In a soft market, one might think that alternative-risksolutions such as captives and rent-a-captives completely losetheir value in light of the attractive pricing of traditionalinsurance products—but this would be an incorrect assumption.

History has shown that alternative-risk transfer (ART) productshave proven their worth in all market cycles. While ART productsmay not be as sought after in a soft market, their fundamental corebenefits remain: offering insureds greater control over theirexposure to risk. So while competitive pricing may be availabletoday in the traditional insurance marketplace, many insuredscontinue to want to self-fund certain exposures, especiallygeneral, products and/or professional liability.

And in many of these situations, a quality fronting carrierplays a critical role in order to achieve the optimal programstructure and desired result.

ART Background

The hard market of the 1980s was perhaps when ART products cameof age, with captives, rent-a-captives and self-insurance gaining astrong foothold in the P&C marketplace. However, insureds stillrequired partners to implement their alternative-risk solutions:reinsurers, claims administrators and, most importantly, frontingcarriers to issue the policy.

Captives and self-insurance continued to be popular andeffective risk-financing approaches during the extended soft marketin the 1990s, the relatively brief hard market in the 2000s and thecurrent soft one. Although some insureds have opted out of captivesin favor of low-priced traditional insurance products, many havestayed committed to their existing alternative-risk structure—and,interestingly, some even have established self-fundedgeneral-liability programs during this (and other) softmarkets.

Impact of Financial Crisis

One recent challenge for the ART market: the worldwide financialcrisis that struck in 2008. The result of the crisis was—andcontinues to be—more difficulty in obtaining financing from banksand more scrutiny of existing ART structures.

Many insureds with captives and those which pursuedself-insurance soon found out that third parties felt more securereceiving general-liability certificates of insurance from anA-rated carrier. In fact, financial institutions often demanded anA-rated carrier serve as a front for a general-liability captive.Despite the strong balance sheets and years of operational successof self-insuring companies, a “flee-to-safety” mentality prevailedand surplus-lines fronting carriers began to play an even moreimportant role.

Nursing homes with captives are a prime example of this: Toobtain HUD financing, they needed to provide evidence that atop-rated carrier was providing general- and professional-liabilitycoverage for them. Contractors may also require a fronting carrierto satisfy loan covenants or lease agreements.

The good news is many types of fronted general-liabilityprograms are now available to captives and self-insureds, enablingthem to maintain their existing program structure on the back endwhile alleviating any front-end issues through a partnership withan A-rated surplus-lines carrier.

Potential Fronting Options

Flexibility in program structure is a key advantage of ARTvehicles. Under one type of fronted, self-funded approach forgeneral liability, an insured may obtain a claims-made and paidpolicy from an A-rated surplus-lines carrier which reimburses themfor losses that arise and are paid within the policy period. Theinsured typically collateralizes the policy's aggregate limit byproviding the carrier with cash and/or a letter of credit, withcollateral either being rolled into the next policy term if renewedor returned at expiration. Occurrence policies are also availablebut often require the insured to post collateral until the statuteof limitations or statute of repose expires.

Some of these general-liability programs are “working” ones,where the insured intends to seek reimbursement for paid lossesfrom the collateral that the carrier is holding. Others are“non-working” and the carrier serves only as a surplus-linesfronting solution, with no paid-loss reimbursements being sought.Both approaches offer one important benefit: the insured maintainssignificant control over its program structure. It can select thepolicy limits and sublimits it desires, and coverages can be added,deleted or modified.

Obviously, insureds that have their own general-liabilitycaptive or are self-insured are strong prospects for this type offronted approach. Ideally, the insured is willing to activelyparticipate in establishing loss-control procedures, selecting aclaims administrator and providing active oversight. The insuredshould be financially sound and be able not only to fund theaggregate limit of its policy, but also to absorb any losses thatmay occur along the way. Coverage considerations can range from thetypical to the unique (products recall, errors & omissions,environmental impairment).

Despite the current soft market, self-funding ofgeneral-liability exposures remains a viable option for manyinsureds. And when signs appear that a hardening of the market ison the horizon, interest is sure to increase.