Risk Retention Groups and Purchasing Groups
In the United States, liability risk has increased enormously, so much so that many insurance companies are not willing to cover many of these risks, and if they do cover the risk, they generally charge a high premium that seems to increase annually. Additionally, insurance companies are regulated on the state level, making it difficult to achieve economies of scale by crossing state lines. Moreover, the cost of operations increases by having to comply with myriad state laws and regulations. As a result, the United States Congress passed laws that allow specific groups to either form a risk retention group that can operate across state lines without the need to comply with most of the laws of that state or to form a group that buys insurance for specific exposures for the entire group, which is usually prohibited by state law. The federal law governing liability risk retention or the formation of purchase groups is codified under 15 USC Chapter 65, Liability Risk Retention. Specifically, the main laws pertaining to risk retention groups are codified in §3902 and for purchasing groups, in §3903.
Risk Retention Groups
Risk retention groups (RRGs) are insurers owned by a group of businesses within a specific industry that share similar liability risks. Their main benefit is providing insurance for risks that are not covered by commercial insurance companies or to provide coverage at lower cost. In 2016, 56.4% of RRGs provided liability coverage for healthcare professionals.
An RRG is chartered in the state of domicile, which governs the RRG. A major benefit that an RRG has over a regular or captive insurance company is that federal legislation allows an RRG to operate in any state without complying with most of the insurance laws of that state.
The Product Liability Risk Retention Act of 1981 created risk retention groups. This Act was later expanded to include commercial liability and renamed as the Liability Risk Retention Act (LRRA) of 1986. RRGs are organized as insurance companies under the state of domicile and operate pursuant to the LRRA. Risk retention groups are owned by the policyholders, who are also shareholders. RRGs are subject to the insurance laws of the state of domicile, but the LRRA limits the rights of states to regulate RRGs outside of the domicile state, thus allowing RRGs to expand to other states without complying with most of the insurance laws of those states. A risk retention group active in a state other than the state of domicile is referred to as a foreign risk retention group.
An RRG must be owned by its insureds. Most are formed as captives and must be domiciled onshore, except for those grandfathered under the 1981 Act. Vermont is the most popular state of domicile. An RRG can also be chartered as a group captive in certain states, such as Vermont, Colorado, Delaware, Illinois, and others.
RRGs lower costs by reducing much of the overhead of major commercial insurance carriers, by managing the claims process more efficiently, and through other efficiencies garnered through the experience gained by specializing in specific types of risk control. Additionally, RRGs can also benefit from the investment income earned by investing the premiums that would otherwise go to insurance companies if insurance was purchased.
RRGs share some characteristics with excess and surplus (E&S) lines carriers in that they do not participate in state guaranty funds and their rates and forms do not need approval from the insurance department of non-domicile states. However, they must be approved by each state and must abide by the insurance laws in each state in which they do business. Financial statements must be filed quarterly with the insurance department of the state of domicile and also with the National Association of Insurance Commissioners (NAIC). Unlike RRGs, E&S insurance companies can only write insurance for risks not covered by admitted insurers. An admitted insurer is one who is licensed to do business within the state. Although the LRRA forbids RRGs from participating in state guaranty funds, this is not a serious disadvantage, since state guaranty funds vary from state to state, provide limited coverage, typically $300,000 per claim, and use their own defense counsel to handle claims.
There were 238 RRGs in 2014, most of them covering medical malpractice liability in a number of specialties.
Liability Risk Retention Act of 1986
The Risk Retention Act of 1981 removed captives from state regulation except in the states in which they were domiciled. The 1981 act only applied to product liability risks but the 1986 act expanded the law to apply to most liability coverages except employer's liability and workers compensation. The 1986 Act allowed groups to manage their liability risks by forming risk retention groups for self-funding, or by allowing purchasing groups to buy insurance, increasing their bargaining power.
The only legally allowed offshore RRGs are ones chartered or licensed under the laws of Bermuda or the Cayman Islands that have met the capitalization requirements of at least 1 state prior to 1985. The legal structure of an RRG depends on the state of domicile, but options can include a stock or mutual company, or a reciprocal exchange.
Members of an RRG must be engaged in similar businesses or activities and the coverage must pertain to the liability exposures of the group. To prevent unfair competition, any individual or firm within the same industry with the same loss exposures cannot be excluded from the group if the intent of the exclusion is to provide the group with a competitive advantage.
The LRRA limits the regulation of RRGs to the state of domicile, preempting many of the regulations of non-domicile states. Nonetheless, to operate in non-domicile states, RRGs must file quarterly and annual statements required by property and casualty insurance companies, including financial statements, management discussion and analysis (MD&A), risk-based capital (RBC) reports, audited statements, actuarial opinions, and so on. Quarterly surveillance procedures and periodic examinations must be conducted by regulators in accordance with NAIC guidelines.
