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Risk Retention Groups: A Basic Overview

Building Blocks-SF
April 12, 2017

A risk retention group (RRG) is an insurance company formed and operated pursuant to the federal Risk Retention Act of 1981, as amended in 1986, that requires all owners to be policyholders and vice versa. The Act allows the policyholder-owned insurer to underwrite some types of liability risks. Its licensing and regulation by the state of domicile are supposed to be recognized by all other states, thereby reducing multistate licensing laws and regulatory oversight. School-age students learn early that all squares are rectangles, but not all rectangles are squares. Similarly, most RRGs are captives, but most captives are not RRGs.

The existence of RRGs was made possible by two pieces of Reagan-era legislation: first the Product Liability Risk Retention Act of 1981 and then the Liability Risk Retention Act of 1986 (LRRA). The LRRA expanded the original Act beyond products liability insurance, enabling RRGs to write commercial, errors and omissions, professional, and other types of liability insurance coverage for members who engaged in similar businesses or activities. Also, the LRRA allowed industries that have needs not met by the standard insurance market to develop unique insurance products, retain control over their risk management programs, and withstand insurance market downturns.

Given that most RRGs are captives, but most captives are not RRGs, it will help one better understand RRGs by pointing out their differences from other captives.

To begin, other captives can be domiciled anywhere in the world, while RRGs can only be domiciled in the United States. Other captives often require fronting and are subject to federal regulation and regulation in every state in which they operate. RRGs do not require fronting, can do business in all 50 states, and are domiciled in and regulated by only one state.

Other captives can be owned by policyholders and other entities, whereas RRGs can only be owned by policyholders. Other captives may provide insurance for only one entity, whereas an RRG must have two or more policyholders. Capital requirements differ between other captives and RRGs, with the latter generally required to maintain larger amounts of cash on hand to pay claims.

A final, important difference relates to types of insurance coverage. Other captives offer a wide array of first-party (e.g., property) and third-party (e.g., liability) coverages, whereas the federal Act only allows RRGs to write liability insurance. This means that risk retention groups cannot write property insurance, including collision and comprehensive coverage for autos, or workers compensation insurance.

Forming an RRG is a relatively simple process. First, newly formed captives must charter inside the 50 states or Washington, DC, and follow the laws of their state of domicile. In fact, RRGs are exempt from other state laws. However, other states can require an RRG to adhere to laws related to unfair claims settlement; premium and surplus lines taxes; false, fraudulent, or deceptive trade practices; and other similar laws.

During the formation process, RRGs must submit a feasibility study or plan of operation to their state of domicile. This plan provides details on coverages, deductibles, limits, rates, and rating classification systems. The study must include historical and expected loss experience of members, pro forma financial statements and projections, an actuarial opinion on the minimum premium necessary to begin operations and avoid financial difficulties, information on underwriting and claims procedures, reinsurance agreements, investment policies, management and marketing methods, and information on the initial members, organizers, administrator, and anyone else who will otherwise influence or control the RRG.

Once approved by the state of domicile, the RRG submits its feasibility study (including revisions) and a copy of the annual financial statement in each state in which it plans to do business. These financials must be certified by an accounting firm and include an actuarial opinion. Once operations begin, any state or US district court can find an RRG to be "in hazardous financial condition" and require the RRG to stop soliciting, selling insurance, or continuing operations.

Utilizing the LRRA allowed a number of niche insurance businesses to achieve financial success. Examples include United Educators, Educational and Institutional Insurance Administrators, and the National Catholic Risk Retention Group. According to the National Risk Retention Association (NRRA), 235 RRGs do business in the 50 states. These RRGs produce $3 billion in gross written premium and have used the LRRA's inherent flexibility to their great advantage (e.g., not having to do insurance filings in all 50 states).

Another example, Housing Authority Risk Retention Group (HARRG), was formed in 1987 to meet the liability insurance needs of public housing authorities (PHAs). PHAs were facing insurance market conditions so tough that many had no option other than to go without liability insurance. Forming an RRG under the LRRA allowed HARRG to be domiciled in one state (Vermont), headquartered in another (Connecticut), and offer general liability insurance to public housing authorities in all 48 states and Washington, DC.

This flexibility is appreciated by many and abhorred by some. As a result, attempts to broaden and battles to limit the LRRA have taken place for 3 decades. Lobbyists have approached Congress about expanding the LRRA. The National Association of Insurance Commissioners (NAIC) has discussed making this recommendation, as well.

More often, though, RRGs have had to fight in court to retain the flexibility, low frictional costs, and breadth and depth of coverages outlined in the LRRA. Fortunately for RRG members, multiple courts have protected their right to exist and ruled that the LRRA preempts state regulations.

Take, for instance, Alliance of Nonprofits for Ins., Risk Retention Group v. Kipper, 712 F.3d 1316 (9th Cir. Nev. 2013). In that case, the Alliance of Nonprofits for Insurance, Risk Retention Group (ANI), was issued a cease and desist order by the Nevada state insurance commissioner because it was not paying into the state insurance guaranty fund. ANI sued and won in the trial court and on appeal. The United States Court of Appeals for the Ninth Circuit found that "The Liability Risk Retention Act (the 'LRRA') broadly preempts 'any State law, rule, regulation, or order to the extent that such law, rule, regulation, or order would ... make unlawful, or regulate, directly or indirectly, the operation of a risk retention group.'"

Since the ANI decision, multiple other court cases have taken place, all protecting the right of RRGs to do business under the LRRA. The existing RRGs have a vested interest in protecting the LRRA because of its inherent flexibility.

Operating a risk retention group is not foolproof, however. RRGs fail every year. Its members-and-liability-only limitations mean that the insureds of RRGs needing property coverage will remain subject to market forces as they buy their first-party property insurance. Alternatively, they must form a new company that is not an RRG to write the property insurance with all the paperwork and expense entailed.

But for those who understand how RRGs can effectively provide liability coverage to members, the federal Liability Risk Retention Act of 1986 was and is a blessing.

Copyright © 2017, International Risk Management Institute, Inc.

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