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Whether you are negotiating a fronting fee with an insurance company for the first time, as you
have a "start up" captive insurance company, or you are looking to renegotiate a "renewal" captive
company fronting fee, you are going to be in for the insurance education of a lifetime.
The cost of "fronting" goes up on the very basis that there is a shortage of insurance companies
willing to "front." The insurance market losses companies like Quanta Capital, Alea, etc. and thus
reduces the options available. Where are the new fronting insurance companies going to come
from? Hurricanes Katrina, Rita, and Wilma have brought havoc to the property captives, where we
see fronting fees rising to 15%. The new Bermuda companies will acquire U.S. insurance
company platforms and will be the "fronting" insurers of the future.
Owners of captive insurance companies must realize that "fronting" insurance companies need to
be approached on various levels of management, with preferably senior management getting into
the decision making process early on in the negotiations.
Underwriting Departments are playing a greater role in captive fronting, with the financial
departments looking closely at the credit risk of the parent transaction. For instance, several years
ago, construction companies would capitalize captive insurance companies just to insure the self-
insurance deductible under their Owner Contractor Insurance programs. Now "fronting" insurance
companies are examining the financial statements of these same construction companies to make
sure they can sustain the ownership of the captive insurance companies. Interestingly enough,
captive owners need to continue to monitor the financial statement of their fronting insurer, and to
be on top of any potential rating downgrades by the rating organizations. Insurance company
management historically has had a tendency of "failure to disclose" negative results.
Fronting insurance companies are playing a greater role in the selection of the domicile for the
captive insurance company. Domestic versus offshore domicile continues to be debated. Even on
shore domiciles like New York State, with its 35 captive insurance companies, are trying to expand
the captive concept by reducing the threshold, $100 million parent net worth to $25 million parent
net worth captives. More advertising needs to be injected into the New York captive initiative.
Most of the experienced, fronting insurance companies, have shown the ability and expertise to
"front" captives from Vermont domiciles to Hawaiian domiciles, and from Barbados to Bermuda.
The focus has been to continually drive down overhead expenses and those domiciles doing this
are attracting all the new captive formations.
Interestingly enough, domestic captive domiciles did not lead in 2005 formations, with Bermuda
and the Cayman Islands accounting for 134 captive formations. Vermont with 37 captive
formations led the United States.

2. Fronting insurance company pricing for the risks going into captives are getting a closer look by
the actuarial profession. Captive owners have come to recognize they need their own actuarial
support when disagreeing with the fronting insurance company's assessments of what is the
correct price for the risk. Whether you are a residential contractor in California or a nursery home
in Florida, your captive requires adequate pricing executed by the fronting insurer. We are going to
see more litigation in the future between captive owners and their front insurance companies, as
the disagreements over pricing continue to persist on each renewal.
Captive owners want their front insurance companies to come up with independent prices for each
risk, and that concept continues to be a problem with the front company. When it is admitted, and
has to use their filed rates. Insurance company market conduct reports are going to expose front
carriers that they are violating their rate filings when writing primary insurance products which are
reinsured back to the captive insurance company.
The more mature captive insurance company, with over five years of financial history, needs to
have a committee of its Board of Directors look closely into the entire costing structure of the
fronting fee. This would be a great excuse for members of the captive board to understand this
important transactional cost.
What are the detailed components of the fronting fee? How are they monitored by the captive
owner? When was the last time a new fronting company was asked to quote on the captive? Once
the captive board gets this training, the Boards will not be "rubber stamps" and exercise more
judgment at insurance decision making.
More and more mature captives are looking to write their Directors and Officers Liability Insurance
into their captive. The front insurance company writes the traditional D and O form, and that risk in
then ceded back to the captive, acting as reinsurer. The exclusions in the traditional D and O
policy are then covered by a direct procurement policy from the captive, eliminating the need for
the front. The pricing for the direct procurement policy should be controlled by the owner of the
captive. In some aspects, a captive writing direct insurance policies in the United States should
apply for an A.M. Best's rating. If we remember captives are a long time investment and by getting
an "A" rating from Best's, the captive becomes a substantial asset.
Reciprocity among captive owners can be another way of eliminating the "fronting" fee. Each
owner uses the "A" rated captive for each other's risks, and purchases a sophisticated reinsurance
program behind both captive insurance companies. When fronting fees approach double digits, it
is necessary for captive owners to seek alternatives to "fronts." Creative solutions need to be
implemented, and captive company budgets need to have the financial resources to explore
alternatives.
Finding "fronts" for Contractors Pollution Liability Insurance is another area that is getting
significant attention. General contractors, residential or commercial, trade contractors, carpentry
and plumbing, specialty contractors, foundation and pipeline, and remediation contractors, are all
candidates for captives, and in the early years require "fronts." Captives can substantially reduce
the insurance costs of traditional pollution coverage for contractors, especially when layering of
policy limits is introduced above the captive retention. Customary pricing above the captive
retention follows the simplistic approach that the lower liability layers are priced higher than the

