Risk Retention Groups To The Rescue

Tightening medical malpractice insurance market drivesbuyers to seek refuge in captive option

When examining captive trends over the past year, its hard toignore a virtual explosion of risk retention group formations. Inparticular, a tightening medical malpractice market made 2003 anexceptional year for RRGs, market experts say.

Also in the works is a possible expansion of the federal RiskRetention Liability Act for property coverages, which would lead toanother quantum leap for this alternative market option.

On the other hand, RRGs are under fire in some states and are beingexamined by the National Association of Insurance Commissionersbecause of the insolvency of National Warranty RRG, grandfatheredin the Cayman Islands, which left thousands of customers in Texasand Nebraska in the lurch.

Last year, 58 RRGs were formed, while only 7 were retired,bringing the total number of operating RRGs at year-end to anall-time high of 141, according to Karen Cutts, managing editor andpublisher of the Risk Retention Reporter, a monthlynewsletter based in Pasadena, Calif. As of January, that total hadrisen to 145, “with dozens more in the pipeline,” she noted in anarticle in NU's Jan. 26 edition.

“RRGs are a hot topic this year,” agreed Leonard Crouse, deputyinsurance commissioner of the Captive Insurance Division inVermont.

Mr. Crouse said that of 77 captives licensed in Vermont lastyear, 20 were RRGs. Out of those 20, 17 were devoted to medicalmalpractice exposures. The majority of these med mal RRGs wereformed by entities from Pennsylvania, while two were from theMidwest, two were from southern states, and one was from Texas. Heguessed Vermont would license another 20 RRGs in 2004.

“The medical malpractice crisis has driven a lot of it,” hesaid. “And it has a lot of people concerned also.” But is theirconcern justified?

RRGs are “something that has to be watched,” he conceded. “Somany RRGs are in new domiciles, and these states will learn as theygo that these things are a different animal.”

Mr. Crouse said he believes that captive growth may have peakedin 2003, but that “what remains a question is how much RRG growththere will be in 2004.”

He noted that medical malpractice will continue this year “to bea tough, tough line because those [insurance] rates aren't comingdown by any means. So I think we are going to see activity continuein the medical practice field, and there's no question that RRGshave been able to help the crisis in this country.”

Molly Lambert, president of the Vermont Captive InsuranceAssociation, agreed that, “obviously, last year we did see manyformations for RRGs–many in the health care arena.” The medicalmalpractice insurance crisis, she added, “continues and points tomore and more physicians and/or hospital groups taking advantage ofthe RRG [option].”

As for adoption of an amendment to the Liability Risk RetentionAct expanding the lines of eligible exposures, “there is a veryshort window of opportunity to get anything done this year becauseof the presidential election,” she said. “The feeling is that inorder to get the RRG in front of anybody, it will have to bestrategically approached.”

That could mean attaching it to another piece of legislation,the most likely being an extention of the Terrorism Risk InsuranceAct, she said, which will be in effect until 2005 and may or maynot be renewed. “I think it will be tough to get either of theseitems in front of Congress this year, but that can all change,” shesaid.

An NAIC working group is focusing on RRGs, “but this isntnecessarily positive,” Ms. Lambert said. “This could slow thepotential expansion. The draft resolution that NAIC proposed thatcreated a lot of furor in the industry opposed the expansion of theact. They have since established a working group to have furtherdiscussions.”

The other trend that could affect the number of captives in2004, she said, is a softening in some standard insurancemarkets.

“Historically in Vermont, our premium growth continues becausethose engaged in the captive system like it and know how to useit,” she explained. “There are always niche businesses that theyuse the captive for, but the number of formations may not be at theincredible pace we've experienced in the last couple of years.”

In the individual captive domiciles, states of all sizes arereporting mixed results.

Washington, D.C.: Captive Capital?

Washington, D.C. is intent on creating a domicile that isfriendly, but not too friendly, to captives. The effort includes anewly created department and reorganization of captive laws.

