This article is part two of two articles on the marketing of agents' errors and omissions (E&O) policies. (The first article is "New Issues in the Marketing of Producer Errors and Omissions Insurance.") Both articles use two fictitious companies as examples of practices that may adversely affect coverage and treatment of agents: L&D INSURANCE, a life and health insurer, and DOMESTICA, a property and casualty company. Agents for both companies are captive agents.
The Liability Risk Retention Act of 1981, amended in 1986 (15 USC 3901–3906), created two entities to override certain state laws that, in the opinion of Congress, impede access to liability insurance: risk retention groups (RRGs), which are risk bearing entities, and risk purchasing groups (RPGs), which are not risk bearing. An RPG1 means any 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 exposure, as described in Paragraph (3);
is composed of members whose businesses or activities are similar or related with respect to the liability to which members are exposed by virtue of any related, similar, or common business, trade, product, services, premises, or operations; and
is domiciled in any state.
The Act, which is tracked by National Association of Insurance Commissioners' Model Risk Retention Act, eliminates state barriers to group formation but, nevertheless, leaves regulation of RPGs to the states. "Barriers" generally consist of state insurance code requirements designed to avoid "fictitious groups" in insurance argot. Toward this end, Section 3903(a) of the Act states that a purchasing group is exempt from any state law, rule, regulation, or order to the extent that these measures would:
prohibit establishment of a purchasing group;
make it unlawful for an insurer to provide or offer to provide insurance on a basis providing, to a purchasing group or its members, advantages, based on their loss and expense experience, not afforded to other persons with respect to rates, policy forms, coverages or other matters;
prohibit a purchasing group or its members from purchasing insurance on the group basis described in paragraph (2) of this subsection;
prohibit a purchasing group or its members from purchasing insurance on the group basis described in paragraph (2) of this subsection;
require that a purchasing group must have a minimum number of members, common ownership or affiliation, or a certain legal form;
require that a certain percentage of a purchasing group must obtain insurance on a group basis;
require that any insurance policy issued to a purchasing group or any member of the group be countersigned by an insurance broker or agent residing in that state; or
otherwise discriminate against a purchasing group or its members.
Except for the few exceptions regarding group formation, RPGs are subject to all provisions of a state's insurance regulatory system. RPGs must notify insurance regulators in each state of their intent to conduct business in the state, use appointed agents to handle insurance transactions, identify the insurance companies they buy from, specify the types of liability insurance they intend to purchase, and disclose other matters.
RPGs theoretically substitute group for individual buying—that is, liability insurance may be purchased "on a group basis." The RPG is primary, not secondary to any other group or interest; it purchases insurance for its members and no one else; and the statute incorporates the insurance principal that the group members must consist of "substantially similar" risks. RPGs may not only use group bargaining power to negotiate more favorable terms with insurers, but by setting standards of membership and other risk management methods, they may also reduce loss experience to gain better rates.
The Risk Retention Act does not specify any particular form that the RPG must take. It may be unincorporated or incorporated, a limited liability company (LLC), profit, or nonprofit or even operate as an insurance trust. No particular governing structure is mandated. However, these elements of flexibility are not to be taken lightly because failure to adopt appropriate form and structure may affect member liability for the acts of the RPG; further, lack of standards in the statute opens the door for exploitation by parties who are tempted to use the RPG option to further interests that may not be in the best interest of insureds. In other words, inflexibility (too much state regulation) may stifle innovation, but too much flexibility may foster deception. This commentary addresses this phenomenon.
The L&D Insurance RPG Formation and Function
The RPG for L&D INSURANCE was incorporated in the state of Delaware in 2005, listing its address as a city in Pennsylvania, the same address as the insurance broker for the RPG. The broker is president, and his spouse is secretary. The bylaws make several references to a "Program," although the term is undefined. For example, the organization's "Qualification of New Members" states that "any person eligible for membership will become a member upon approval of their application for insurance coverage under the Program," and under "Termination of Membership," one finds that termination is triggered upon "[t]he expiration without renewal or other termination of all of a member's insurance coverages under the Program."
