What do you mean by FRONTING a risk?


Fronting has no long-term benefits... but plentiful of problems in RBC compliance

Fronting has no long-term benefits... but plentiful of problems in RBC compliance

Having sat in numerous meetings involving discussions on subjects relating to Risk-based Capital (RBC) and Risk Management & Compliance (mainly to do with the BNM’s directive in respect of JPI/GPI 22) I noticed people having differing understanding and opinion when articulating the subject concerning “fronting” a risk. In this blog I am not too concern with what they think or the academic sides of things but more on what I think from the real life Malaysian perspectives.




“Fronting” in Malaysia can simply be identified when some of the following elements are present in the business acquisition and placement process:

Risk-Fronting in Malaysia – Recogniseable Elements
  1. A process by which a primary insurer cedes all or virtually all of the insurance risk of loss to a sole or a number (generally not more than 3) of reinsurer(s), where the main reinsurer controls the underwriting and/or claim handling process either directly or through a managing general agency or broker.
  2. The controlling / main reinsurer is likely not licensed in the Malaysia.
  3. Arrangement has tendency of bypassing the country’s industry regulatory directives – JPI/GPI22 being the main….. although such perspectives may be blur.
  4. Insurers adopting fronting take it purely as a soft market strategy to earn income without significant insurance risk – to an extent as a camouflage in propping up the top-line.
  5. Insurers’ strategy to enter a new insurance portfolio gradually with the considerable financial and technical support of a reinsurer. Extended Warranty Insurance is one such portfolio that numerous insurers have gained substantial knowledge through early days of fronting.
  6. Reinsurers have sought to protect their source of income by dealing directly with insureds, their brokers or some prominent general agents who control sizeable books of business. In such practice, insurer is normally the last part of the structure to be put in place, almost as an afterthought. This is sometimes referred to as “reverse flow” business. Since reinsurers usually anticipate very favorable results in these circumstances, a bare front may be preferred. Some of the glaring cases are those relating to Schemes for various Professional Bodies (Professional Indemnity).

Fronting it upside down??

Fronting it upside down??

Whatever and However fronting is being perceived, it is still one sure fire way of staying afloat in an intensely fought market

Whether you are to call these features, forms, characteristics or elements, the fronting mechanism is more of an option for the insurer to pump up their top line and in the process earns some (non-risk carrying) revenues. Forget about their so-called long term objectives – they are there for the show of it or perhaps just to pacify their larger customers or the brokers in particular. Just take a look at those Captives (or so-called captive reinsurers licensed under the LOFSA), the local insurer fronts the risk (LSR) and despite having the necessary treaty capacity to underwrite, the insurer cedes the major part of it to the Captive. The Captive entity then reorganise the risk and coverage profiles, put them back to the Malaysian markets for JPI/GPI22 compliance purposes before ceding to oversea reinsurers. More than often risks placed out by the Captive entity are taken up by the local (re)insurers and this is at a much inferior terms than what was originally written by the original insurer. This is what I called fronting! It has nothing to do with the amount that is being retained by the original insurer although the retained limit is usually almost very small or negligible. This has also nothing to do with learning new underwriting capabilities – merely getting the top-line and some “pocket-money” revenue for short gun! Whatever is it, we cannot blame the setting up captives simply because it is the business of very large conglomerates to achieve effective costs savings…. against the inherently die-hard tariff market!

Global risks are also susceptible of being put into fronting with almost or 100% of the whole account going out to the fronting insurer’s global partner(s). There may be incidences the risks profiles are unidentifieable…. those risks were part of the global insurance programme, but the terms of coverage are never made know to the fronting insurer… simply because the global partner believes “secret must stay where they ought to be…”

There are also instances where specialised risks are difficult to obtain readily available reinsurance capacity – examples are Aviation, Oil & Gas and Terrorism risks, thus fronting becomes a norm for Malaysian based insurers and cessions are almost at 100% out to overseas reinsurer(s). While this aspect of fronting looks good – looks like some forms of technical know-hows are being channeled down to the local underwriters, it is still difficult to see how local insurers can one day lay claim to adequate treaty capacity to underwrite such highly specialised risks on their own.

The difficult part of fronting

Fronting presents both business opportunities and problems for participants. Naturally and for decades, some of the insurers have been using available fronting facilities to open up new market niches and able to participate in large and specialised risks (LSR) especially those relating to aviation, power plant, and Oil & Gas risks, which would otherwise not available without fronting.

From Bank Negara’s perspectives, they do have concerns over the financial health of those insurers relying heavily on fronting to raise their business profile – in  situation where the main fronting reinsurer failed in the face of a very sizeable claim. They may also find it a mammoth task regulating those overseas reinsurance securities that are controlling those fronting business  and solvency issues of the insurers when such programs go wrong.

The Malaysian Risk-based Capital at a glimpse

Under the Malaysia RBC, it seeks to regulate such practice from two main directions – (a) Supervisory Capital adequacy ratio (SCAR) and (b) Internal Capital adequacy ratio (ICAR).Under the SCAR computation of the ratio: Total Capital Available (TCA) / Total Capital Required (TCR) would be serious affected if there are many sizeable losses having long-tail element.and having most fronting arrangement supports coming from overseas securities, it would be a daunting task for the insurer to par down those risk charges in order to keep the ratio above the 130% level. Of course if there is no claim, then they should not be any major issues to answer.

However, things do not stop at SCAR as BNM also insisted on compliance in respect of ICAR – currently putting a guide at nothing less than 180%. Insurers are requested to stress-test their reinsurance securities, ie. What if the larger ones failed when they matter most? If the insurer is overly exposed to a few bigger reinsurers (participated substantially in many of the insurer’s list of risks under fronting arrangement), then the stress-test may show a TCA/TCR ratio way below the 180% mark or perhaps nearer to the 130% level!

Ultimately fronting is one good way to keep the insurer competing well at the fore front but the acceptance controls must be there otherwise the insurer may end up with a long list of risks falling within such fronting arrangement – arrangement that we think can bring new capabilities to the company but in reality it is still a “nice to think so only!”

Shoisk sendiri with good topline?

Fronting like "Shoisk sendiri" with good topline and abit of bottomline?

Shiosk Sendiri??

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6 comments for “What do you mean by FRONTING a risk?

  1. hb.lw
    January 16, 2016 at 16:55

    Really good and understandable article. I am writing a law master thesis about international programs and in this respect the reinsurance market in Malaysia. As of such I am searching in the web the “Guidelines on General Reinsurance Arrangements Circular JPI/GPI-22”, but unfortunately I couldn’t find it. As you comment on them I was wondering whether you could provide me with them via email?

  2. Anonymous
    March 29, 2010 at 10:49

    Care to comment, how would the RBC ICAR affected by the increase in risks fronting?

    • April 8, 2010 at 23:48

      ICAR… Just think if you have substantial exposure to fronting and relying on one or two reinsurers to take care of the very sizeable placement. Also think what if these two or three reinsurers failed you, what would be your damage (in term of TCA:TCR) if it is true a very sizeable claim comes true. Even if you do not think in this manner, the BNM would be thinking for you…. they would just request you to add this lob-side transaction as part of your ICAR computation, ie. BNM would add 50% to the SCAR of 130% – you would get 180%! It would be difficult …as you need to achieve a computation of > 180%!

  3. KELVIN Ng
    November 17, 2009 at 00:18

    Good article! Didn’t know you blog.

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