D.C. officials recently announced a newly-created agencycombining its Department of Insurance and Securities Regulationwith the Department of Banking and Financial Institutions.

The merged entity, called the Department of Insurance,Securities and Banking, will be headed by Lawrence H. Mirel, who iscurrently commissioner of insurance and securities.

William P. White, D.C. director of captive insurance, toldNational Underwriter that the move “goes back to wantingto create an environment where D.C. can become more of a financialservices center.”

The District added 18 captives last year to bring its total to20. Captive growth in D.C., according to Mr. White, is a “falloutin the traditional market from tough lines of business,” as well asa continuation of “anything that has to do with medical and healthcare.”

He also noted a greater interest in sponsored and segregatedcell captives, as well as risk retention groups.

He said many organizations are turning to RRGs because they need“an organizational structure that will allow them to quickly andseamlessly go into new areas without the administrative hang-upsthey might have with having to go through a complete licensingprocess everywhere.”

He said D.C. is being tough on requirements for RRGs, but “witha side glance toward what might happen in terms of changing therisk retention federal legislation.”

If Congress decides that property and possibly workers'compensation can be included in RRGs, “we don't think we will haveany problem because we have fairly stringent requirementsalready.”

As a single captive category, he said that D.C. has more RRGsthan anything else.

He noted that the domicile is doing a “quick and dirty”evaluation of its captives to allocate the proper resources tosupport them. “We need to learn from this portfolio of captiveswhat the current needs are, but also project out to the emergingneeds and emerging concerns for the organizations that will havethe same motivations our current group has,” he said.

He added that D.C. is “not trying to compete with otherdomiciles based on how many captives we have,” but ratherattempting to add value to the marketplace. The domicile is doingthis, he said, by creating “the right kind of businessenvironment,” so that companies and other organizations cannot only“do business on a fairly sophisticated basis, but have that tie-into those government agencies that they need, whether it's Treasury,Commerce or Department of Labor.”

Mr. White said D.C is updating its captive law, implemented in2001. The new law, he explained, is focused on “making it veryclear what we will allow in this domicile, and also opening up afew things so that it is a little easier to do business usingcaptives as a mechanism.”

He noted that D.C.'s captive law and some supporting legislationis working its way through the legislative process and willhopefully “end up on Congress' desk some time in April.”

Mr. Mirel said the structure of the financial services industryis changing rapidly and that a consolidated regulatory agency isneeded in D.C., “just as they have been in leading financialcountries such as Great Britain, Germany and Japan.”

By merging the two agencies, he said, “the District willdemonstrate that it is ready and able to regulate modern financialservices organizations.”

Hawaii: A Captive Paradise?

Craig Watanabe, Hawaii's captive insurance administrator, toldNational Underwriter that 2003 was a record year, with 23new captives licensed.

“The growth is there, but compared to some East Coast domiciles,we're not as quick to grow,” he said. “I think the driving factorback east was the med mal captives.”

He noted that over the past six months, medical malpractice hasbecome more of a problem in western states, which could spurcaptive growth in Hawaii.

“We are starting to see more inquiries,” he said. “Californiahas a cap on medical damages, so it's slow there in terms of acrisis, but some carriers have pulled out of the market. The supplyis diminishing, so some of the hospital and medical groups arescrambling for coverage now.”

Hawaii has 18 medical malpractice related captives, he said, ofwhich five are RRGs.

The captive growth trend from Japan and the Pacific Rim iscontinuing slowly, he observed. In 2003, there were two captiveslicensed from Japan. “These are generally manufacturing operationssuch as equipment, pharmaceutical drugs. We should have a couplemore this year,” he said.

Hawaii is not currently amending its captive statutes, Mr.Watanabe noted.

Kentucky: RRGs Keep Pace

Pat Talley, chief financial analyst in the Kentucky insurancedepartment, said his state, overall, has licensed one pure captive,one association captive and two risk retention groups.

