Hard Market Hikes Friction With Fronts

As the insurance market hardens, captives and the carriers that sometimes “front” for them are increasingly at 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 are reeling from the deletion of coverages and even non-renewal of their policies, according to Brian C. Donovan, president of Steel Tank Insurance Company, a captive insurer with offices in Chicago and Burlington, Vt.

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

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

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

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

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

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

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

Typically, the fronting involves a reinsurance relationship in which the captive insures part or all of the risks of the primary carrier 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 the current situation. “Five years ago when the market was less than hard and getting a lot softer,” insurers seeking either a “competitive advantage” or “to keep up with the competition” often suggested that captives expand coverage under their policies, he said. Since the added protections–such as employee benefits liability coverage as an endorsement to a general liability policy–usually did not cost the insured, the captives generally agree 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” will take a “quantum leap” with January 2002 renewals. “Very honestly, I don't have a problem with them becoming more restrictive–they should've been more restrictive five years ago,” he indicated. But “from a captive standpoint, it would be an easier world to operate in if the insurance companies were consistent year after year.”

As to why insurers are pulling away from fronting relationships when the captive market is growing, Mr. Donovan believes that insurers either don't spend the time or don't have the interest in recognizing that captives are “a unique risk group.” He also surmises that some carriers view the captive market and the premiums it generates as too small. Admitting that this smacks of improvidence, 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 or 15 years down the line, [the insurance industry] looks at the next quarter,” he observed.

“If you don't like the way captives are operating in this fronting relationship, then you sit down with them and you say we need to make a few modifications but we're in this for the long haul,” 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 are about 600 captives in the United States, he suggested that some captives could pool their resources with an insurer to form a stand-alone fronting business with a “long-term vision” and the goal 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 ease the crunch.

Although Mr. Donovan could not say whether the current hard commercial insurance market will last, he suggested that a softening market could help problems with fronting companies “go away.”

Mr. Mead also could not predict whether current insurance-market conditions will reach the “crisis proportions” of the mid-1970s or mid-1980s. “But I think a lot of people are seeing it already,” he said, 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 serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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