In a soft market, one might think that alternative-risk solutions such as captives and rent-a-captives completely lose their value in light of the attractive pricing of traditional insurance products—but this would be an incorrect assumption.
History has shown that alternative-risk transfer (ART) products have proven their worth in all market cycles. While ART products may not be as sought after in a soft market, their fundamental core benefits remain: offering insureds greater control over their exposure to risk. So while competitive pricing may be available today in the traditional insurance marketplace, many insureds continue to want to self-fund certain exposures, especially general, products and/or professional liability.
And in many of these situations, a quality fronting carrier plays a critical role in order to achieve the optimal program structure and desired result.
The hard market of the 1980s was perhaps when ART products came of age, with captives, rent-a-captives and self-insurance gaining a strong foothold in the P&C marketplace. However, insureds still required partners to implement their alternative-risk solutions: reinsurers, claims administrators and, most importantly, fronting carriers to issue the policy.
Captives and self-insurance continued to be popular and effective risk-financing approaches during the extended soft market in the 1990s, the relatively brief hard market in the 2000s and the current soft one. Although some insureds have opted out of captives in favor of low-priced traditional insurance products, many have stayed committed to their existing alternative-risk structure—and, interestingly, some even have established self-funded general-liability programs during this (and other) soft markets.
Impact of Financial Crisis
One recent challenge for the ART market: the worldwide financial crisis that struck in 2008. The result of the crisis was—and continues to be—more difficulty in obtaining financing from banks and more scrutiny of existing ART structures.
Many insureds with captives and those which pursued self-insurance soon found out that third parties felt more secure receiving general-liability certificates of insurance from an A-rated carrier. In fact, financial institutions often demanded an A-rated carrier serve as a front for a general-liability captive. Despite the strong balance sheets and years of operational success of self-insuring companies, a “flee-to-safety” mentality prevailed and surplus-lines fronting carriers began to play an even more important role.
Nursing homes with captives are a prime example of this: To obtain HUD financing, they needed to provide evidence that a top-rated carrier was providing general- and professional-liability coverage for them. Contractors may also require a fronting carrier to satisfy loan covenants or lease agreements.
The good news is many types of fronted general-liability programs are now available to captives and self-insureds, enabling them to maintain their existing program structure on the back end while alleviating any front-end issues through a partnership with an A-rated surplus-lines carrier.
Potential Fronting Options
Flexibility in program structure is a key advantage of ART vehicles. Under one type of fronted, self-funded approach for general liability, an insured may obtain a claims-made and paid policy from an A-rated surplus-lines carrier which reimburses them for losses that arise and are paid within the policy period. The insured typically collateralizes the policy’s aggregate limit by providing the carrier with cash and/or a letter of credit, with collateral either being rolled into the next policy term if renewed or returned at expiration. Occurrence policies are also available but often require the insured to post collateral until the statute of limitations or statute of repose expires.
Some of these general-liability programs are “working” ones, where the insured intends to seek reimbursement for paid losses from the collateral that the carrier is holding. Others are “non-working” and the carrier serves only as a surplus-lines fronting solution, with no paid-loss reimbursements being sought. Both approaches offer one important benefit: the insured maintains significant control over its program structure. It can select the policy limits and sublimits it desires, and coverages can be added, deleted or modified.
Obviously, insureds that have their own general-liability captive or are self-insured are strong prospects for this type of fronted approach. Ideally, the insured is willing to actively participate in establishing loss-control procedures, selecting a claims administrator and providing active oversight. The insured should be financially sound and be able not only to fund the aggregate limit of its policy, but also to absorb any losses that may occur along the way. Coverage considerations can range from the typical to the unique (products recall, errors & omissions, environmental impairment).
Despite the current soft market, self-funding of general-liability exposures remains a viable option for many insureds. And when signs appear that a hardening of the market is on the horizon, interest is sure to increase.