What is a significant drawback of using fronting in insurance?

Using fronting in insurance involves a primary insurer passing risk to a reinsurer while still accepting the policyholder as their client. One of the significant drawbacks of this arrangement is the credit risk associated with claims payments. When a fronting arrangement is in place, the primary insurer remains responsible to the policyholder for claims, even if the reinsurer does not fulfill its obligations due to financial difficulties or insolvency. This exposure can create a substantial risk for the insurer, especially if the reinsurer is not financially sound or if there are challenges in recovering funds. The primary insurer must ensure they have the financial strength and the stability of their reinsurer to effectively manage this risk.

While other factors, such as increased competition and higher claim processing times, can influence the effectiveness and efficiency of insurance operations, they do not capture the essence of the inherent financial risk posed in fronting arrangements. Similarly, while regulatory compliance may add complexity, it does not directly relate to the financial implications of claims payments as credit risk does. Hence, credit risk is a critical consideration and a notable drawback in the use of fronting in insurance business strategies.