However, he said the last two captives he licensed in 2003 wereRRGs, “in keeping with what we're seeing nationally. I suspect thisis a trend we will continue to see, particularly with thediscussion about expanding the scope of the Risk RetentionAct.”

Kentucky's RRGs are professional liability and medicalmalpractice, he said. The pure captive is also professionalliability, while the association captive is workers'compensation.

Mr. Talley said Kentucky is currently in its annual legislativeprocess “and there is nothing [for captives] on the table. Isuspect that next year there will be a need to do some fine tuning.There was a need this year, but Kentucky just went through a changein party.”

Arizona: Stays On Target

Arizona Captive Administrator Richard Marshall told NationalUnderwriter that Arizona was on target in meeting its fiscalyear objectives.

Arizona's captive legislation was adopted during the summer of2002 and an amended law went into effect on Sept. 18, 2003. The newlaw permits agency captives, protected-cell captives anddirect-writer captives for workers' compensation.

Group captive insurers include risk retention groups andindustry groups. The expanded law also includes several reinsuranceoptions, including personal lines, which were not part of theoriginal act.

Nevada: Bucking The Trend

Tom Canfield, an insurance examiner for the Nevada insurancedepartment, said the state picked up a few RRGs, “but we were notanticipating the number of pure captives which came in. We haven'tbeen marketing like some states have.”

He added that the “word got out and people have been coming tous. So last year we had five new single-owner captives, which wassomething we hadn't anticipated and we're really happy withthat.”

Mr. Canfield said companies are coming to Nevada to formcaptives because “we're a small state. People can come in and talkto us and deal with us and talk to the commissioner.”

He said his department does not have a captive division, but“there is anticipation that some time this year they will actuallyput in a full-time captive person and start a captive section.”

Such a position was not funded when the state's captive law waspassed in 1999, he said, but as the number of captives grows, 10percent of the premium tax for captives will eventually beallocated to the program. “So I think they are reaching a pointwhere they might be able to support that, and from there on itcould grow. And with a full-time person, they might be able tomarket better and the program would grow faster.”

Mr. Canfield said that because the Nevada legislature meetsevery other year, and already met in 2003, no changes in thecaptive law are in the works.

“However, we do anticipate proposing lowering taxes on fees andpremiums for foreign RRGs for 2005,” he said. “There has been talkthat someone has been looking at protected-cell legislation fromthe industry.”

South Dakota: Missing The Boat?

Wendell Malsam, chief examiner of the South Dakota insurancedepartment, said the state had no captives licensed in 2003.

What's hold the state back? “It could be people think we're inthe hinterland–certainly not a prime location for a board meeting,and our law is only a pure captive law,” he explained.

He said there have been no changes made to the state's originallegislation and no requests for updates.

“To be truthful,” he added, “Id be somewhat concerned aboutending up with the rejects out here.”

Montana: Keeping Busy

John Huth, captive insurance coordinator with the Montana Officeof the State Auditor, said his state has been busy in the captivemarket.

“Our last four new captives are re-domiciles,” he noted, meaningthey have moved from other locations. The facilities licensed arepure captives. “Three of them are rural phone co-ops out of Kansascovering liability and line interruption–coverage that the marketwon't provide, that they have been self-insuring. The one in-houseis also another phone co-op.”

He added that two health care organizations are on line–one outof Topeka, Kan., and the other from Montana. “We're getting a lotof inquiries from Florida right now–also medical,” he said.

Montana is considering two legislative changes, he said. One isclarifying RRGs in the law, while the other would charge actualpremium tax to Montana firms rather than the $5,000 minimum onpremium written.

Mr. Huth said the domicile currently has one trucking RRG andthree health-related captives–of which one is an RRG. He noted thatthe domicile started a captive association last year, which isplanning its first conference.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, March 12, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.