Besieged by pleas from business people and
municipalities across the United States who were unable to obtain or
afford liability insurance during the mid 1980's, Congress responded
by enacting amendments to the 1981 Product Liability Risk Retention
Act. The new legislation, known as the Federal Liability Risk
Retention Act of 1986 (the Act), created two vehicles by which
insurance buyers could more readily avail themselves of liability
insurance: risk retention groups (RRGs) and purchasing groups (PGs).
Let's compare and contrast these two insurance
vehicles.
RRGs and PGs Compared
According to the Act, a risk retention
group must form as a liability insurance company under the laws of
at least one state. The owners of the risk retention group must also
be its insureds. Membership in the risk retention group is limited
to persons engaged in similar businesses or activities with respect
to the liability to which they are exposed. The Act requires the
risk retention group to prepare a feasibility study or plan of
operation which includes the coverage, deductibles, coverage
limits, rates, and rating classification systems for each line of
insurance the group intends to offer. The feasibility study or plan
of operation must be filed with the risk retention group's licensing
state as well as with every state in which the entity intends to
operate.
Unlike a risk retention group, a
purchasing group is not an insurance company. Rather, a purchasing
group can be any group of persons with similar or related liability
risks who form an organization, one of whose purposes is to purchase
liability insurance on a group basis. No specific requirements are
imposed regarding the legal structure of a purchasing group. In the
case of a trade association, a simple resolution of the board
authorizing the organization's officers to make arrangements to
purchase liability insurance on a group basis would be sufficient to
establish the purchasing group.
Like participants in risk retention
groups, members of purchasing groups must be in similar or related
businesses which expose them to similar liability risks. However,
unlike risk retention group participants, purchasing group members
need not concern themselves with raising capital or arranging
reinsurance. Further, whereas risk retention groups typically must
provide quality loss experience, have a minimum number of
participants, a minimum premium volume, and the willingness to make
a long-term commitment, purchasing groups may find these factors
helpful to their formation, but not critical.
From the foregoing, it becomes apparent
that purchasing groups are much easier to form. They require no
capital contributions, and although loss data is helpful to
underwrite the risks, it is not essential. In addition, purchasing
groups need not file feasibility studies, but can become operational
upon the filing of a notice with their state of domicile and the
other states in which the group intends to operate. The notice must
state the name and domicile of the purchasing group, the lines and
classes the purchasing group intends to buy, and the insurer from
which the group intends to buy. While it may take as long as 18
months to form and qualify a risk retention group, a purchasing
group can be up and running in approximately 60 days.
The Act requires a risk retention group to
file annual financial statements with its chartering state and all
other jurisdictions in which it is going to operate. Financial data
submitted by the risk retention group must be certified by an
independent public accountant and must include a statement of
opinion on loss and loss adjustment expense reserves made by a
member of the American Academy of Actuaries or a qualified loss
reserve specialist.
It should be noted that risk retention
groups are specifically exempted by the Act from participation in
state guaranty funds; if a risk retention group becomes insolvent,
insureds and claimants have no protection through such a fund.
Similarly, purchasing groups insured by non-admitted carriers are
not covered by state guaranty funds.
Regulatory Issues
Over the past 40 years, with few
exceptions, Congress has left regulation of the insurance industry
to the states, each of which have their own requirements, including
licensing laws, "seasoning" requirements, fictitious group laws,
restrictions on the ability of insurers to offer to a group special
terms regarding rates and coverage, higher tax rates on foreign
(out of state) insurers, and countersignature laws.
To help promote the formation and
multi-state operation of group liability insurance programs, Congress
enacted the Products Liability Risk Retention Act in 1981 and
expanded its scope through amendments in 1986. With the advent of
the 1986 Risk Retention Act, counter-signature and fictitious group
laws which had previously restricted formation of group purchase of
liability coverage, were eliminated. Moreover, Congress prohibited
discrimination against risk retention and purchasing groups by the
states. It was Congressional intent to enable businesses,
professionals, nonprofit organizations and governmental agencies to
establish self-insurance pools (RRGs) and to purchase liability
insurance on a group basis (PGs). On a practical level, preemption
of state regulation for risk retention groups provides a
particularly effective way for the company to commence operations.
Assuming a risk retention group has obtained a license from its
chartering state and has raised its capital, it can begin operations
in other states almost immediately. The Act requires that a risk
retention group which intends to operate in other states file its
plan of operation or feasibility study. States are permitted to
require that risk retention groups comply with specified state laws,
such as unfair claims practices. Moreover, states can bring an
action in state or federal court to enjoin a risk retention group if
it deems the group to be in hazardous financial condition.
For purchasing groups, preemption of state
regulation works differently than for risk retention groups. The Act
prohibits states from passing laws that would prohibit formation of
purchasing groups. Moreover, the Act makes it unlawful for a state
to prohibit an insurer from offering to provide the purchasing group
or its members advantages, based on their loss and expense
experience, not afforded to other persons with respect to rates,
policy form, coverage, or other matters. Because purchasing groups
are not risk bearers like risk retention groups, regulation of the
purchasing group's insurer is of equal importance to the overall
operations and regulation of purchasing groups. As a general rule,
admitted insurers of purchasing groups have greater regulatory
flexibility, particularly on rate and form requirements, while
purchasing groups insured by surplus lines carriers are benefited
from placements using non-resident surplus lines
brokers.
Continued Growth of Risk Retention
While the "liability" crisis served as the
initial motivation for enactment of the 1986 Risk Retention Act, the
fundamental advantages derived from risk retention groups and
purchasing groups - from both economic and regulatory perspectives -
are responsible for their continued growth.
For risk retention groups, major benefits
include the ability of members to control their own program; to
obtain rate stability over the long-term; to implement effective
loss control/risk management programs; to obtain dividends for good
loss experience; to have access to reinsurance markets; and to
maintain a stable source of liability coverage at affordable rates.
For purchasing groups, major benefits
include the ability to negotiate tailor-made coverage at favorable
rates with insurers. For insurers, purchasing groups offer the
ability to write profitable programs, while also lowering costs and
increasing service to insurance buyers. For agents and brokers,
purchasing groups offer an ideal way to expand a single-state
program into a national program, and also to add value to the group
through enhanced loss control and risk management programs.
Growth of the alternative marketplace, of
which risk retention groups and purchasing groups are a key part --
is here to stay. Industry experts predict that by the end of 1997,
the alternative risk-financing marketplace will comprise 40% or
approximately $114 billion of a $285 billion property/casualty
commercial market.
Where does risk retention fit into this
picture? According to statistics developed by the Risk Retention
Reporter - an authoritative monthly journal for the risk retention
marketplace that systematically monitors activity of risk retention
and purchasing groups - growth of both entities has been steady
since passage of the Act. The May 1998 issue of the Risk Retention
Reporter cites more than 600 purchasing groups and over 60 risk
retention groups. The latest survey published in the October 1997
Risk Retention Reporter found that risk retention group premium for
1996 totaled more than half a billion dollars.
Risk retention is a growing force in the
property/casualty marketplace. It provides an alternative risk
financing mechanism which, when used responsibly, can serve the
needs of the American insurance-buying public.