Risk Retention Group Formation
Each RRG must submit a feasibility study and a plan of operation for approval by the state of domicile before offering coverage. Submitted information must include coverages and their limits, deductibles, rates, and rating classification systems, historical and expected loss experience of the members, pro forma financial statements and projections, an actuarial opinion defining the minimum premium necessary to remain solvent, and underwriting and claims procedures, reinsurance agreements, investment policies, and management and marketing methods, and information on the initial members, organizers, and all people who will control or influence the RRG.
To each state in which the RRG plans to recruit members, the RRG must submit a copy of the feasibility study along with revisions and a copy of the annual financial statement, certified by an independent accountant, along with an opinion of loss and loss adjustment expense reserves by an actuary or a qualified loss reserve specialist. An RRG cannot write coverage prohibited by state statute or by the state's highest court, such as for punitive damages. Furthermore, states can require proof of financial responsibility before issuing a license for certain activities, such as for motor vehicle operations or the hauling of hazardous waste.
All insureds of an RRG must be owners of the RRG, and all owners of the RRG must be insured. RRGs may be formed under a state's captive or traditional insurance laws. The RRG can do business in a non-domicile state by registering with the state and designating the state's commissioner as agent for service of process; however, unlike other captives, RRGs do not require an insurance license from any non-domicile state. Hence, RRGs are treated as multi-state insurance companies subject to NAIC accreditation standards for RRGs.
How RRGs Work
RRGs are owned by the insured but are managed by a Board of Directors, who are selected members of the RRG, and by standing committees, such as for underwriting, finance, and claims and risk management. However, specialized services, including actuarial studies and claims management, are usually provided by outside groups who specialize in such services. An actuarial firm will generally be used to perform a loss reserve valuation and certify that loss reserves are adequate.
After a number of years of operation, increased loss reserves may be used to reduce premiums or to pay a dividend to the insured.
State and Federal Jurisdiction
Owners of RRGs are exempt from filing registration statements under federal security laws and state Blue Sky Laws, but any solicitation for funds must disclose all material facts regarding the RRG and its operations. Although RRGs do not have to follow the insurance regulations of states outside of the domicile, states can require the following: the payment of applicable premium or surplus lines taxes; participation in residual market mechanisms, such as assigned risk pools; submission to financial examination by the state insurance commissioner absent an examination by the domicile state. Furthermore, states can require compliance with: unfair claim settlement practices; deceptive, false, or fraudulent trade practice laws; orders for delinquency or dissolution proceedings; or an injunction for a hazardous financial condition.
States can also require that RRG insurance policies contain a statement that the RRG is not subject to all state laws and regulations, and that RRG claims are not protected by the state's insolvency guaranty fund.
The LRRA forbids states from discriminating against RRGs and prevents non-domicile states from regulating the following: rates, coverages, forms, insurance-related services, management, operation, investment activities, or loss control and claims administration.
However, any state or U.S. District Court may enjoin a financially distressed RRG from soliciting or selling insurance or to even continue operating.
For both RRGs and PGs, states may require agents acting on behalf of these entities to be licensed, but may not impose residency requirements for licensing nor require that the policy be countersigned by a resident agent or broker.
A purchasing group (PG) is an organization that buys liability insurance for a group with similar risks. Previously, the group purchase of insurance was forbidden by state law. Group purchasing was thought to reduce costs, provide more coverage, and promote greater premium competition among general liability insurers. It was believed that this expansion would encourage insurers to set premiums that would compete with the new formations created under the revised law.
PGs are regulated much like RRGs, in that they can only buy insurance for members with similar loss exposures and is limited in providing specific types of coverage. However, PGs do not have to comply with most state laws that regulate insurance companies or the purchase of insurance. Specifically, states may not:
- prohibit purchase groups
- require a certain legal form or a minimum number of members or require a common ownership or affiliation
- require that the insurance policies purchased be countersigned by an insurance agent or broker residing in the state; or
- pass any other law that would otherwise discriminate or hinder the operation of the purchasing group
A state may require that an agent or broker buying insurance on behalf of the purchase group to be licensed by the state, but many may not impose a residency requirement to obtain the license.
A purchasing group may also provide management services or insurance related services under the federal exemption from state law.
However, a PG must provide notice to the state insurance commissioner of its intent to do business within the state. The notice must identify:
- the state of domicile for the group
- the lines and classifications of liability insurance that will be purchased
- the insurance company from which insurance will be purchased and its domicile; and
- the principal place of business for the PG
Like RRGs, PGs must designate the state insurance commissioner as the agent for receiving service of legal documents or process.
Permissible State Authority
USC §3905 specifies permissible state authority in regard to RRGs and PGs. These groups must comply with state motor vehicle and related financial responsibility laws. Insurance policy coverage cannot be provided or purchased if it is prohibited by state law or by a ruling by the state's highest court. The federal exemptions from state law do not apply to the offering or purchase of any other type of insurance outside of the group's core coverage. Additionally, states may require proof of financial responsibility before allowing an RRG or PG to operate within the state.