Members have no voting rights.
The broker testified that an E&O insurer asked him to form the RPG and made the following admissions under oath:
The RPG has never engaged in negotiations on behalf of members for anything.
The RPG has never shopped around for insurance.
The RPG has never asked the insurer to modify the policy.
He is unable to recall anything the RPG has done to advance member interests.
The RPG has never paid taxes or any accounting fees.
The RPG engages in no corporate activity and has no annual meetings.
The RPG has no bank account.
The RPG has no membership fee.
The RPG provides no risk management services.
The RPG is basically a dormant corporation. An agent employed by the broker stated that while the RPG is the entity under which an agent is insured, L&D—the insurance company—is treated as the master policyholder, not the RPG.
In contrast, the certificate of coverage states that the RPG is the master policyholder, to wit: "THIS 'CERTIFICATE OF INSURANCE' IS ISSUED IN ACCORDANCE WITH THE 'MASTER POLICY' TO THE [RPG], INC." Yet, to the agents handling transactions, business is conducted as if the RPG is a mere phantom.
In actual practice, then, the group was not formed by insurance agents; the precondition for membership is an appointment with an insurance company—namely, L&D INSURANCE; membership continuation is contingent on remaining an L&D agent; and if L&D terminates an agent's appointment, the agent loses not only insurance but also membership in the group. Ergo, membership in the RPG is controlled by an external organization, not the RPG. Further, the formation and governance of the RPG is subject to conflicts of interest. The broker gets a 14 percent commission; therefore, he needs to satisfy his client, L&D, and the E&O insurer for administrative acts. His broker-owned separate entity agency conducts all of the business one would normally expect of an RPG. When asked about any possible conflict of interest when it comes to negotiating insurance, the broker acknowledged, "You can't really negotiate with yourself, correct?"
The RPG is essentially the alter ego of a broker acting in concert with L&D INSURANCE.
If the RPG functioned as a viable entity, there might have been more fruitful negotiation on the terms and conditions of the agents' E&O insurance policy. For example, the "consent to settle" provision (the hammer clause), discussed in my earlier article, could be modified to be more favorable to certificate holders; the contractual liability exclusion could be clarified to include percentages of interest in the entities specified in the exclusion. Further, one exclusion eliminates coverage for any claim made against any insured or the additional insured by:
any "additional insured";
any other insurance company;
any other insurance agency; or
any person or entities that in the past were, but are not currently, parties to an agent contract with the "additional insured."
Thus, there is no coverage for any agent who is sued for professional shortcomings by an "additional insured," such as L&D; the insuring agreement obligates the certificate holder to share his/her policy limits with the additional insured. Further, the definition of "insured" as amended by an endorsement includes partners, officers, directors, stockholders, and employees of the named certificate holder, but the policy contains no severability provision or spousal coverage. Spousal coverage is important because many producers are small businesses, and any lawsuit is likely to name any possible source of recovery for a plaintiff, including a spouse.
In the areas of professional liability insurance, these contract provisions are but a modest review of the matters worthy of negotiation with insurers, a task for which RPGs exist in the first place but, as the foregoing illustrates, the L&D RPG does not address significant aspects of E&O coverage and policy administration.
The Domestica RPG Formation and Function
According to the information from DOMESTICA, in order to participate in the agents' E&O program, agents must join an RPG that is operating as an LLC. There is no cost to join and remain a member of the RPG. DOMESTICA identifies the purchasing group as an "affiliate," and all officers are DOMESTICA employees. The officers (known as "managing members" in LLC speak) have the same address as DOMESTICA.
