GAO Report Could Alter RRG Status

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RRG owners urged to voice concerns over NAIC call for more stateoversight

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An anxiously awaited Government Accounting Office report couldback state regulators' claims that risk retention groups should betreated as any other insurer, which would alter some of thebenefits critical to some RRGs, according to a captiveregulator.

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Dana Sheppard, acting director of the compliance division at theRisk Finance Bureau for the Department of Insurance, Securities& Banking in Washington, D.C., has seen the GAO report but notits recommendations. However, he told National Underwriter thatrisk retention group owners need to be aware that the GAO reportcould recommend, among other things, changes in accounting methodsnow used by RRGs.

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The National Association of Insurance Commissioners is "reallyinterested in RRGs and changing the way captive domiciles regulateRRGs," he said. "Many states never accepted the federal RiskRetention Act and have even ignored it." Those same states, hesaid, have argued that the intent of the federal law was toregulate RRGs as traditional insurers rather than as captives.

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Captive domiciles, on the other hand, have regulated RRGs ascaptives–using different standards for captives and RRGs than forstandard, state-licensed insurers–"which these states say violatesthe spirit, if not the intent, of the federal law," he said.

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Mr. Sheppard explained that some insurance regulators areattempting to change RRG standards to those applied to traditionalinsurers through the NAIC's accreditation process, which rewardsstates for adhering to a group of core NAIC model laws andpenalizes those that do not.

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Instead of going back to Congress to modify the law authorizingRRGs, which could give them a result they may not be happy with,state insurance regulators are taking "a back-door approach bysaying to states, 'If you are going to continue to be accreditedand be in good standing with the NAIC, you are going to have toregulate RRGs more like traditional companies,'" he said.

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Tim Wagner, director of the Nebraska Insurance Department andchair of the NAIC's Property-Casualty Insurance Committee, said hehas nothing against RRGs, but that RRGs need uniform regulatorystandards. As it stands, RRGs are granted "national access withminimal regulation," he said.

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Mr. Wagner noted he has an issue with RRGs that are not owned bytheir members. One example was National Warranty, he said, whichowned 99 percent of the stock of the RRG and controlled the board.The remaining members, more than 500, owned only 1 percent.Nebraska was severely affected by National Warranty Company'sfailure, which he called "the crowning blow" to current RRGregulation.

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National Warranty acted as a third-party administrator for itsmembers' program. It was regulated by the Cayman Monetary Authorityunder the 1981 Risk Retention Act and declared insolvency in 2003.The 1986 Risk Retention Act mandated that RRGs be domiciled in theUnited States.

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Mr. Wagner added that there are other instances where "interestsof the management of the RRG and the interests of the members maynot be the same." He cited failed medical malpractice RRGs inTennessee and Virginia, where losses "will be $200 million," hesaid. "Who will pay that?"

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Mr. Wagner said he personally believes in RRGs, surmising thatthe insurance industry "will be capital starved." He added: "Weneed to have as many mechanisms to handle risk as we can find.There is a perception that because you want standards that you'reagainst something, and that is simply not true."

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The standards in question include accounting methods and variousratios–such as a requirement that no one risk can represent morethan 10 percent of the entity's surplus. "Those things where wetend to be more flexible on the captive side, they want us toimpose stricter, more conservative NAIC standards," Mr. Sheppardsaid.

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The big area for RRG owners is GAAP versus statutory accounting,Mr. Sheppard noted. "Because in many of the captive states, we usea modified GAAP, where you can organize a company with letters ofcredit and surplus notes, but you can't use surplus notes andletters of credit to provide the initial capitalization for atraditional company," so by strict statutory accounting standardsthis would not be permitted, he explained.

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Another area is deferred acquisition costs. In statutoryaccounting, all start-up costs must be expensed the first year ofoperation. Under the GAAP method, however, those costs can beexpensed over a period of time. Other changes eyed by the NAICinclude risk-based capital calculations and the credit forreinsurance law.

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Washington's position, he said, is that "in some areas we wouldbe willing to agree to more uniform standards. But the three bigareas for us, where we would like to see flexibility, are the useof GAAP accounting, credit for reinsurance and flexibility withsome of the ratios, including the risk-based capitalcalculation."

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The NAIC currently is in the process of going through each ofthe standards to "come up with the ones that should apply tocaptives and the ones that shouldn't," he said. He noted that themajority of the commissioners want to move away from captive-styleregulation to traditional regulation of RRGs. "There is a lot ofmomentum and it looks like this will happen," he said.

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If this does become a reality, he noted, some of the benefitsthat "risk retention groups now enjoy would be done away with."

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Many RRGs, he said, are just now getting involved in this issue.RRGs need to come up with alternative ideas, voice their concernsand let the NAIC know "how these changes could impact the way theyoperate." These changes would most affect doctors, nursing homes,hospitals, builders and the transportation industry–"all of theindustries that still have a hard market, that have turned to RRGsfor relief," he said.

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The best way for RRG owners to get involved is at theassociation level, he said, adding that it is important for ownersto be heard. "It's one thing to hear it from an attorney or managerwho makes a living this way," but it's another thing for an ownerto say, "'RRGs have provided solutions in many of the hardmarkets,'" he added.

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Flag: Recap

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Head: What's The Beef?

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Those who oppose greater state regulation of risk retentiongroups say there are some areas where they would be willing to livewith more uniform standards. Opponents, however, draw the line onthree points:

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1 The use of GAAP accounting, with particular concern about theuse of surplus notes and letters of credit to provide initialcapitalization, as well as treatment of deferred acquisitioncosts.

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2 Credit for reinsurance.

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3 Flexibility with some of the benchmark ratios, includingrisk-based capital.

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