Risk purchasing groups: Soft market strategy?

By Michael J. Moody, MBA, ARM

The news regarding Risk Retention Groups (RRGs) was hot and heavy during the first six months of 2008. Several interested groups and associations actively worked toward expanding the scope of coverage being offered by RRGs to include property coverage.

When Congress convenes in January 2009, it will continue to consider H.R. 5792. This bill would greatly increase the usefulness of RRGs by allowing them to include property coverage as well as the current liability lines. While there are still a number of details to be worked out, such as the exact definition of “property” coverage, it would appear that there is a high probability that some meaningful agreement can be reached.

Despite this positive development, however, the current soft property and casualty market is adversely affecting some RRGs. Reduced pricing from the commercial market is beginning to attract the attention of some RRG participants. As a result, industry observers think that, depending on the length of the soft market, the pricing pressure will continue to erode participation in some RRGs.

RRG basics

Certainly the legislation that allowed for the formation of RRGs was a landmark movement by the federal government. In essence, the Risk Retention Act of 1981, and its subsequent amendments in 1986 allowed for broad preemption of state insurance regulations. Originally, the Act extended only to product liability coverage, but it was expanded to all liability exposures in the ’86 amendment and allowed groups to collectively insure their related risks. Congress revised the ’81 legislation to help businesses, professionals and municipalities obtain liability insurance. Many had been having affordability and, in some cases, availability issues due in large part to the “liability crisis” of the mid-1980s.

RRGs typically are formed as a corporation or limited liability association that essentially functions as a captive insurance company. As such, an RRG’s primary purpose is assuming and spreading the liability exposures of the group’s members. Pursuant to the Act, the RRG must be chartered and licensed as a liability insurance company in one of the 50 states or the District of Columbia. The RRG then can operate in any of the 50 states and D.C. The major advantage of this structure was that it did not require a fronting carrier to be used with the RRG, as would be required by most captives.

The other side of the coin

While the risk retention group aspects of the Act received much front-page attention, the second part of the legislation was just as revolutionary. This section dealt with risk purchasing groups (RPGs) and allowed unrelated companies with similar loss exposures to band together to buy liability insurance.

Historically, most states have prohibited the purchase of property and casualty insurance on a group basis. This practice known as “fictitious groups,” while popular with accident and health products, was never accepted by state insurance commissioners for P-C coverages. Most state insurance laws have limited property and casualty coverage to individually issued and underwritten policies.

The preemption of state group purchasing laws has resulted in more than 750 purchasing groups being formed since the introduction of the Act. RPGs are in stark contrast to the RRGs because the purchasing group is not required to form an insurance company. The Act defines a purchasing group as a group that:

• Has as one of its purposes the purchase of liability insurance on a group basis.

• Purchases such insurance only for its group members and only to cover their similar or related liability exposures (i.e., homogenous exposures).

• Is composed of members whose businesses or activities are similar or related with respect to liability via common business, trade, product, service, premises or operations.

• Is domiciled in a state.

Historically, there are a number of advantages typically associated with RPGs. Among the more important ones for insureds are that they usually can expect better coverage, higher limits and/or lower pricing than the individual members could obtain on their own, due in large part to the dynamics of bulk buying. Brokers and agents also find RPGs advantageous because, among other things, the Act removes the state counter-signature requirements. This is especially important for national programs.

Additionally, most agents/brokers have found that because RPGs are not insurance companies and thus do not require capitalization or risk bearing, they are much easier to form than RRGs. Insurance companies favor purchasing groups as a way to reduce the expense factors associated with writing small individual accounts, as well as being able to waive many of the state rate and form filing requirements.

Soft market strategies

Today, many agents and brokers are concerned about developing and implementing strategies that will help them survive the current soft market. Well, that’s the beauty of a risk purchasing group; it is actually considered a soft market strategy. As a matter of fact, according to the Risk Retention Reporter, the growth of RPGs over the past three years has averaged more than 50 new groups per year, bringing the total RPGs to 756. Obviously, this dwarfs the total RRG population of 255.

The Reporter notes that while the number of RPGs has not yet reached its year 2000 high, new groups are continuing to be formed. And while many RPGs come and go quickly, 2007 saw only 18 retirements. Despite this impressive growth, it still lags the glory years of 1990 to 2000, when almost 100 groups were formed each year.

While 345 insurance companies currently provide liability coverage to risk purchasing groups, the market is dominated by several key players. In total, 28 insurers account for over 82% of all RPG business. By far the largest participant is the Underwriters at Lloyd’s of London who currently write 68 groups. They are followed by the Lexington Insurance Company that is a member of the AIG Group and currently insures 45 groups. Other AIG companies include American Specialty Lines Insurance Company with 37 groups, followed closely by National Union Fire Insurance Co. of Pittsburgh, Pennsylvania, that insures 36 groups.

Other notable players include the Federal Insurance Company that also has 36 groups and American Guarantee & Liability that provides coverage for 32 groups. Rounding out the most utilized carriers is St. Paul Fire & Marine Insurance Co. that also accounts for 32 groups.

The Risk Retention Reporter also indicates that recent (from 2000 to 2007) additions of new RPGs have occurred in three primary business sectors. The most obvious sector would be the health care market which was the largest area of growth and which also dominated growth in the risk retention area as well. Within the health care sector, over 50% were organized to insure physicians.

The second sector is professional service organizations, which also had significant growth during this period. Within this sector, coverage for agents and brokers who are employed by large insurance companies accounted for 62% of those RPGs.

The third sector was made up of property development firms; over 50% were organized to cover property owners as well as managers of commercial and residential properties. The remaining startups were spread among a number of business sectors.

Obviously, these three groups also accounted for a good number of retirements over this period of time as well. Retirements from health care and professional service firms accounted for about 45% of all retirements. Other sectors that also saw significant retirements during this period were government and institutions, manufacturing and commerce, and transportation. Additionally, property development had a number of retirements during this period as well.

Conclusion

Soft markets always require some extra effort and challenges for agents and brokers to overcome. As was noted above, risk purchasing groups thrive in a soft market as carriers look for creative ways to reduce their expenses and stay competitive. As a result, this may be a great time to explore the RPG option with homogenous group customers or prospects. Working with groups or associations to develop a viable solution for their liability risk management needs can lead to further options at a later date.

A number of agents/brokers have used RPGs as a starting place for developing a more creative solution for the group’s needs. Once started, an RPG can be a springboard to a risk retention group or other group captive solution. While it is easy to start an RPG, it gets the participants comfortable with the group purchasing concept and it can also allow the agent/broker to start a formal relationship with the participants.

Once the purchasing group has begun operation, it is much easier to consider hard market options such as an RRG or group captive. Additionally, because a relationship has already developed with a carrier, it would be the logical choice to provide reinsurance to a captive. The RRG can just be a continuation of the group’s long-term strategic plan.

This approach can provide an easy method for an agency to enter the alternative risk financing market. Further, it may also lead to additional opportunities that can present themselves during hard markets. It also may open the door to the opportunity to other coverage lines for participants of the RPG. Agents and brokers should be alert for these soft market opportunities as they can lead to significant alternative risk transfer options in the future.