An enhanced role for RRGs
Future looks good for further expansion of risk retention groups
By Michael J. Moody, MBA, ARM
As every commercial insurance buyer can attest to, hard insurance markets come and hard insurance markets go in the United States. Certainly, some markets prove to be more challenging and problematic than others, but for the most part, commercial insurance buyers usually find a way out of the mess of a hard market, one way or another. However, in the late 1970s, there were more problems than solutions.
One of the hardest hit business segments of that hard market was manufacturers. In general, manufacturers were being deluged with hundreds of lawsuits and claims over products they had manufactured, regardless of or despite when they had manufactured them. As a result, for all intents and purposes, the product liability market disappeared. Some manufacturers were being forced to pay $1 million for a$1 million product liability policy, just to be able to have a "policy" so they could provide their customers with insurance certificates. It soon became clear this was not going to be just another hard insurance market.
Major changes required
Up to that point, insurance regulations within the United States had been a patchwork of different regulations that were enacted by each of the 50 states. Each state had drafted and passed its own insurance laws, so insurance buyers operating in different states had to comply with as many as 50 state regulations. This had long proven to be over burdensome for many multi-state manufacturers, but for the most part, the federal government stayed out of the regulation of insurance. However, eventually the product liability crisis proved too complex for each state to tackle on its own. So, Congress enacted a federal law designed to provide a solution to the national product liability crisis.
After much debate in Congress among many different groups, all with vested interests, in 1982 the Liability Risk Retention Act (LRRA) was passed. One of its primary features was that insurance buyers were allowed to license an insurance company in one state but could transact business in all 50 states. This feature alone was a significant change in insurance law, since previously the business would need some risk transfer mechanism (i.e., fronting) that was licensed in all 50 states. Needless to say, this solution was not popular with the individual state insurance commissioners.
Regardless, LRRA was signed into law and groups of manufacturers could begin their own insurance companies to write business nationwide. Problem solved! There was just one small issue. The regulation negotiations had taken so long that the insurance market had moved to the soft part of the insurance cycle, thereby eliminating the need for product liability insurance company formations and, in fact, few risk retention groups (RRGs) actually were formed as a result of the new federal legislation.
However, as luck would have it, shortly after the passage of the LRRA, the insurance industry again headed towards a hardening market. This time the scope of the problem was much greater and included most kinds of liability. While the original legislation mostly languished with fewer than two or three RRGs being formed, it was clear to Congress that quick action was required for the current situation. So Congress modified one phrase, expanding product liability to any liability, and the Risk Retention Act of 1986 was born. However, after an initial flurry of RRG activity following the 1986 Act, again few additional RRGs were formed, thanks largely to another soft insurance market.
For a variety of reasons, for the first 10 or 12 years of its existence, the federal legislation had few takers from the insurance buying community. There were some exceptions; however, with a continued soft insurance market, there were just too many hurdles to overcome for many groups to start a RRG.
Over the past decade or so, growth in RRGs, like that of captives in general, has been accelerating. So much so that, today, recent estimates indicate that there are currently more than 260 RRGs. Their recent growth has not been driven by the factors that brought about the legislation in the first place—namely, the lack of coverage and/or increased cost of coverage.
Rather, much of the growth has come from industry segments that are struggling to find a stable insurance market. These are typically sectors that are willing to take a more active role in developing and maintaining their own insurance organizations. Bottom line, they want to control their own destiny; and this has been one of the primary driving forces behind the recent RRG formations.
To be certain, RRGs continue to have a number of issues that they have been trying to actively resolve, both individually and as a subsector to the captive insurance industry. Many of the state insurance departments have never really been fans of the federal legislation, and this remains problematic. Ongoing conflicts between individual state insurance departments and the federal government continue today, some 25 years after the law was originally passed. Parties interested in RRG success have sought and received several "objective" reviews of the problems from the Government Accounting Office; however, each time the GAO responded to very narrow issues only, leaving much larger problems unresolved. Despite all the roadblocks and speed bumps, RRG growth continues.
Where to from here?
In the insurance industry you can no longer set your watch by the "seven year underwriting cycle." The dynamics of the industry, due in some measure to the success of the ART market in general and, more specifically, RRGs, has changed dramatically. And while it is difficult to predict the future of RRGs, some issues are coming into focus.
For example, in the last few years a number of RRGs have felt the need to obtain some type of objective rating to be able to continue to attract new members or even maintain current members. Historically, A.M. Best has been one of the most popular rating options; however, today a newer rating service, Demotech, Inc., has become an attractive option. Demotech's "Financial Stability Ratings" are rapidly becoming an accepted standard for some RRGs.
Demotech has recently published a report, "Analysis of Risk Retention Groups – 2nd Quarter 2012," that provides some clues as to where RRGs are headed. The report itself provides a wealth of valuable information for those that are currently involved with RRGs as well as those that are considering becoming involved with them. First, they note that the financial health of the sector is quite good, pointing out that RRGs "continue to exhibit financial stability." Further, they indicate that total assets including surplus "have continued to increase at a quicker rate than total liabilities," thus confirming a positive financial future for RRGs, in the aggregate.
So for the most part, RRGs have been established and operated as financially viable risk-financing vehicles. There are also several other key indications regarding the future of RRGs. While they have been formed by a wide variety of industry sectors, the health industry has really taken advantage of them; in fact, recent figures note that 60% of all RRGs are involved with medical professional liability in some form or fashion. Stated another way, medical professional liability RRGs are projected to account for about $1.5 billion to $1.6 billion in premium over the next 12 months.
There have been a variety of reasons for this growth; however, today a significant portion of the RRG growth sector is coming from hospitals and their affiliates that are having doctors joining the hospital staffs as a lead-up to the full implementation, in 2014, of The Patient Protection and Affordable Care Act. Most medical malpractice experts expect continued growth of RRGs, with near term increases likely due to the uncertainty surrounding the PPACA.
Additionally, one would expect to see better utilization for new and existing RRGs over the next few years. Several times recently, proponents of RRGs have tried to expand the scope of coverage, but there has been little movement to date. For the most part, this expansion has been directed at the inclusion of property coverage. The last several sessions of Congress have been requested to take up the matter of the expansion known as "Risk Retention Modernization Act." However, each year Congress manages to end up with more pressing issues and the bill has not advanced. However, after Hurricane Sandy and the projected disruption in the property market it will cause, 2013 may be the year RRGs see this long-awaited extension come to fruition.
Initial growth of risk retention groups was quite slow and difficult. However, over the intervening years, formations have become easier and RRGs have become a viable approach for financing of risks. Both insurance companies and insurance buyers have become much more accepting of RRG business. And while there are a number of issues yet to be dealt with (i.e., common approach by individual state insurance departments, aspects of the Dodd-Frank Bill that apply to RRGs, the role of a federal insurance overseer, etc.), the future of RRGs appears to be quite good. They have become an important component of the overall ART market and one would expect, as the insurance market hardens, they will solidify this position.