Fronting Policy Definition

What Are Fronting Policies?

A fronting policy is a risk management technique in which an insurer underwrites a policy to cover a specific riskbut then cedes the risk to a reinsurer. Fronting policies, which are a type of alternative risk transfer (ART)are most commonly used by large organizations. Because the reinsurer takes on the entire policy risk, it consequently maintains complete control over the claims process.

Understanding Fronting Policies

The insurance company that underwrites the original policy is known as the fronting company. This entity receives a percentage of the premium despite ceding all of the risks to the reinsurerwhich is responsible for all claims made against the policy it now effectively controls. The insurance company’s only function, other than underwriting and ceding the original policy, is to make sure that the reinsurer is in a fiscal position to pay off any claims that may come its way. To be clear: the insurance company itself never pays any of the claims in these types of arrangements.

Fronting policies are most commonly employed by large companies that conduct business across multiple regions or states. Not surprisingly, regulators have historically been dubious of fronting policies because companies may use them to circumvent state insurance regulations. This is due to the fact that the reinsurer taking on the entire risk underwritten by the fronting company is often unlicensed in a particular jurisdiction. In essence, the reinsurer acting as the insurer represents a regulatory loophole.

Strategy of Fronting Policy

For the primary insurance company, fronting is often used as a soft market strategy that provides income without incurring significant risk. This source of added capital can be used for staffing increases, systems upgrades, or any other expenses. Furthermore, the considerable financial and technical support of a reinsurer presents an easy way for a fronting company to explore a new insurance field on a gradual basis. Fronting can also provide a means to exit a new line of business, if it’s not profitable for the fronting company, over the long term.