Bermuda Brokers on the rapid evolution of hybrid fronting models

Bermuda Brokers on the rapid evolution of hybrid fronting models | Insurance Business Canada

Reinsurance

Bermuda Brokers on the rapid evolution of hybrid fronting models

CEO and chief broker weigh in

Reinsurance

By
Mia Wallace

An AM Best special report into how risk-sharing partnerships between specialty commercial-focused fronting insurers and their reinsurers are evolving revealed that “the market is ripe with opportunities for companies offering hybrid fronting arrangements to demonstrate their value and gain greater acceptance.”

Amid changing market conditions and growing interest from managing general agents (MGAs) and capital providers, hybrid fronting companies are growing in number. But what’s behind the evolution of the hybrid fronting model? Speaking with Re-Insurance Business, Bermuda Brokers CEO Hugh O’Donnell (pictured left) joined chief broker Neil Hitchcock (pictured right) and business development consultant Kurt Bounds to discuss what’s happening in the market.

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What’s the difference between traditional and hybrid fronting models?

Traditional or ‘pure fronts’ saw fronting insurers just putting out their paper, Hitchcock said, which saw them bear little, if any, of the underwriting risk – or even the credit risk – involved. He noted that certain carriers had very tight contracts which many reinsurers didn’t want to adhere to because they were just too tight.

“The hybrid ones are carriers that are putting out their paper – whether that’s admitted or non-admitted – where they’re taking a meaningful share of risk,” he said. “That meaningful share of risk tends to be creeping upwards. It used to be that if they took 10% of the risk then reinsurers were happy because it meant there was someone else with skin in the game rather than just effectively renting out their insurance licences.

“Now, a lot of reinsurers are requiring the issuing paper to take 20% or 25%, which changes the landscape because they now need a lot more capital and a lot more underwriting wherewithal, unless they’re completely happy just blindly following the reinsurers’ agreements,” he said.

The three forms of risk a fronting company can take

O’Donnell highlighted that there are three broad ‘buckets’ of risk that a fronting company can take – and each has been significantly impacted by the switch to hybrid fronting. The first is proportional participation, he said, which means that if you write $10 million of premium, you have to take on €2 million of that risk yourself at a 20% retention. In that scenario, you keep 20% of the premium and pay 20% of any loss, you get a fronting fee and cede out 80% of the risk.

“But we’ve moved to the world of hybrid fronting because we’ve so many MGAs, and part of that move has been that the MGAs themselves are being required to take on a lot more risk,” he said. “Also, the type of reinsurers looking to participate has changed from being purely large A-rated or A-minus rated entities to a lot more varied collateralized reinsurer of a large cap.

“That brings us to the second kind of risk that fronting companies are being required to take on today – credit risk. Credit risk that they will not be able to recover from the MGA and their captive, or from the MGA and their sliding scale commission, or from the collateralized reinsurer. The fact that fronting companies have been willing to move and positively explore credit risk as opposed to saying it’s an area they won’t go has been one of the other big changes of the last few years.”

The third and final portion of risk is tail risk, which O’Donnell said really emerges most clearly for property-catastrophe proportional business. Tail risk is the risk of the loss ratio exceeding the available reinsurance.

“A clear example is when it comes to cat risk, the reinsurance limit is often expressed as a one in 100, or one in 200, or one in 400 year event,” he said. So if the reinsurance limit is for a one in 500 year event – and there is a one in 600 year event, the fronting company has to eat some of the loss themselves.”

How has the hybrid fronting model evolved?

It haa been interesting to see the evolution of the hybrid fronting model, noted Bounds, particularly in the context of the two tiers of hybrid fronting markets that exist. The first is the hybrid fronting market that looks at programmes bringing $50 million or higher in premium to the table, and the second is those markets looking at programmes bringing less than $25 million, potentially even less than $10 million.

“I find it uniquely tied that the rise of hybrid fronting models has grown exponentially alongside the rise of insurtechs,” he said. “[That’s because] these many little insurance carriers, which I view as hybrid fronting models, are being fueled by the amount of technology and data able to be mined for each of these programs.

“I think as we go 10 years out from now, what you’re going to see is a period where primary insurers and hybrid fronting models start to get closer to each other.”