Being clear up front: There are more areas of potential reinsurance coverage disputes than you may think. (Property/Casualty: Underwriting Insight).

Fronting policies for other insurers and reinsurers has always been fraught with peril. Underwriters often dismissed these risks, because policy-issuing insurers were able to garner more recognition from customers and brokers. The fact that a carrier's name was on a policy suggested control of the business and influence in negotiating terms and conditions.

Some insurers also used fronting fees paid by reinsurers to defer some of their own overhead administrative expenses in artificially reducing their expense ratio. Artificial, because typically fronters did not show a debit on the balance sheet for uncollectible reinsurance or negative cash flow associated with these fronting transactions.

The massive claims associated with World Trade Center losses have demonstrated that fronting risks may not simply be a drag on earnings but, in fact, may imperil the survival of an enterprise itself. The most recent decline in Mutual Risk Management's stock price can be directly associated with fronting risk. Apart from the obvious credit risk associated with ceding business to other insurance and reinsurance companies, the peril of fronting also may manifest itself in coverage disagreements.

While only a few well-known multinational carriers are actively engaged in the fronting business of global insurance programs, every insurer, in fact, is subject to the risk of fronting. Buying reinsurance in the form of a traditional reinsurance treaty is no different from facultative reinsurance arrangements. This is because the traditional safety of "follow the fortune" that characterized the relationship between primary insurer and reinsurer in the past is increasingly being replaced by a strict contractual interpretation of such reinsurance treaties. The pressure exerted by stockholders on large reinsurers is profound. Gone are the days when contractual disputes were resolved by generous "ex gratia" payments by reinsurers seeking to preserve long-term relationships with cedents. And there are more areas of potential reinsurance coverage disputes than you may think. Here are a few of the most common problem areas that underwriting managers may miss:

* Absolute treaty exclusions. It may seem as if this is a fairly straightforward subject, since all that needs to be done is to communicate treaty exclusions to underwriters and have the exclusions executed on every policy. But a recent request I received from a Fortune 50 customer illustrates that it is not always so. The customer wanted a master policy of a global program to cover losses occurring worldwide in the event that the local operating companies of the global fronting carrier were to become insolvent. Most field underwriters would look at this request as the standard "Difference in Conditions or Difference in Limits" extension and sign off on the clause. Reinsurers, on the other hand, would look at this arrangement as a "financial guarantee," which is excluded from most property treaties.

* Difference in language. Reinsurers have recently introduced a number of exclusions for terrorism, cyber-risk and mold, to name a few. Insurers that do not pass on these clauses verbatim but allow their underwriters to negotiate exclusions tailored to the demand of individual retail insureds--not uncommon for large commercial policyholders--run the risk of nonrecovery under their reinsurance treaties as losses can fall between the cracks.

* Difference in definitions. Insurers are incurring a common risk by not replicating definitions contained in reinsurance treaties on their retail policies. Reinsurers, having learned their lessons in the past, are rather precise when it comes to defining what they mean by an "occurrence." Natural catastrophe perils, such as windstorms, are usually compartmentalized by so-called "hour clauses." Most insurers' reinsurance treaties will define an atmospheric disturbance within 72 hours as a single occurrence, although it is not uncommon for underwriters to provide retail insureds with a definition that allows 168 hours for a single windstorm occurrence without blinking an eye. The disconnect between insurance payouts and reinsurance recoveries that is pre-programmed in cases of a hurricane first sweeping the Caribbean and then the U.S. East Coast ends up in the insurer's balance sheet in the shape of multiple catastrophe treaty retentions.

While these examples only scratch the surface of the issue, it becomes obvious that only clear communication between the chief underwriter or purchaser of reinsurance and the field underwriters will avoid the problems of fronting. Absolute discipline in the execution of manuscript policy forms is essential if an insurer wants to avoid unpleasant surprises down the line.

Klaus Gebhardt, a Best's Review columnist, is senior vice president of Ace Bermuda Insurance Ltd. He can be reached at [e-mail]