Under the insurance policy, the DOMESTICA RPG is the insureds' representative and holder of a master policy issued by an E&O insurer. Among other duties, the insureds' representative (DOMESTICA) serves as the sole agent of all insureds for the purpose of effecting or accepting amendments to or cancellation of the policy, for the payment of premium and the receipt of any return premiums that may become due under this policy, and for exercising or declining to exercise any right to an extended reporting period. Certificate holders have no voting privileges, nor do they have any governing or oversight roles.
From publicly available DOMESTICA documents, one is unable to determine how the RPG was formed; whether it is profit or nonprofit; whether it is free to shop the E&O coverage to companies other than the current one; whether it holds annual or other regular membership meetings; whether it files tax returns; whether it maintains records about claims experience; whether it has an expressed policy of maintaining an arm's length relationship with DOMESTICA; whether the RPG handles premium money; whether there is an LLC operating agreement; or whether managing members receive a salary, to mention a few examples of missing material information.2
Based on available evidence, the RPG seems to be the alter ego of DOMESTICA. Indeed, how else could one explain how and why DOMESTICA employees exercise authority to make coverage determinations, as cited in my previous commentary?
Possible Courses of Action
RPGs are intended to serve group members' interests, not the interests of third-party entrepreneurs or companies that treat independent contractor agents more like indentured servants than the "insurance professionals" they are trained to be. RPGs are also supposed to focus on securing the most favorable rates and terms for members.3 Yet, as the examples of L&D and DOMESTICA suggest, some insurance producers, whether wittingly or unwittingly, are being shortchanged by their RPGs.
Heretofore, congressional efforts have centered on expansion of the types of insurance RPGs and RRGs could offer and the degree to which states can exercise regulatory authority over these entities. For RPGs, however, a more pressing issue may be the need to clarify governing principles to ensure that persons forming an RPG are unable to undermine the objectives for which RPGs were sanctioned by federal law in the first place. Additionally, state regulators who exercise regulatory authority over RPGs need to pay closer attention to their regulatory duties.
The Mass Marketing of Property and Liability Insurance Model Regulation is a good starting place. First, regulatory action could amend the Model Regulation by specifically including RPGs within the definition of "Mass Marketing Plan." While Section 4 of the regulation prohibiting fictitious groups is inapplicable to RPGs, the disclosure and continuation of insurance when one is no longer a group member could address at least some of the problems. Section 10, for example, requires:
Section 10. Disclosure Required. Every insurer, agent, or broker selling insurance subject to a mass marketing plan shall, prior to sale, make full and fair disclosure to prospective insureds of all features of such a plan, whether favorable or unfavorable, including but not limited to premium rates, benefits, duration of coverage, policyholder services, conversion privileges available, and the financial interests in the plan, if any, of the sponsoring employer, association, organization or the group.
As the federal legislation permits, states may regulate all aspects of RPG operations except those exempted from state regulation. Consequently, all other provisions regarding rate and form filing,4 unfair and deceptive trade practices, unfair claims settlement practices, and licensure are available to address RPGs. A few concentrated market conduct examinations may demonstrate that the practices discussed herein and in my companion commentary constitute the soft underbelly of this aspect of the alternative risk management industry.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
1 According to the Risk Retention Reporter, there were 884 RPGs in the United States as of February 2013.
2 I understand that a federal judge rejected a motion to introduce a policy analysis of Domestica's E&O policy comparing it with other available policies on the grounds that the evidence would be "prejudicial" to Domestica. I agree it would be prejudicial. That is why a jury should hear it; otherwise, they lack an anchor against which to evaluate the policy.
3 See Karen Cutts, A Practical Guide to Purchasing Groups, 2nd ed. (Pasadena, CA: Insurance Communications, 2004), 54.
4Insurance Co. of the State of Pa. v. Corcoran, 850 F.2d 88 (1988), is an early case upholding New York's authority to regulate forms and rates. It is important that the federal statute regulates RRGs and RPGs, not insurance companies. Stated differently, laws and regulations governing insurers are unaffected.