Fronted Policies – When It Makes Sense

As the insurance market continues to firm and policy terms and conditions are constricting on corporate liability programs, more and more Risk Managers are strongly considering “fronted policy” structures.

What is fronting? Fronting may be defined as the provision of insurance by a licensed, admitted insurance company to an insured entity without the actual transfer of insured risk. The ultimate risk of loss is retained by the insured via a deductible and indemnity agreement or other similar agreement or transferred to a captive insurer via a reinsurance agreement.

So… when may a fronted program make sense? What are some of the benefits and major considerations that should be contemplated?

Some of the many potential benefits of a fronted policy in the casualty insurance space are:

Setting Policy Terms a

The global pandemic has generated a shift of thousands of employees from a centralized workspace to home-based work. Many employers look forward to a near-term return to the workplace while others see advantage in a dispersed workforce and are considering a larger permanent home-based workforce. These employers are wise to also consider the loss potential of homebased or remote work and mitigation steps to minimizing loss.

General Loss Exposures

The first consideration may be to identify jobs and employees well suited to remote work. Can the work be conducted successfully and efficiently from a remote location? Can that be verified? Can the work be done with limited in person group interaction and communication? Can work materials and tools be limited and kept secure?

Once the appropriate work is identified, suitable employees can be similarly vetted. Consider whether the remote employees have a strong knowledge of the work process and a track record of independence and dependability. Working remotely may not always be suited for newer employees or those with established performance issues.

Having identified the work and a workforce that are well suited to low exposure remote work, specific loss exposure types should be considered.

Cyber Exposures

Much of today’s remote work is conducted electronically. To the extent possible, work that is conducted remotely should be done so that work product and proprietary data remains secure. When remote employees are using computers setup and controlled by the employer’s IT department, it is a plus. When employees are working on their own equipment, the employer can consider communication and security protocols, and security training to limit loss or breach of sensitive data. Good practices can include:

• Sensitive information and communications accessed and stored only on secure local or remote computers and servers accessed through a secure virtual private network or website.
• Password security protocols that can include frequent password changes, complex password length and character composition, password reuse prohibitions.
• Employee security training to include exposure from phishing emails, malicious links and malware avoidance, and non-business use of company computer equipment, encouragement of “business use only” passwords.

Employee Injury or Illness

Work-related injury exposure often is less identifiable and controllable in the home. Being “at work” is not as black and white when the home and workplace are one and the same.

• Encourage the establishment of separate workspace within the home when possible. Set an expected work schedule. A segregated workspace and expected work hours may be helpful in determining whether or not slip/fall and other housekeeping incidents occurred “at work and on the clock”.
• For computer work, encourage the use of ergonomically designed equipment and workspaces. Where appropriate, provide ergonomics training and work practice expectations to remote employees.  

Other Loss Considerations

Consider if remote employees present any significant auto liability exposure:

• New work-related errands (office supplies, post office, client contacts).
• Set boundaries. If driving is not required, consider prohibiting it. If expected, define work-related vs personal missions. Set driving behavior expectations. You may find it necessary to review driving records for any significant new exposure.
• Do client visits or work-related deliveries expand your general liability exposure? If so, the condition of walking surfaces (particularly in winter) and maintenance could be a concern. Employers can remind employees of these potential exposures and encourage good exposure avoidance and maintenance practices.
• Finally, business personal property, tools and inventory can be more easily lost when kept remotely. Employers may wish to consider identification markings on deployed property assigned to remote employees. Recorded IDs at deployment may assist in recovery of durable property “checked in” at replacement or employee separation.

When seeking the benefits of a greater home-based workforce, planning and preparation can minimize potential loss contributors and facilitate a successful transition to a long-term remote workforce.

Since the licensed/admitted insurance carrier offering the fronted policy is transferring the ultimate risk resulting from the policy back to the insured or to a captive reinsurer (or, in certain situations, to another party), there may be some flexibility to provide broader coverages than are typically available under a traditional policy.

Direct Involvement with Claims

Since under a fronted policy, the insured (or captive reinsurer) is responsible for all claim payments under the policy and allocated loss adjustment expenses (ALAE), the carrier may allow a fair amount of flexibility in claims administration. A common motivator for the insured is to protect its corporate brand regarding sensitive claim issues. In some circumstances, the self-administration of claims and selection of outside defense counsel also may be permitted, subject to the carrier’s ultimate control. Keep in mind, the self-administration of casualty claims brings with it a responsibility to follow state claim practices regulations and any applicable adjuster licensing requirements.

Reduce/Smooth Up-Front Premium Costs

Fees charged by the fronting carrier are intended in large part to cover its internal costs to issue the policy and are usually much less than traditional risk transfer policy premiums. The carrier’s fronting costs include administrative costs for policy issuance and servicing throughout the policy term, costs to ensure regulatory compliance/filings (such as state auto filings, use of state approved forms, taxes & assessments), claims oversight and/or support as appropriate, and a general capital/surplus charge for premiums flowing through the insurer. There may be economies of scale available if the fronting policies are combined with other lines of business for your organization through one insurer.

Effective Use of a Corporate Captive

As stated above, the transfer of the insured’s risk from the issuing carrier may be a great addition to your existing corporate captive. Depending on the situation, your corporate captive may be able to directly reinsure the issuing carrier’s policy, or it might issue an internal deductible buy-back policy. In both cases, this allows the captive to bear the risk of losses stemming from the fronted policy.

Added Primary Limit/Capacity

Current market conditions often see lead umbrella policies requiring higher attachments. Possible responses are to increase the limits under the fronted primary policy to meet these requirements or to utilize a fronted buffer layer policy sitting directly above the primary policies (an example: $5mil fronted buffer layer excess of a Primary $5mil CSL Auto program to achieve $10mil total limits).

As you can see, there are many potential benefits to a fronted policy. However, there are also major considerations to analyze before deciding if one is right for your risk management program.

Increased Security Requirements

A fronting insurer must ensure that the policies it issues work as intended – i.e., that the insurer does not take on insurance-related risk that the parties intended to remain with the insured, or to be transferred to a third-party such as the insured’s affiliated captive. As such, the insurer will typically require some sort of financial security (often called collateral) from the insured or captive reinsurer. This protects the insurer against insolvency by the insured or captive or other circumstances that might pose risk to the insurer. Keep in mind that occurrence-based liability policies can accumulate substantial collateral requirements over time.

Controlling Total Cost of Risk (TCOR)

Retaining losses + ALAE (often major components of TCOR) can bring volatility to operating expenses. The insured’s risk tolerance must be weighed against the cost savings associated with the use of fronting policies.

Long-term or Short-term Solution

It is always best to determine if fronting a certain risk is a long-term strategy within your risk management program… or are you simply trying to solve a current problem (insurance market conditions that lead to increased risk transfer premiums, reduced capacity, restrictive policy terms, etc.). It is not unusual to see insureds decide to make use of a fronting policy as a tool to retain more risk and save current premium dollars in the short run, only to decide this is in fact the right long-term strategy.

Understanding your company’s level of risk tolerance and taking steps to efficiently control your TCOR are very important components to a sound risk management program. Naturally, detailed analytics and more in-depth conversations with your broker and carrier partners may be advantageous to best determine if a fronted policy is an appropriate solution for your company.