Tougher RRG Regs Could Hurt Ins. Buyers

In the past few years captives have become an increasinglynecessary form of risk finance and transfer for businesses seekingalternatives to a difficult and shrinking commercialproperty-casualty market.

Much has been made of the elements of change driving the searchfor alternatives to the traditional insurance market, includingmergers and acquisitions, collapse of markets, reduced investmentincome, and terrorist attacks.

Though these issues exist, of greater concern are the challengesand barriers to commerce being raised while legislators andregulators consider all of the angles. In spite of all that hasbeen faced–litigation, regulatory burdens, lack of markets anddifficult pricing–business owners will find a way to insure theirventures and protect themselves.

Throughout the challenges the insurance industry has thrown atbusiness owners, one of the toughest problems has been securityagainst future claims, and another is regulatory approval. Thesechallenges are becoming intertwined in a titanic struggle in theinsurance industry which plays out as the Feds vs. the states.

To clarify, all insurance policies must provide to regulatorssufficient evidence of ability to pay claims in order to operate ina given jurisdiction. All would agree that this is a good thing.This certitude can be in the form of the public strength of theissuing admitted and rated insurance carrier, or from letters ofcredit or other forms of security. Many professionals spend a greatdeal of brain power and time to be certain that there is areasonable probability of those payments being made.

Inasmuch as fronting (a risk-sharing partnership between alicensed primary carrier and a captive) continues to be a challengeto everyone in the captive community, we are seeing more prospectsinvestigate risk retention groups. RRGs, while a form of captive,do not require a risk-sharing partner as a front.

RRGs were created under the 1981 Product Liability and RiskRetention Act, revised in 1986. The act contains exclusions,exceptions and exemptions to state insurance statutes andregulations. State regulators often have a problem with theseexemptions and exclusions. A particularly troublesome exemption isfrom state insurance taxes and fees for supporting pools andassessments.

While not new, risk retention groups have not been as attractivea solution as captives because of inherent limitations on lines ofcoverage in the act. RRGs are not permitted to cover workers'compensation, personal lines, health insurance or propertyexposures among other limitations. The original intent of Congresswas to address a product liability crisis of the late 1970s andearly 1980s. RRGs did address that crisis.

When the act was passed by Congress, it was a significant moveinto the longtime protected practice of state regulation ofinsurance companies. The urgency of gaining some rational responseto excessive litigation in regard to liability for the manufactureand sale of products prompted the move. The act saved companies andjobs.

But the states rights lobby is a powerful and compelling one, soCongress stayed away from additional excursions into the regulationof insurance companies (more or less) until recently when underpressure from many insurers unhappy with regulatory delays andbureaucratic morasses. The Gramm-Leach-Bliley Act was passed toforce states to produce some consistency in regulation and pace ofapprovals.

The states were given two years to comply, and compliance wasset as a majority of the states by number. That number was met in atimely fashion, with 35 states complying by the deadline. However,the states not complying include the states with the mostpolicyholders: New York, Pennsylvania and California, amongothers.

As these roadblocks to commerce have arisen, RRGs have become areasonable alternative, particularly for the medical professions.Several states have developed expertise in licensing RRGs, and as asolution the RRG model provides a good choice. But with thelimitations on lines of coverage and the burden of letters ofcredit against projected future losses, and now mounting stateregulatory interference, again commercial consumers must faceproblems not of their making.

In order to exist, an RRG must receive approval from one stateand then be accepted to do business by all other states. This isnot always enthusiastically accepted.

Beyond the tax issue, some regulators have legitimate concernsabout the ability of some creatively formed RRGs to pay claimsagainst the policies issued by the RRG. In order to be certain ofclaims paying ability, the regulators require a rigorous procedureculminating in acceptance to do business in our state. If thisprocedure is replaced by a federal act, however, the regulatorsperceive a loss of control.

The unfortunate and very public demise of an automobile warrantyRRG, operating under grandfather provisions from the CaymanIslands, has exacerbated this debate. In my view the failure of theRRG being discussed had nothing to do whatsoever with structure ordomicile, but it enables others to have a wonderful platform tourge restrictions or reforms on RRGs, depending on their bias. Iwould expect to see something come out of Congress this year,although insurance is not a great sound bite in an electionyear.

As the coming battle moves toward a more open forum, some stateshave taken more aggressive postures. One prominent state with manypolicyholders and numerous insurance challenges has decided tocompel RRGs to have a very large amount of capital–$18 million–anda rating from A.M. Best & Company in order to operate. I willleave other, more qualified people to determine the legitimacy andsustainability of this restrictive move, but in terms of anotherburden to legitimate risk finance, this is a very destructivechoice.

The looming battle for regulatory rights carries the potentialfor yet another impediment to legitimate and rightful commerce. Iftraditional carriers have chosen to retreat from some lines ofcoverage and types of risk such as anything to do with medical orprofessional malpractice–which is certainly their right and duty toshareholders–then it would seemingly behoove regulators to fosteralternatives rather than create obstacles.

At the National Association of Insurance Commissioners meetingthis month, the organization representing state regulators, therewill be considerable discussion about these issues. We can onlyhope that fostering commerce will be at the heart of theagenda.

Michael R. Mead, CPCU, is director and a former chairman ofthe Captive Insurance Companies Association as well as vicepresident and director of the Arizona Captive InsuranceAssociation. He also is president of Crusader Captive Services, anewly formed alternative risk consulting company, a member of theCrusader International Group, comprised of several domicilemanagers and intermediaries. See www.crusadercaptiveservices.comfor more information..

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.