Abandoned in the soft market of the 1990s, risk retention groups are on the rise, offering form, rate, claims, taxation, and admitted paper benefits. However, state taxation, federal regulation, and litigation are growing problems.
The Federal Product Liability and Risk Retention Act of 1981 (LRRA), modified in 1986, created another form of captive: the risk retention/risk purchasing group. These structures, while effective, have not played a large role in the large world of alternative risk transfer until lately.
The original goal of the legislation was to provide a market for insurance for manufacturers to offer relief from crippling litigation against products they produced, but which may have been misused, modified, discontinued, or otherwise have become used not as originally intended. The manufacturers were being confronted with mass torts, bad publicity, and the ever-aggressive plaintiff's bar. Congress agreed to step up and enacted this bill.
The Act simply states that a group of insureds with a similar exposure can come together to create their own insurance company and that company is preempted from certain state insurance regulation including rate and form approval and taxes. In theory, it resides in one state and must be admitted in all other states.
Risk purchasing groups (RPGs) are another form which is rarely encountered. RPGs are groups of buyers who aggregate their buying power and negotiate with traditional insurers. These structures do have their uses, but it is usually for a very limited audience.
Soft Market Response
The Act did indeed provide some relief for manufacturers, but the market turned soft again. The traditional markets responded by writing business in such an attractive manner that many manufacturers left the RRGs and returned to buying insurance commercially.
With the long running soft market of the 1990s, few RRGs were formed. There was seen no reason to assume risks when transfer was relatively inexpensive. Traditional commercial policies were bought, some tort reform was enacted, and life was good.
For proponents of RRGs, formations became few and far between. The need still existed, and several notable RRGs were formed. At that point, regulators began to notice that, with the formation of RRGs, taxes paid to their domicile, not the home domicile of the RRG, were declining. (It's always all about the money.)
Taxation and Regulation Issues
Some regulators then began to challenge the preemptions of RRGs from state taxation. These efforts were resisted heartily by the RRGs, notably through one of their associations, the National Risk Retention Association (NRRA). Suits were filed, and there was some success. A large case in Oregon for an auto warranty firm was perhaps the peak of litigation victory for the RRGs.
But for every victory against a Department, another two taxes seemed to arise. RRGs found themselves in a constant battle over small taxes. They fought back on principle, expending material sums for legal fees.
This seeming litigious nature of the beast, required by the persistent actions of regulators, did not go unnoticed. Insureds considering forming RRGs were sometimes turned off by the litigation and the possibility that their vehicle could be caught up in battles unrelated to their basic mission.
However, RRGs retained their original structure, which features the ability to operate without being admitted to write insurance in all but the home domicile. The adroit RRG could establish itself in a friendly domicile (Cayman and Barbados were popular until the 1986 revision removed those choices) and write business elsewhere with no restrictions on rate, form, claims policy, counter signature, or licensing. This was, and is, a tremendous advance in regulation in favor of the commercial consumer.
RRGs likewise retained the limitations on lines of coverage, being liability only. They are not permitted to write workers compensation or property coverage. Commercial automobile can be written, but there are often so many state restrictions that the effort is not worth the result.
Today's RRGs—Opportunities and Challenges
In today's market, where risk sharing partners to provide admissibility and credit worthiness ("fronts") are few and shy, more people are realizing that these 2-year-old-plus vehicles can provide an excellent structure if their need is for liability protection. Now, instead of beleaguered manufacturers, we see doctors, lawyers, hospitals and other groups forming RRGs. Suddenly, medical professionals who commit to risk management discipline and financial support, can take control of their risk destiny without becoming entangled with fronts.
This development has quietly caused a veritable flood of applications in to domiciles perceived to be "friendly," such as the District of Columbia and South Carolina. The volume has become such that the regulators of those domiciles are concerned about not only their ability to handle the flow, but their ability to separate the wheat from the chaff.
In addition to liability protection, however, the RRG structure provides immediate admission of paper through the federal preemption. An RRG admitted in one domicile must be admitted in all other domiciles. This has become a huge point of difference. Not all RRG owners need the certification of admitted paper, and some do not need such certification beyond the borders of the domicile state.
Starting an RRG is a complex matter, requiring the services of knowledgeable professionals. One is indeed starting an insurance company, with all that implies. All policyholders are owners, so issues of shareholder relations and corporate governance become more important than in a standard captive. Policy wordings must be carefully crafted, and claims management must be responsive to various state regulations on fair claims practices. But the rewards of achieving a high level of risk control are compelling to many—and a great solution for risk challenges.
Some state regulators continue, and have indeed increased efforts to oppose, delay, restrict, and otherwise deter RRGs. Taxes that clearly do not apply are applied at virtual gunpoint. Indeed, it has been opined that a 50-state RRG must pay over 650 separate taxes and fees, and that is with a federal preemption.
There is a very active movement afoot to expand the LRRA. Many firms believe that the RRG structure would work well offering workers compensation and property. The National Association of Insurance Commissioners (NAIC) has passed a strongly worded resolution opposing such expansion, and it faces a tough fight in Congress. It is clear that even if Congress does not respond positively this Session, the issue will rise again.
At the end of the day, the RRG structure does provide some very significant advantages, and it is my hope that more regulators will see that their constituency is helped by using such a technique. In addition to relative freedom of form, rate, claims, and taxation, the RRG provides admitted paper for those firms in need of such. With fronting in such a difficult state, RRGs can provide relief for regulators who are being forced to overlook certificate inadequacies, and for insurers whose capital and resources are stretched too thin to respond to the needs of the market.
The author has an ownership position in three captive management companies but is not in a captive management position.