Risk retention groups are a solution to the challenges of availability and affordability
For the most part, the U.S. insurance industry has functioned quite well for over 150 years. Thanks in part to the McCarran-Ferguson Act, most insurance-related matters are regulated at the state level, as opposed to the federal level. A nationwide crisis in the product liability/completed operations arena, however, caused a paradigm shift with respect to product liability coverage.
The late 1970s saw a major product liability insurance crisis. For several years, numerous U.S. manufacturers were unable to find appropriate coverage at any cost. Congress was hearing from these manufacturers that something needed to be done to resolve this issue. For its part, Congress had spent too much time considering the possibilities available to resolve this matter and was slow to act.
The RRG unquestionably is a viable option as part of an overall risk financing strategy.
A radical approach finally was advanced. It required Congress to develop a federal program that would allow homogeneous groups to self-insure their product liability exposures. The approach was established by the federal government and overseen by the individual domiciliary state. Initially, the legislation was strongly opposed by both insurance commissioners and agents and brokers.
Some experts believed the legislation ultimately would resolve the matter. Congress, however, took too much time to act on the issue, so by the time the Risk Retention Act of 1981 was signed into law by President Reagan, the pressure that originally led to the legislation had subsided. The commercial insurance market already had begun to soften significantly. As a result, there was little to no interest in forming risk retention groups (RRGs).
Several years later, however, other liability coverages became unavailable or unaffordable, and Congress again was facing a liability crisis. By the mid-1980s liability shortages were widespread and Congress was asked to assist in resolving the matter. This time, Congress concluded its task in a timelier manner. It merely expanded the definition of liability to include all commercial liability exposures.
When President Reagan signed the Liability Risk Retention Act (LRRA), many business groups were able to take advantage of the new law. The LRRA proved to be a viable alternative to purchasing liability coverage from a traditional insurer.
A risk retention group is a liability insurance company that is owned by the people it insures. The owners/insureds of the RRG must be a homogeneous group and conduct similar business activities. As with any insurance company, the owner/insured must capitalize the company. Unlike traditional insurers, RRGs need to be licensed in only a single state.
To date, RRGs have been formed primarily as captive insurance companies subject to the rules and regulations of a single state. One state, Vermont, was quick to see the value of this new form of captive. As a result, the lion’s share of RRGs are domiciled there. It is this single-state feature that has led to most of the legal problems that affect RRGs, because many states are guilty of overreach.
The LRRA also applies to the purchase of liability insurance through risk purchasing groups (RPGs). An RPG is an entity that purchases liability insurance on a group basis from either an insurance company or an RRG. An RPG need not form its own insurance company; instead it uses existing insurance companies.
Like the RRG, the RPG must be a homogeneous group that purchases liability coverage jointly. These programs can be established by the group, an agent, or an association. Enabling legislation waives several rate and form filings. Acceptance by insurance buyers has been high, and today participation stands at around 1,000 RPGs.
Initially few organizations represented the interests of RRGs. In 1987, the National Risk Retention Association (NRRA) was formed. In addition to serving as an educational resource, NRRA has been involved in legal challenges to the law. In most such cases, the association serves as amicus curiae (friend of the court).
The NRRA’s annual meeting in late September was a notable success. The meeting provided ample opportunities for owners/insureds to meet and discuss a variety of topics with like-minded individuals. Educational sessions were available on topics such as The Legal Outlook, the Regulator’s View, Enterprise Risk Management, and The Changing Face of Medicine.
Where are RRGs going? According to Robert Myers, partner in Morris, Manning & Martin, who serves as NRRA general counsel, “In the short term, it looks like more of the same.” At the time of this writing there were 232 licensed RRGs. Although some RRGs have closed, Myers notes, usually another one is waiting to be formed. “Over the life of the RRG legislation, the number of RRGs has been between 210 and 240.”
One group that has voiced concern about the RRG approach is the National Association of Insurance Commissioners (NAIC), which has never been a fan of the RRG legislation. The RRG legislation was passed in 1981 and amended in 1986, in large part because of the crisis in the liability insurance market and because of the inability of state insurance commissioners and the NAIC to resolve this massive problem.
Since passage of the 1986 act, the NAIC has proposed model legislation. Many individual state commissioners have been searching for a method to restrict the role of the RRG and its domiciliary states. Although numerous attempts to limit the scope of the RRG have been made, notes Myers, “A number of approaches have been used to dissuade formations.” The act has survived these adversarial attacks. “In fact, while we have seen very few changes, the court cases have served to help clarify the scope of the act.”
Shortly after passage of the LRRA, RRG owners/insureds began to look at other ways to expand the coverage. From the start, property appeared to be a viable option. But to date, Myers says, “this has not occurred, primarily because of the soft insurance market.”
At present, he explains, the NRRA is looking to expand into the property coverage area although attention has been directed to an extremely narrow scope of exposures. “This would be limited to tax-exempt charities that have minimum capital of $5 million and have been in business X number of years.” He points out that this would affect less than a handful of RRGs.
Myers indicates that chances are slim of expanding beyond the current scope of coverage. Looking at the longer term, he points out, “It would be difficult to guess what the conventional insurance market will do, so it is hard to say.”
Additionally, he states, “If property coverage becomes as distressed as liability coverage in 1986, it’s possible.” Such a crisis could cause Congress to take swift action. Many captive experts believe it is possible to take timely action similar to what was done in expanding the original 1981 legislation by broadening the definition of “what is covered.”
A coverage that is likely to experience additional growth is stop loss, because most captive experts believe this is a liability coverage. Myers notes that one RRG, the Auto Dealers, has tried to gain admittance in California. “However, California took the position that this was health coverage and issued a cease and desist order.” The Auto Dealers ultimately decided to abandon their case. Myers suggests, however, that given the ever-increasing cost of health insurance, chances are good that others will try to use an RRG to provide stop loss coverage. Growth in this area could occur quickly.
The RRG unquestionably is a viable option as part of an overall risk financing strategy. Tightening in the conventional insurance market will hasten this movement. Overall, RRGs are an effective method of risk transfer. In a recent analysis of the RRG market, rating firm Demotech notes that, “despite political and economic uncertainty, RRGs remain financially stable and continue to provide specialized coverage to their insureds.”
Michael J. Moody, MBA, ARM, is the retired managing director of Strategic Risk Financing, Inc. (SuRF), a firm that was established to provide consulting services to captive and other alternative risk transfer mechanisms. As a regular columnist, he continues to actively promote the benefits of the ART market by providing current, objective information about the market, the structures being used, and the players involved.