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Does this mean that members of the captive fronting community must save each other from themselves?
A new covenant needs to emerge in the fronting captive arena.
The call for a covenant should not imply that fronting carriers that deal with captive reinsurers need to be protected from themselves.
Collateralization for the fronting company is required for two primary reasons: 1) to protect the fronting company from credit risk; and 2) to address the balance sheet impact of captive reinsurance on the primary insurer trader statutory accounting principles.
Credit risk is the most significant exposure for the fronting company, occurring when the reinsurer is unwilling or unable to honor its financial obligations.
Regarding the issue of balance sheet impact, as an insurance company a fronting company assumes a liability when it issues a policy.
The fronting carrier must require collateral commensurate with the risk and pricing.
The collateral can be in the form of a trust agreement funded by the captive's investment securities, a letter of credit issued on behalf of the captive by a bank, or captive funds withheld by the fronting company.
8% of respondents state that they provide collateral as part of the fronting arrangement.
In 1993, time National Association of Insurance Commissioners adopted a model bill addressing fronting activities after urging by state insurance regulators.