Fronting is most typically understood as when a ceding company (insurer) underwrites a policy and transfers the entire risk to a reinsurer.
The company that underwrites the initial policy is the fronting company and receives a portion of the premium, despite ceding the entirety of the risk to the reinsurer.
Since the ceding company originally issued the policy it appears to be the insurer, however, the reinsurer is now responsible for ensuring all claims are paid against the policy.
Apart from both underwriting and ceding the original policy, the ceding company’s only function is to make sure that the reinsurer can play its obligations, although the insurer itself does not pay any of the claims.
Fronting has become a common practice in the insurance-linked securities (ILS) market, where investors and ILS funds work with fronting insurers in order to access risk more efficiently, benefit from the rating a fronting provider has, while also often utilising the fronting providers ability to hold onto the tail risk associated with the transaction.
Fronting for other entities has also become a business model in its own right, as fronting specialists have emerged who write business for MGA’s and ILS funds, while holding onto very little of the risk itself except for the tail in some cases.
Fronts enable ILS investors to work with a broader range of ceding companies, especially those who cannot accept fully collateralised reinsurance and require rated paper to transact with.