Captive Fronting

What is Captive Fronting?

Captive fronting is a mechanism that enables a captive insurance company to provide coverage in jurisdictions where it is not itself admitted (licensed) to write insurance directly. Many insurance buyers — particularly large corporates operating across multiple countries — are required by law, contract, or counterparty expectation to hold policies issued by admitted insurers: entities licensed by the local insurance regulator and subject to local regulatory oversight. A captive domiciled in Bermuda, Cayman Islands, or Vermont may not hold an admitted licence in every country where its parent operates, creating a regulatory gap.

Fronting solves this problem. A licensed admitted insurer (the fronting carrier) issues the local policy directly to the insured in the required jurisdiction. The fronting carrier then cedes substantially all (typically 90-100%) of the risk back to the captive under a reinsurance agreement. The net effect is that the captive bears the economic risk and premium, while the fronting carrier provides the regulatory wrapper — the admitted licence, the policy documentation, and the counterparty standing — that satisfies the insured's local compliance requirements.

The Fronting Carrier's Role and Fee

The fronting carrier is not a passive intermediary: it remains the legal insurer of record and retains primary legal obligations to the policyholder. If the captive fails to reimburse the fronting carrier for claims paid, the fronting carrier is still obligated to pay the policyholder in full. This counterparty credit risk is why fronting carriers require collateral from the captive — typically in the form of a letter of credit, trust funds, or a cash deposit — to secure the reinsurance recoverable. The fronting carrier charges a fronting fee (typically 5-15% of the gross premium) for providing this service, covering its regulatory costs, administration, and the credit risk it assumes on the captive's reinsurance obligation.

The collateral requirement is one of the most significant ongoing administrative tasks in captive fronting programmes. Fronting carriers review collateral levels annually — often more frequently for larger programmes — and may require additional posting if claims activity increases or if the captive's financial condition deteriorates. Managing collateral across multiple fronting carriers in a global captive programme is a material operational challenge for corporate risk managers.

Regulatory and Tax Considerations

Tax authorities in multiple jurisdictions scrutinize captive fronting arrangements carefully, particularly where the premium transferred to the captive generates a deduction in a high-tax jurisdiction while the profit accumulates in a low-tax domicile. The OECD's Base Erosion and Profit Shifting (BEPS) framework and local transfer pricing rules require that captive premiums be set at arm's-length rates and that the captive genuinely bear risk. Fronting arrangements where risk transfer is nominal rather than real may be challenged as tax avoidance structures, making actuarially defensible premium calculations and genuine risk transfer essential features of a compliant captive fronting programme.

Documentation and Compliance Requirements

Fronting arrangements generate extensive documentation requirements: the fronting policy, the reinsurance agreement between the fronting carrier and captive, collateral agreements, premium payment schedules, claims reporting protocols, and regulatory filings in each fronting jurisdiction. Each of these documents must be maintained, tracked, and updated as the programme evolves. The fronting carrier's compliance team will typically require annual audits of the captive's claims handling processes and financial position, adding to the governance burden of the captive management function.