RRGs Providing Options For Insurance Buyers A sudden increase in the number of newly formed captives is expected in times when the commercial insurance market is incapable of providing protection for a fair price.

Downgrades of notable reinsurance and insurance companies, less competition, higher fronting costs, and strict underwriting are compelling savvy insurance buyers to look into the variety of alternative risk transfer methods available.

But what has been notable in this current market is the dramatic rise in the number of risk retention groups, commonly called RRGs.

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

In 1986, during a hard market similar to what we are experiencing now, Congress responded by expanding a 1981 law and passed 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 own insurance companies.

Since then, both RRGs and captives have become increasingly acceptable forms of risk retention strategies, but the RRG concept noticeably lagged behind the more popular captive model. The trend seems to be changing, however, in todays marketplace environment.

According to an article published in National Underwriter earlier this year, by Karen Cutts, editor of the “Risk Retention Reporter” (NU March 10, 2003), gross premium written for RRGs in 2002 is estimated to total $1.28 billion. The figure represents an increase of $284 million over 2001 and is 53 percent higher than the 2000 premium.

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

Recent formations of RRGs represent the most dramatic growth for this type of risk transfer model. While most of the newer RRGs are from the health care, transportation and professional fields, the real question is why are RRGs, as opposed to captives, becoming an increasingly attractive alternative to the traditional insurance market?

Several industry observers I have spoken with reveal that the new RRGs are being formed because of a lack of fronting. They say managing general agents are having a harder time with their reinsurance partners and are beginning to “roll over” their niche books of business into RRGs.

While there are many similarities in captives and RRGs, clearly they are not created equal, nor should either one be selected without a careful analysis of the needs that each will fill.

Without going into the complexities of each model, there are some important considerations to keep in mind when making comparisons.

A captive can insure virtually anything. Indeed, one of the biggest benefits of a captive is its ability to customize any line of coverage so long as it makes financial and underwriting sense.

In contrast, at this time, an RRG may only provide commercial insurance coverage for casualty risks such as general, auto and professional liability, although adding workers compensation and property coverage under an RRG is being seriously debated.

Securing coverage from the traditional market can augment additional coverage for both models.

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

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

Probably the most important function the front performs is guaranteeing the captives creditworthiness. One of the ways it does this is by requesting collateral to fund business losses over the course of time.

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

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

While the RRG will now have to make state filings, licensing and compliance matters under its own mantel of operations, it may secure the services of a professional manager to perform these duties in exchange for a negotiated fee.

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

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

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

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

Membership in an RRG is limited to similar or related businesses or activities relative to coverage provided by the RRG. Also, while there are cases of an RRG being formed under a single parent doctrine, youll usually find that there are several policyholders within 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 a captive may be domiciled, offshore and on, it appears that Vermont, Hawaii and South Carolina are the most often used domiciles for RRGs.

The minimum amount of capital needed to start a captive or RRG is dependent, to some degree, upon where it is formed. Captives and RRGs can have several minimum capitalization requirements. There is not enough space to capsulate them all, but generally speaking, a captive 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 if you want to impress the state regulators and gain approval, consider using more.

Also, under a captive arrangement, non-policyholders may contribute 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 completely dissimilar for a single line of coverage. For example, an agency may use a captive to place all of its best clients in and provide profit sharing incentives for good experience.

In an RRG, an individual or business that meets membership rules cannot be excluded if the intent is to provide the group with a competitive advantage.

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

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

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

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

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RRGs Providing Options For Insurance Buyers

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