What is a potential drawback of fronting arrangements?

A fronting arrangement involves an insurer (the fronting company) issuing an insurance policy on behalf of a risk-bearing entity, often to comply with regulatory requirements or to facilitate market access. The key issue with fronting arrangements is the credit risk that arises for the fronting company. This occurs because the insurer retains a legal obligation to the policyholder while the actual risk is transferred to a reinsurer or another party. If the reinsurer fails to meet its obligations, the fronting insurer remains liable to the policyholder, potentially leading to financial strain or losses for the fronting company.

This situation highlights the inherent credit risk interconnected with fronting, as the fronting insurer may not have control or insight into the financial stability of the reinsurer it relies on. While fronting arrangements can facilitate access to the insurance market and may help streamline regulatory compliance, the accompanying credit risks require careful management.