RRGs and states clash on oversight

RRG association hopes GAO study will strengthen its case

By Michael J. Moody, MBA, ARM

Periodically, the insurance industry serves up unpleasant surprises for insurance buyers. Sadly for the buyers, these surprises typically take the form of escalating rates and decreased availability. Historically, these trends have forced buyers to seek alternative forms of insurance protection, such as captive insurance companies. With increasing frequency, these alternatives have centered around one particular type of captive known as a risk retention group (RRG), and these entities have been growing in importance with each passing year. Recent statistics show that RRGs now account for about $2.5 billion in premium.

RRGs were born out of the hard liability insurance market of the mid-1980s and ultimately resulted in Congress passing the Liability Risk Retention Act of 1986 (LRRA). This unique legislation marks one of the few times that the federal government has been allowed to supersede state insurance laws. In essence, the LRRA gave RRGs the freedom to operate nationally while being licensed in a single state. This flexibility is available to RRGs because the act preempts many non-domiciliary state regulations, except for a small list of standard insurance company-related items such as premium taxes and notices to policyholders.    

Differing views

Obviously, state insurance regulators were not thrilled with the passage of the LRRA. There is little question about Congress's intent with regard to the legislation. In fact, the 1986 law was an amendment to a 1981 law that was directed at the product liability and completed operations coverage crisis and established the concept of "lead state regulation." This approach gave the domiciliary state primary responsibility for oversight of the RRG, leaving non-domiciliary states with very restricted oversight authority.

Over the years, a number of non-domiciliary state insurance regulators have tested this "lead state regulation" concept. According to Robert Myers, National Risk Retention Association (NRRA) general counsel and partner in Morris, Manning and Martin, LLP, the following are typical of actions that non-domiciliary states have been taking and that have served as obstacles to the legitimate operations of RRGs:

• Registration requirements – A number of states impose unlawful registration requirements, including fees for filing and renewals, and are not providing timely responses to RRGs.

• Discriminatory practices – Some states have instituted practices that in effect discriminate by requiring insurance buyers to obtain coverage from members of the state insurance guaranty association, an organization that an RRG is exempt from joining.

• Cease and desist orders – Some states obstruct RRG operations by imposing an administrative cease and desist order as opposed to seeking an injunction in a federal or state court as required by the LRRA.

Myers also points out that, while some jurisdictions have found the states' actions to be in violation of the LRRA, "these have not been followed as precedents in other jurisdictions." He adds that, in many cases, "RRGs have been deterred from taking cases to court due to the costs of seeking relief through litigation." The problem is exacerbated by the fact that a win in one jurisdiction does not carry any weight in another jurisdiction, so the RRG has to go through the whole process again. 

Most recent in a long list of infractions arose in New Jersey. According to Myers, legislation that is awaiting action by the governor would effectively block taxicab companies operating in the state from using RRGs to purchase liability insurance. The law would require taxi operators to secure needed coverage from an admitted insurance carrier that is a member of the New Jersey Property Liability Insurance Guaranty Association. Myers explains that, as general counsel for the NRRA, he wrote to the governor pointing out that the measure "would discriminate against risk retention groups in a manner prohibited by federal law." At the time of writing, Myers said the NRRA had not received a response. 

What's next for RRGs?

Interference from state insurance regulators is nothing new. It has been going on almost from the moment the LRRA legislation was passed. It started with minor issues that, for the most part, involved insignificant amounts or money or time. It was just a few petty things that allowed state regulators to flex their muscles and "show the feds who's the boss." What started out as minor inconveniences, however, have turned out to be major roadblocks to efficient RRG implementation.

It was hoped that a 2005 report from the Government Accountability Office (GAO) would highlight some of these practices, but for the most part it did not touch on them. Myers points out that the GAO has indicated that it did not fail to address this issue in the original study but rather that it was not requested by Congress to explore this aspect. 

Recently, however, Congress again requested that the GAO conduct a study of how state regulators are interacting with RRGs. The request noted that the original 2005 report did not address the harmful and inconsistent treatment RRGs are facing from non-domiciliary states. According to Myers, the purpose of requesting the current GAO study is to have an independent, non-partisan government body collect information about the extent to which some states are ignoring important provisions of the 1986 act. 

More specifically, Congress has asked the GAO to review, among other things:

• Differences in non-domiciliary state regulation of RRGs

• The costs associated with compliance with non-domiciliary state regulations

• Legislative solutions that could bring state regulations into compliance with the federal act

At this point the GAO is conducting its investigation and expects to complete it early in 2012. Assuming the GAO study confirms NRRA's assessment, the association and its members will push for federal oversight, and Myers says this will require better legislation via an amendment to the act as well as federal oversight through the Treasury Department. 

Ideally, with the support of a GAO study to back its claims, NRRA can begin to assist RRGs in dealing with state insurance regulators. 

Another way to improve the climate for RRGs is to expand the scope of the Liability Risk Retention Act. There is precedent for such a move because Congress, in the face of a hardening liability market, was quick to expand the scope of the original charter from product liability to any liability coverage. While a number of possible areas for expansion have been discussed, most likely prospects have centered on property coverage. This was particularly topical after Hurricanes Katrina, Rita, and Wilma. 

Last year, Myers says, four members of the House of Representatives co-sponsored legislation to expand the scope of the LRRA to include commercial property coverage. Titled "The Risk Retention Modernization Act," HB 4802 contained several key features that were advantageous to both insurance regulators and RRGs alike, most notably the inclusion of commercial property insurance. 

Other noteworthy provisions would have improved corporate governance standards, imposed a fiduciary duty on RRG boards of directors, added a dispute resolution mechanism, and imposed regulations to ensure that non-domiciliary states do not interfere with RRG implementation. As in past years, however, the House failed to advance the legislation. Myers says that NRRA is working on getting legislation similar to 4802 introduced into the current session of Congress.   

Summing up

The original RRG Act of 1981 was born out of a critical insurance market dislocation. In 1986 the law was revised, again because of major disruptions caused by affordability and availability issues in the insurance marketplace. Since then, RRGs have become a stable force in the liability insurance market. 

Although the law is clear with respect to preemption of state regulation, certain regulators have served as a continuing impediment to successful RRG implementation. 

In that regard, it is hoped that the GAO study will spur Congress to take action and allow RRGs to operate as originally envisioned. As Myers points out, this will probably require an amendment to the 1986 act, with specific oversight responsibilities provided by the federal government.