Hard Market Hikes Friction With Fronts

As the insurance market hardens, captivesand the carriers that sometimes “front” for them are increasinglyat odds, experts on the front lines say.

Not only are captives being socked with rising fronting fees(see National Underwriter, July 2, page 23), they also arereeling from the deletion of coverages and even non-renewal oftheir policies, according to Brian C. Donovan, president of SteelTank Insurance Company, a captive insurer with offices in Chicagoand Burlington, Vt.

As pointed out by Michael R. Mead, president of M.R. Mead &Company, LLC, and chairman of the Minneapolis-based CaptiveInsurance Companies Association, “risk-sharing is a commodity likeanything else.” M.R. Mead is a Chicago-based intermediary thatforms and manages captives, principally offshore.

With a shrinking number of insurance companies willing to frontfor captives, the remaining fronts enjoy “a seller's market,” Mr.Mead explained. He reported that many insurers refuse to partnerwith a captive that cannot deliver a minimum of $5 million inpremiums. This disqualifies many captives, he said.

Even if a captive can meet the premium requirements, the carrieris likely to insist on the use of its own claims adjusters, riskcontrol and other services, Mr. Mead said.

Mr. Donovan, who chairs the CICA communications committee andserves as a director of the Vermont Captive Insurance Association,has seen similar developments. He said that in the past his companyhad a claims administration agreement under which the carrier waskept informed about claims and was consulted in matters of policyinterpretation. But in the past year, the carrier has insisted onhandling all of the claims and on imposing surcharges, he said.

Mr. Donovan believes that fronts are disregarding “the captive'sability, its unique knowledge of the insured and its specializedknowledge of the business of the insured.”

Mr. Mead noted that captives are generally set up to handle riskfinancing or risk transfer for one or more entities where insurancefrom a traditional source is unavailable or unfeasible.

But as Mr. Donovan explained, a captive licensed to do businessonly in its state of domicile may need to show evidence ofinsurance to a lender or to regulators in other states or overseas.Because this is only a periodic need, fronting has been a practicalsolution for many captives, he said.

Typically, the fronting involves a reinsurance relationship inwhich the captive insures part or all of the risks of the primarycarrier for a particular set of insureds, explained Mr.Donovan.

The carrier in turn provides its admission into various states,compliance with state regulations, the payment of fees and taxes,reinsurance and other services, noted Mr. Mead.

Mr. Donovan blames the fronts' lack of discipline for thecurrent situation. “Five years ago when the market was less thanhard and getting a lot softer,” insurers seeking either a“competitive advantage” or “to keep up with the competition” oftensuggested that captives expand coverage under their policies, hesaid. Since the added protections–such as employee benefitsliability coverage as an endorsement to a general liabilitypolicy–usually did not cost the insured, the captives generallyagree to the additions, he added.

But with the 2001 renewal period and the hardening market,several carriers began eliminating those added coverages, Mr.Donovan explained. He forecast that this restrictive “trend” willtake a “quantum leap” with January 2002 renewals. “Very honestly, Idon't have a problem with them becoming more restrictive–theyshould've been more restrictive five years ago,” he indicated. But“from a captive standpoint, it would be an easier world to operatein if the insurance companies were consistent year after year.”

As to why insurers are pulling away from fronting relationshipswhen the captive market is growing, Mr. Donovan believes thatinsurers either don't spend the time or don't have the interest inrecognizing that captives are “a unique risk group.” He alsosurmises that some carriers view the captive market and thepremiums it generates as too small. Admitting that this smacks ofimprovidence, he questioned whether the insurance industry has ever“demonstrated that it is anything but shortsighted.”

Like many other U.S. business sectors, “instead of looking 10 or15 years down the line, [the insurance industry] looks at the nextquarter,” he observed.

“If you don't like the way captives are operating in thisfronting relationship, then you sit down with them and you say weneed to make a few modifications but we're in this for the longhaul,” Mr. Donovan declared.

Despite the current difficulties with fronting companies, Mr.Donovan predicted that the inherent “entrepreneurial orientation”of captives will lead to a solution. Considering that there areabout 600 captives in the United States, he suggested that somecaptives could pool their resources with an insurer to form astand-alone fronting business with a “long-term vision” and thegoal of helping captives control their own destiny.

Mr. Mead believes that the addition of one or two more carriers“willing to entertain risk-sharing propositions” would help easethe crunch.

Although Mr. Donovan could not say whether the current hardcommercial insurance market will last, he suggested that asoftening market could help problems with fronting companies “goaway.”

Mr. Mead also could not predict whether current insurance-marketconditions will reach the “crisis proportions” of the mid-1970s ormid-1980s. “But I think a lot of people are seeing it already,” hesaid, adding that this “makes risk-sharing very important.”

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, October 1, 2001.Copyright 2001 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.

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