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.