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
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!”