Tight Re Market Puts Heat On Fronts
London Editor
Bermuda
During the soft market of the past seven years, many companies that provided fronting for captives have been left with their fingers burned as a result of reinsurance recoverable problems and the general tightening in the reinsurance industry, according to a Bermuda captive manager.
As a result, fronting capacity has dried up and fronting is becoming one of the biggest challenges facing captive owners for the next couple of years, said Peter J. Mullen, president with Artex Underwriting Managers in Bermuda, the rent-a-captive facility for Arthur J. Gallagher.
Mr. Mullen, speaking here at the World Insurance Forum, noted that there are very few companies that specialize in fronting.
"A reinsurer is going to not pay claims because theyre either unwilling or unable to pay," he added. "If theyre unable, thats your fault. They shouldnt have been on your approved list to begin with. But if theyre unwilling to pay it means youve done something wrong."
For example, he said, the contract might not have been put together properly or the fronting company failed to look after the underwriting correctly, which leads the reinsurer to resist paying claims.
In an interview, David J. McManus, president of Arthur J. Gallagher & Company (Bermuda) Ltd., explained that reinsurers that wont pay are those that feel the fronting companies didn't meet certain contractual obligations, such as failing to control the underwriting pen of a managing general agency. Mr. McManus chaired the World Insurance Forum session on captives.
Soft market conditions tend to lead "the amateurs" to stray into the fronting business, Mr. Mullen said during his speech, adding companies have "looked to earn fees just for issuing paper."
They delude themselves that its only fronting and that theyre not taking any risk, he said. "Theyre not necessarily set up to front but they see it as an attractive business and get into it. The ones that survive until the next hard market are probably going to get out of it again."
Mr. Mullen said a fronting company that is going to survive has to realize that it is assuming risk and then it is passing that risk on to reinsurers. "Its not just flowing through them," he said. If the reinsurer cant or wont pay, the fronting company is stuck with the risk, he added.
To survive long-term, fronting companies must focus on underwriting, on collateral from the captive, and on systems and accounting to make sure they can account for the business properly.
"When youre reinsuring to a professional reinsurer, youve got to make sure that your list of authorized reinsurers is kept current," he added.
Mr. Mullen said he came to captive management after 10 years with American International Group, where he put fronting programs together for captives.
Brokers were constantly asking why the fronting company needed a 5 percent fronting fee because the assumption was that the insurer was not taking any risk, Mr. Mullen recalled. "If fronting companies truly didnt take any risk, I think some of the fees being charged would be outrageous, but fronting companies take 100 percent of the risk and then they try and lay that risk off," he said.
(Mr. Mullen stood in for Robert Mulderig, chairman and CEO of Mutual Risk Management in Bermuda, who could not speak at the meeting because of the financial difficulties his company is experiencing. MRM is a risk management company that specializes in fronting and rent-a-captives. Its subsidiary, Legion Insurance Group, was recently downgraded from "A-minus" to "B" with a negative outlook by A.M. Best.)
In addition to fronting, Mr. Mullen said that captive owners and risk managers are also faced with other challenges in the hard market. "With the Enron situation, there is going to be increased scrutiny of captive programs," he said, adding that executives of parent companies will be asking why they own a subsidiary offshore.
Further, captives are going to have to operate for the next couple of years in a low-interest-rate environment, "which is not great for all of those reserves that a captive will hold." Investment income ultimately helps to reduce the net cost of risk for a captive, Mr. Mullen noted.
In addition, captives are going to have to contend with higher reinsurance pricing over the next few years, as well as higher retentions, he predicted.
Mr. Mullen noted that in the mid-1980s there were captives owned by large multinational companies with $100,000 retentions, a situation that hadnt changed materially until last year when retentions started to rise.
Captives that built up capital over the last couple of years will be in a position to take the higher retentions, he said. However, the captives that dont have the capital "will have to go to their parent for additional capitalI would guess that in todays environment its going to be more difficult to persuade the CFOs to put more capital offshore," he added.
Very few captives used the soft market to build up reserves in order to offer their owners stable prices in a hard market environment, Mr. McManus told National Underwriter. "Captives have got to start saying that theyll be disciplined during a soft market in order to differentiate themselves from the traditional [insurance] market."
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, March 4, 2002. Copyright 2002 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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