At mid-year, interest in captives and risk retention groups remains strong
and growing. While no records for new licenses are likely to be set in 2004,
the continuing interest is impressive.
Recently I wrote an article on the use of risk
retention groups as a potential solution to the scarcity of medical malpractice
coverage in some states. I stand by those comments and encourage healthcare
professionals to look into such an option. However, I have become aware that
as this interest grows, some basic issues are being exposed, and there seem
to be no good answers.
Capitalization
The most troubling issue is capitalization. Traditionally, RRGs have been
capitalized as insurers, as indeed they are. But with the U.S. regulatory set
up of 50 jurisdictions from which to choose, some promoters are seeking approval
in jurisdictions that perhaps have not considered the true capital needs of
an RRG.
It is incumbent on each state insurance department to review actuarial feasibility
studies and the financing of the proposed company. All departments require such
studies and actuaries work long and hard to offer mathematical insights into
a future that is often very unclear. Normally, great care is exercised to predict
potential claims and the required funding to pay for them.
With an RRG, one must look further. While considered to be a captive, it
is decidedly not just another captive. Often regulators and operators consider
only the ratio of capital and surplus to premiums. The argument has quietly
been raised that one could look at exposed limits to capital and surplus.
For an extreme example, if an RRG is established with 500 doctors as member/insureds
for limits of $1,000,000/$3,000,000, then the actual potential exposure is $500,000,000/$1,500,000,000.
This is because every single policy could be seen as a full-limit claim. Capital
requirements for such an exposure would be beyond reach, if not as great as
the potential exposure itself.
This can be dismissed as a ridiculous example, but perhaps not too quickly.
In certain circumstances, such an extreme example may be closer to reality than
not. It is quite dependent on the legal climate and the facts and circumstances
of the event. Recent court rulings, such as those in Arizona, leave very unclear
the ability to predict ultimate payouts in medical malpractice.
Obviously, traditional insurers do not capitalize to a 1:1 limits to capital/surplus
ratio, but regulators rely on them being established, mature, publicly-held
companies subject to regulation and oversight from a variety of sources. That
is not the case with RRGs. An RRG is restricted by law as to coverage offered,
hence the premiums collected are the main source from which to pay claims, and
to shareholders who are also policyholders. The ownership/management is new
to the challenge and, after domicile approval and the National Association of
Insurance Commissioner (NAIC) filing, the only real oversight is the manager
and the board. Some regulators have hinted that the RRG, or the combined shareholders,
need to demonstrate the ability to come close to a 1:1 ratio. This is unworkable,
but troublesome.
As healthcare RRGs proliferate, some parties who rely on the certificates
of coverage and the approval of regulators may become uncomfortable as they
analyze their true exposure. A hospital board of directors may have agreed to
accept an RRG from their valued staff, but as locum tenens provide coverage
through an RRG, and the board has not kept current with changing circumstances,
one ugly claim could cause major problems. At that point, as the trial bar seeks
deep pockets, they may view the culpability of the board as an enticing target.
Perhaps a directors and officers claim.
Before we go completely around the bend, we must step back and recognize
that most RRGs will have reinsurance to protect them from extreme levels. Because
of the extreme example cited above, the reliance on reinsurance must be well
informed as to the identity and rating of the reinsurer, and the language of
the reinsurance contract. But with good, solid reinsurance in place, strong
financing, and informed active management, there should be no more concern for
a med mal RRG than any other insurer.
Domicile Concerns
Along with the capital issue, and perhaps linked to it is the suspicion that
an occasional RRG promoter is actively seeking a domicile where capital requirements
are enticing and regulatory scrutiny is thin. Redomiciling is becoming an active
segment of some consulting and legal practices. It may be that some domicile
regulators have had their head turned by a seemingly attractive new statistic.
Redomiciling is a perfectly legitimate transaction, and there are many sound
reasons to do so, including regulatory changes, administrative changes, and
personnel changes to name but a few. In today's corporate environment, some
major firms are more leery of offshore captive domiciles, and may wish to reduce
the perception of a negative image by moving to a U.S.-based domicile. Such
moves don't apply to RRGs, as they can only be licensed in the United States,
but serve as an example of redomiciling. As the RRGs must demonstrate some level
of compliance with the domicile which they propose to exit, this should not
become a big problem. But one should also ask, why the move?
Is It Time for Captive Standards?
It would seem that now is a good time to advocate the creation of some type
of standard evaluation of RRGs and their capitalization which could assist their
constituencies in understanding the true exposure and having confidence in what
they are shown beyond regulatory approval. Certainly there are others better
qualified than I to propose such standards, and some private firms may have
them currently. Hugh Rosenbaum has frequently advocated an accounting approach
he called Generally Accepted Captive Standards. Perhaps the time has come.
As captives and RRGs become more in vogue, the industry accepts that they
are individually crafted structures designed to address a particular need. That
may not be clear to all other constituencies in an expanding audience. In today's
world of corporate governance, clarity is vital.
While true tort reform would also solve many problems, I hold out no hope
for that option. It is better to construct industry standards than rely on a
diet plan from those who feed at the trough they created.