RRGs Providing Options For Insurance Buyers Asudden increase in the number of newly formed captives is expectedin times when the commercial insurance market is incapable ofproviding protection for a fair price.

Downgrades of notable reinsurance andinsurance companies, less competition, higher fronting costs, andstrict underwriting are compelling savvy insurance buyers to lookinto the variety of alternative risk transfer methodsavailable.

But what has been notable in this current market is the dramaticrise in the number of risk retention groups, commonly calledRRGs.

Like a captive, an RRG is an alternative risk transfer programthat was borne out of necessity by buyers who wished to createstability and consistency in insurance pricing.

In 1986, during a hard market similar to what we areexperiencing now, Congress responded by expanding a 1981 law andpassed the Liability Risk Retention Act (LRRA). The Act, in effect,allowed similarly insured policyholders of casualty insurance,notably general liability and professional lines, to form their owninsurance companies.

Since then, both RRGs and captives have become increasinglyacceptable forms of risk retention strategies, but the RRG conceptnoticeably lagged behind the more popular captive model. The trendseems to be changing, however, in todays marketplaceenvironment.

According to an article published in NationalUnderwriter earlier this year, by Karen Cutts, editor of the“Risk Retention Reporter” (NU March 10, 2003), grosspremium written for RRGs in 2002 is estimated to total $1.28billion. The figure represents an increase of $284 million over2001 and is 53 percent higher than the 2000 premium.

The “Risk Retention Reporter” noted 90 RRG formations by the endof 2002 and 69 in 2001.

Recent formations of RRGs represent the most dramatic growth forthis type of risk transfer model. While most of the newer RRGs arefrom the health care, transportation and professional fields, thereal question is why are RRGs, as opposed to captives, becoming anincreasingly attractive alternative to the traditional insurancemarket?

Several industry observers I have spoken with reveal that thenew RRGs are being formed because of a lack of fronting. They saymanaging general agents are having a harder time with theirreinsurance partners and are beginning to “roll over” their nichebooks of business into RRGs.

While there are many similarities in captives and RRGs, clearlythey are not created equal, nor should either one be selectedwithout a careful analysis of the needs that each will fill.

Without going into the complexities of each model, there aresome important considerations to keep in mind when makingcomparisons.

A captive can insure virtually anything. Indeed, one of thebiggest benefits of a captive is its ability to customize any lineof coverage so long as it makes financial and underwritingsense.

In contrast, at this time, an RRG may only provide commercialinsurance coverage for casualty risks such as general, auto andprofessional liability, although adding workers compensation andproperty coverage under an RRG is being seriously debated.

Securing coverage from the traditional market can augmentadditional coverage for both models.

Finding and purchasing the year-to-year services of frontingcarrier is arguably the most important component when considering acaptive, but this is not necessarily so with an RRG.

Under a captive arrangement, an insurance company is used toissue policies, pay premium taxes, underwrite and make filing withthe state of business. Commonly it will have a reinsuranceagreement with the captive to accept some portion of the risk andthen transfer the remaining risk back to the captive.

Probably the most important function the front performs isguaranteeing the captives creditworthiness. One of the ways it doesthis is by requesting collateral to fund business losses over thecourse of time.

In addition to the costs of using a front, which can often be ashigh as 15 percent or more of standard premium, the front itselfmay become financially unstable and may have to withdraw from themarket. This would leave the captive without a valuable partner andwould possibly tie up the captives funds while it undergoesreorganization.

An RRG, on the other hand, sidesteps a search for a frontbecause it is, in fact, its own front. All of the fees, expensesand corporate culture idiosyncrasies associated with a front areinstead funneled to the capitalization and operation of theRRG.

While the RRG will now have to make state filings, licensing andcompliance matters under its own mantel of operations, it maysecure the services of a professional manager to perform theseduties in exchange for a negotiated fee.

Another consideration is that an RRG usually does not belong toa state guaranty fund. For many, that is acceptable because the RRGknows its risk extremely well. Under a fronting arrangement, thecaptive may decide whether or not it will be required toparticipate in a guaranty fund by selecting an admitted or anexcess and surplus lines licensed insurer to be its front.

Both a captive and an RRG are accepted forms of risk transfer inall states, but in the case of a start-up captive, a policy-issuingcarrier licensed in that state may be required.

An RRG, however, once domiciled in one state can be licensed inall states to conduct business. Eventually both can achieve anindustry rating, such as from A. M. Best, usually within five yearsof start-up.

In many cases, a captive is set up to insure the risk of asingle policyholder. Non-policyholders, for profit reasons, mayalso own a captive. For example, an insurance carrier may have anownership position in a captive, but could not in an RRG unless allmembers are insurance companies.

Membership in an RRG is limited to similar or related businessesor activities relative to coverage provided by the RRG. Also, whilethere are cases of an RRG being formed under a single parentdoctrine, youll usually find that there are several policyholderswithin the entity who would then satisfy the definition of a“group” under which an RRG can be formed.

While there is a virtually ever-expanding universe under which acaptive may be domiciled, offshore and on, it appears that Vermont,Hawaii and South Carolina are the most often used domiciles forRRGs.

The minimum amount of capital needed to start a captive or RRGis dependent, to some degree, upon where it is formed. Captives andRRGs can have several minimum capitalization requirements. There isnot enough space to capsulate them all, but generally speaking, acaptive can be started by using virtually no capital vis-?-vis a“rent-a-captive, or if ownership is desired, for as little as$125,000-$250,000, mostly in offshore domiciles. RRGs, in contrast,typically require at least $600,000-$750,000 as a minimum, but ifyou want to impress the state regulators and gain approval,consider using more.

Also, under a captive arrangement, non-policyholders maycontribute to the capitalization of a captive and also be owners,but in an RRG, only policyholders may be owners.

Policyholders for a captive can be heterogeneous and completelydissimilar for a single line of coverage. For example, an agencymay use a captive to place all of its best clients in and provideprofit sharing incentives for good experience.

In an RRG, an individual or business that meets membership rulescannot be excluded if the intent is to provide the group with acompetitive advantage.

While there are many other variables to consider in decidingwhether to form a captive or an RRG, both are strong models forcontaining insurance costs, obtaining coverage and getting “back incontrol” of ones insurance program.

While captives are surely here to stay, RRGs are quicklybecoming popular with policyholders. And, like captives, members ofRRGs will find ways to evolve to accept more types of coverages,particularly if the insurance markets continue to fail to providethem with solutions to their problems.

Christopher L. Kramer is vice president, alternative riskmanagement for Neace Lukens in Beachwood, Ohio.

Reproduced from National Underwriter Edition, April 7, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.