Nearing the end of 2023, real estate companies face a difficult insurance market. Property premiums have skyrocketed this year, in part due to capacity constraints fueled by growing catastrophe losses, the impact of rampant inflation on property valuations, and challenges in the reinsurance marketplace. The casualty market, meanwhile, has long been a concern for real estate companies due to persistent and costly claims related to slips and falls and violence inflicted on tenants and their guests.
With the cost of insurance coverage rising, many real estate companies would ideally be able to reduce their insurance expenses by retaining more risk on their own balance sheets. Banks and others that lend to real estate companies, however, typically set limits on the amount of liability real estate companies are permitted to retain — and the ceiling for those limits is often low.
Facing these competing needs — to reduce their insurance expenditures while meeting lender requirements — what is a real estate company to do? The answer may lie in alternative risk solutions, including fronted programs.
What is fronting?
Through a fronting arrangement, an insurer provides coverage to a business without any risk being transferred. In exchange for a fronting fee, a company secures evidence of A-rated coverage to satisfy requirements from lenders and others.
The fronting insurer assumes credit risk, which is secured by collateral provided by the company paying the fronting fee. The company, however, retains the underlying risk — for example, property or general liability — on its own balance sheet.
Fronting with reinsurance is a slightly different arrangement. Here, a company forms or uses a preexisting captive insurer it owns or rents via a cell facility to self-insure for one or more lines of coverage. The captive then enters into a reinsurance agreement with the fronting insurance company, which provides evidence of A-rated coverage to satisfy the policyholder’s contractual obligations to lenders and others.
Who can benefit?
A fronting arrangement can be a favorable alternative to traditional insurance for many real estate companies. The solution is most beneficial to those organizations that have seen their insurance premiums rise substantially in recent years. Organizations whose loss profiles frequently change — for example, those that are rapidly growing or that regularly engage in mergers and acquisitions — can also benefit.
In addition, fronting solutions can yield savings for real estate companies that purchase traditional coverage from multiple insurers. An organization that purchases insurance from a single carrier may find it difficult to reduce costs by retaining more risk, as the premium discount from fronting may not be significant. Those with shared layers, however, can find fronting solutions to be far most cost-effective.
Aggregated vs. unaggregated limits
Fronted programs can be structured in two different ways. The first is with an aggregated limited, which is typical for fronted programs without reinsurance.
For property, for example, a program could have a $5 million front for a primary layer of coverage that has a $5 million aggregate limit. Here, the policy will respond to up to $5 million in total losses incurred during the policy period — which could be exhausted after a single large loss.
If the $5 million aggregate limit is reached, the policy will essentially shut down, meaning that a real estate policyholder will potentially not satisfy lender requirements. Any additional losses that occur within that primary $5 million layer would be retained by the policyholder, unless it secures excess coverage from a carrier that is willing to drop down.
A fronted program with reinsurance, on the other hand, can be structured with an unaggregated limit. Here, a program could have a $5 million front for a primary layer of property coverage; the policyholder’s captive reinsures the fronting insurer. With this unaggregated limit, the primary layer will provide up to $5 million in coverage for each individual loss incurred during the policy period, regardless of the number of occurrences.
Importantly, an unaggregated front would ensure that lender requirements are satisfied for the duration of the policy period. The decision on whether to choose an aggregated or unaggregated limit, however, must be carefully weighed.
An aggregated limit can offer sizable premium savings for real estate companies, but carries the risk that coverage will be exhausted very quickly. By contrast, an unaggregated limit can offer far broader protection. But because it requires a policyholder to have a captive — which may need to be formed to enact this specific solution — it carries significant capital requirements.
In making this choice, real estate companies should also consider their own risk tolerance and their risk profiles, including recent loss history. If choosing an aggregated limit, a policyholder should discuss with its excess carriers whether they are willing to provide drop down coverage. Lenders may also wish to weigh in with concerns and questions related to either structure.
Getting the right advice and support
As real estate companies explore fronted programs and other alternative risk options, it’s vital that they work with the right insurance broker. Companies should seek out brokers that understand the real estate industry, including the pressures they face from lenders and other third parties to secure and/or show evidence of robust and effective insurance coverage.
Real estate companies should also seek to work with brokers with deep experience and an understanding of the ins and outs of fronted program and the pros and cons of these solutions within the broader alternative risk landscape.
Some brokers will fixate on the value of a particular solution, such as a fronted program, or have teams that work in siloes — one focused on captives, another on structured risk, and so on. Each of these siloed teams have their own agenda, including selling clients and prospective clients on a specific solution.
More trusted advisors, however, will provide a more balanced perspective. These advisors can provide buyers with access to specialists with knowledge of the entire landscape and arm them with information and insights. That enables and empowers buyers to make more informed decisions about the best way to protect their balance sheets given their risk tolerance and risk profile.
For more information, contact a member of your Lockton team.