3. upper layers, again giving the captive owner a "pricing" discount.
The identification of the "fronting" carriers has not changed dramatically in the last few years:
1.AIG
2.ACE
3.Old Republic
4.Zurich
5.Liberty Mutual
6.Discover Re
7.Chubb
8.Hartford
9.Arch
The negotiating process with each of these carriers has always been a challenge for captive
owners. Insurance company "fronts" are a dynamic group, and with people constantly changing
positions, requires that you pay significant attention to your fronting carrier to continually provide
favorable relationships and eliminate misunderstandings. When was the last time you asked your
fronting carrier, how is my program going rather than react 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 on what the "fronting fee" includes, or should include. The
amount of these fees keep changing but the overall concept remains the same. Focus and
concentrated efforts are required to keep this "fee" economically effective.
Among the recent "fronting fees" the following is included:
1.State Premium Taxes (not negotiable);
2.Federal Excise Taxes (not negotiable);
3.Government schemes (not negotiable, but try and get how they are arrived at);
4.TRIA charges (usually not negotiable);
5.Aggregate protection (negotiable, look at the concept of purchasing this yourself from outside
the structure); and
6.Profit margin for carrier/fronter (negotiable).

4. If loss ratios are attractively low for your captive insurance company, make every effort to obtain a
lower "fronting fee." Insurance carriers are always seeking low loss ratio business even as a
"front." If you can, try to influence the decision maker. Many "fronting fees" get renewed as is
when they are comparatively high in mature, and it is in the carrier's interest to renew as is
because there is little additional costs in doing renewals. It is the "lifeblood" of the insurance
company.
On the basis of regulatory and rating agency fear, "fronting" carriers have made a conscious effort
to require and substantially increase the collateral requirements they are asking for from captive
owners. This is an area of negotiation and as many Agent Owned Captive Insurance Company
Owners have found out, too late, over collateralized programs lead to the inability of the agent to
fund the letter of credit and therefore the "front" cancels the program.
Captive Owners need to know that over-funded collateral is another way a "front" company can
access additional capital for growth. You need to understand the true components of the collateral
required:
1.Loss Reserves (Schedule F - loss reserves plus unearned premium reserves and Incurred But
Not Reported losses) ... IBNR deserves the most attention since these are estimates, and does
the Captive Owner want to pay for an independent actuarial study for the loss payout pattern, and
full development.
2.Many "front" companies want funding that would include funding the letter of credit equal to high
loss ratios, this is despite the fact they had set the pricing on the "fronted" policy. Owners need to
have the expertise to challenge the methodology of the pricing.
In conclusion, "fronting" insurance companies provide "licensed paper," which is asset value; they
provide regulatory compliance and finally support services. Remember if fronting fees are greater
than 5%, and mostly in the 6-10% range. When going over 10%, it is imperative that you look for
another option.
About this Author
Andrew J. Barile, MBA, CPCU
President / CEO
P.O. Box 9580 • Rancho Santa Fe, CA 92067
abarile@abarileconsult.com
Tel: 858-759-5039 • Cell: 619-507-0354 • Fax: 858-759-8436
http://www.abarileconsult.com
Article Source:
http://EzineArticles.com/?expert=Andrew_Barile

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A great way to provide group health insurance to 50 or more employees!
http://www.captiveinsurance.info/Health/health.html
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