might also have to provide collateral to the fronting insurer. Moreover, the fronting insurer might require the captive or self-insured entity to hold a certain amount of capital in reserve.