Time to shine
Risk retention groups tend to deliver most value for their members during hard markets, and their numbers already show evidence of increasing during this cycle, despite many being subjected to illegal fees by non-domiciliary states. Captive International reports.
Risk retention groups (RRGs) thrive in hard markets. As commercial insurance rates increase across most lines, companies that have maintained their membership of RRGs will be enjoying the warm glow that comes from knowing previous work is about to pay off.
However, the upbeat mood around RRGs is being somewhat tarnished by accusations that many US states are charging them registration fees to which they are not entitled, according to the National Risk Retention Association (NRRA).
An RRG is a form of group captive that has a licence allowing it to operate across state lines. They took in 8.3 percent more premium in 2019 than the previous year, according to a panel discussing RRGs at the Vermont Captive Insurance Association’s (VCIA) annual conference in August. That represented the largest percentage increase since 2006.
This fits into the typical pattern RRGs have displayed since they were first conceived by the federal Liability Risk Retention Act (LRRA). The LRRA was passed in response to challenges created by the hard market of the 1980s, and the number of RRGs has waxed and waned in correlation with hard and soft market cycles.
Numbers declined in the soft market of the 1990s and then increased again from around 2000 as the market hardened, before dipping again after 2008. Now their numbers are again on the increase, a trend that looks set to continue while hard market conditions persist.
This growth is coming despite many RRGs complaining that they are being subjected to illegal charges that are not permitted under the terms of the LRRA, costing them potentially tens of thousands of dollars per year.
“The key is working with the NAIC collectively and educating states about the different manner in which RRGs are to be regulated.”
Jon Harkavy, Risk Services
“Insureds that remained with their RRGs during the soft market will benefit from that decision as the market continues to harden.”
Mollie O’Brien, Premier Insurance Management Services
In August the NRRA wrote a letter to the National Association of Insurance Commissioners (NAIC) laying out some of the concerns of its members. One of the biggest of these concerns, the NRRA says, is the imposition of registration fees by “foreign” states—those in which the RRG is not domiciled.
The issue has been raised before, and some progress has already been made. South Carolina, for example, previously imposed biennial licence fees on RRGs operating in the state but not domiciled there, but has now stopped, the NRRA says.
However, it notes, 28 states still impose foreign RRG registration fees, while 19 of these also impose foreign RRG registration renewal fees.
Jon Harkavy, of counsel at Risk Services, notes that RRGs generally attract more regulatory attention than other types of captives. RRGs tend to fulfil their functions much more visibly in non-domiciliary states, due to the registration and information filings RRGs must make in every policyholder’s state under the LRRA, he explains.
A single parent captive generally files only with its domicile and other than the payment of premium taxes has little contact with non-domiciliary insurance departments.
“Single parent captives generally focus on insuring a single owner or ownership group, and the regulator tends not to worry too much about protecting a policyholder from itself,” adds Harkavy.
“RRGs are different, they are perceived to be in greater competition with commercial insurers, which creates more friction, both from the state’s admitted market which complains to the regulator of unfair competition, and from the non-domiciliary regulators which see their authority and laws abridged or pre-empted under the LRRA.”
This means regulators have a much greater degree of visibility into what RRGs are doing, compared with other forms of captive.
States go after captives because they are looking for payment of premium taxes, but their interest in RRGs is not about raising revenue, says Harkavy, as RRGs are required to remit state premium taxes.
He says it is “more about regulatory turf protection and the RRGs’ competition with commercial insurers in their state.”
The problem is difficult to resolve in part because the numbers are relatively small, often a matter of hundreds of dollars. Even at $1,000, it is easier for an RRG to pay than to pursue a legal challenge, the cost of which would be many times higher.
Whether this is a calculated move by states which know they are unlikely to be challenged, or the result of states’ not fully understanding the LRRA, is unclear.
“This problem is more haemorrhoidal than jugular,” says Harkavy.
“Even if an RRG is paying $100,000 per year it can be seen as a cost of doing business. But collectively, considering the number of RRGs in the US, it is a big problem.”
The numbers involved make the issue difficult to litigate.
“It would be very expensive and the potential rewards are relatively small,” explains Harkavy. Instead, the NRRA intends to contact the states concerned and ask them on what basis they consider themselves entitled to charge these registration fees, he says.
“The aim is to get the offending states to acknowledge that they are breaking the law. There is an element of trying to leverage peer pressure, to have them on the record justifying their position. The hope is that will encourage them to start operating within the federal mandate.”
Harkavy believes this offers a more constructive approach to resolving the issue than dragging it through the courts.
“The key is working with the NAIC collectively and educating states about the different manner in which RRGs are to be regulated under the federal law,” he says.
Some have called for the NAIC, if the issue is not resolved, to bring the treatment of RRGs within the scope of the accreditation programme, which essentially regulates the regulators, but this does not appear to be the preferred option.
“There is an argument that the accreditation programme is about financial solvency, and does not extend to oversight of states’ behaviour towards RRGs,” says Harkavy.
“NAIC clearly wants to see this resolved at the state level, and not have the LRRA amended to change the law by creating an expanded role of the federal government to resolve disputes between RRGs and non-domiciliary states.”
Harkavy believes the relationship between RRGs and commercial insurance carriers is already evolving in ways that could ease regulatory concerns about competition between the two groups.
“Back in 1986 when the Risk Retention Act amendments were passed it was a zero sum game between RRGs and traditional insurance carriers, but now the relationship is becoming more symbiotic, especially due to the hard market,” he says. “There are a number of risk-bearing and non-risk bearing functions which traditional insurers can provide to RRGs, be it in reinsurance or excess coverage or claims handling.”
He adds: “RRGs, which cannot write non liability coverages such as workers’ compensation or property, make an excellent potential platform for traditional insurers to write such coverages.
“To the extent that the traditional insurers view RRGs as just another marketplace sector such as surplus lines where profits can be made directly or indirectly, regulatory acceptance, albeit often reluctantly, will develop.”
There is already evidence of this happening, for example with Attorney Protective—AttPro—a Berkshire Hathaway-owned insurance company and RRG providing coverage for lawyers.
Whatever happens between the NAIC, non-domiciliary states and RRGs, it is unlikely to impact the popularity of RRGs in an environment where the cost of commercial coverage is increasing. Longer-running RRGs have had to work hard to justify their existence during the soft market conditions that prevailed until relatively recently, but are now in a position to deliver real value to their members.
“It’s hard to be an RRG during a soft market because there’s a lot of commercial coverage available at very low prices,” Mollie O’Brien, vice president of claims and litigation at Premier Insurance Management Services, said at the VCIA annual conference.
Insureds that remained with their RRGs during the soft market will benefit from that decision as the market continues to harden, she added.
“Considering the problems associated with COVID-19 and the hardening market, I think we will see an increase in the number of RRG formations going forward,” agrees Harkavy.