RRGs Have Had a Small but Important Effect on Increasing the Availability and Affordability of Commercial Liability Insurance

RRGs have had a small but important effect on increasing the availability  and affordability of commercial liability insurance, specifically for groups  that have had limited access to liability insurance. Difficulties in finding affordable commercial liability insurance prompted  the creation of more RRGs from 2002 through 2004 than in the previous 15  years. Three-quarters of the RRGs formed in this period responded to a  recent shortage of, and high prices for, medical malpractice insurance. 1). As a result, RRGs generally domicile in those states that permit  their formation as captive insurance companies, rather than in the states in  which they conduct most of their business. Most RRGs Have Domiciled in States That Charter Them as Captives but Have Conducted Most of Their Business in Other States

Regulatory requirements for captive insurers are generally less restrictive  than those for traditional insurers and offer RRGs several financial  advantages. Moreover, even among states that charter RRGs  as captives, the financial reporting requirements for RRGs vary. Some Evidence Suggests That States Have Set Their Captive Regulatory Standards to Attract RRGs to Domicile in Their States

Some regulators, including those from New York, California, and Texas— states where RRGs collectively wrote about 26 percent of all their business  but did not domicile—expressed concerns that domiciliary states were  lowering their regulatory standards to attract RRGs to domicile in their  states for economic development purposes. RRG Failures Have Raised Questions about the Sufficiency of LRRA Provisions for RRG Ownership, Control, and Governance

Because LRRA does not comprehensively address how RRGs may be  owned, controlled, or governed, RRGs may be operated in ways that do not  consistently protect the best interests of their insureds. Consequently, some regulators were concerned that RRGs were  being chartered primarily for purposes other than self-insurance, such as  making a profit for someone other than the collective insureds. Further,  LRRA does not recognize that separate companies typically manage RRGs. Yet, past RRG failures suggest that sometimes management companies  have promoted their own interests at the expense of the insureds. However, the regulation of RRGs by a single state, in combination with the  recent increase in the number of states new to domiciling RRGs, the  increase in the number of RRGs offering medical malpractice insurance,  and a wide variance in regulatory practices, has increased the potential for  future solvency risks. As a result, RRG members and their claimants could  benefit from greater regulatory consistency. Yet, LRRA has no  provisions that establish the insureds’ authority over management. Thus, the mandated development  and implementation of uniform, baseline standards for the regulation of  RRGs, and the establishment of governance protections, could make the  success of RRGs more likely. Amendments to LRRA could   require that a majority of an RRG’s board of directors consist of   “independent” directors (that is, not be associated with the  management company or its affiliates) and require that certain  decisions presenting the most serious potential conflicts, such as  approving the management contract, be approved by a majority of  the independent directors;    provide safeguards for negotiating the terms of the management  contract— for example, by requiring periodic renewal of  management contracts by a majority of the RRG’s independent  directors, or a majority of the RRG’s insureds, and guaranteeing the  right of a majority of the independent directors or a majority of the  insureds to unilaterally terminate management contracts upon  reasonable notice; and  impose a fiduciary duty upon the management company to act in the  best interests of the insureds, especially with respect to  compensation for its services. Objectives, Scope, and Methodology

Our objectives were to (1) examine the effect risk retention groups (RRG)  have had on the availability and affordability of commercial liability  insurance; (2) assess whether any significant regulatory problems have  resulted from the Liability Risk Retention Act’s (LRRA) partial preemption  of state insurance laws; and (3) evaluate the sufficiency of LRRA’s  ownership, control, and governance provisions in protecting the interests  of RRG insureds. Definitions of acronyms and terms used in this questionnaire  Risk Retention Group (RRG):  An RRG is a group of members with similar risks that  join to create an insurance company to self-insure  their risks. 1. In addition, in some states RRGs can be chartered under more than one set of  laws. Traditional Insurance Laws/Regs  c. Other (Specify):   8.
Why GAO Did This Study

Congress authorized the creation of risk retention groups (RRG) to increase the availability and affordability of commercial liability insurance. An RRG is a group of similar businesses that creates its own insurance company to self-insure its risks. Through the Liability Risk Retention Act (LRRA), Congress partly preempted state insurance law to create a single-state regulatory framework for RRGs, although RRGs are multistate insurers. Recent shortages of affordable liability insurance have increased RRG formations, but recent failures of several large RRGs also raised questions about the adequacy of RRG regulation. This report (1) examines the effect of RRGs on insurance availability and affordability; (2) assesses whether LRRA's preemption has resulted in significant regulatory problems; and (3) evaluates the sufficiency of LRRA's ownership, control, and governance provisions in protecting the best interests of the RRG insureds.

What GAO Found

RRGs have had a small but important effect in increasing the availability and affordability of commercial liability insurance for certain groups. While RRGs have accounted for about $1.8 billion or about 1.17 percent of all commercial liability insurance in 2003, members have benefited from consistent prices, targeted coverage, and programs designed to reduce risk. A recent shortage of affordable liability insurance prompted the creation of many new RRGs. More RRGs formed in 2002-2004 than in the previous 15 years--and about three-quarters of the new RRGs offered medical malpractice coverage. LRRA's partial preemption of state insurance laws has resulted in a regulatory environment characterized by widely varying state standards. In part, state requirements differ because some states charter RRGs as "captive" insurance companies, which operate under fewer restrictions than traditional insurers. As a result, most RRGs have domiciled in six states that offer captive charters (including some states that have limited experience in regulating RRGs) rather than in the states where they conduct most of their business. Additionally, because most RRGs (as captives) are not subject to the same uniform, baseline standards for solvency regulation as traditional insurers, state requirements in important areas such as financial reporting also vary. For example, some regulators may have difficulty assessing the financial condition of RRGs operating in their state because not all RRGs use the same accounting principles. Further, some evidence exists to support regulator assertions that domiciliary states may be relaxing chartering or other requirements to attract RRGs. Because LRRA does not specify characteristics of ownership and control, or establish governance safeguards, RRGs can be operated in ways that do not consistently protect the best interests of their insureds. For example, LRRA does not explicitly require that the insureds contribute capital to the RRG or recognize that outside firms typically manage RRGs. Thus, some regulators believe that members without "skin in the game" will have less interest in the success and operation of their RRG and that RRGs would be chartered for purposes other than self-insurance, such as making profits for entrepreneurs who form and finance an RRG. LRRA also provides no governance protections to counteract potential conflicts of interest between insureds and management companies. In fact, factors contributing to many RRG failures suggest that sometimes management companies have promoted their own interests at the expense of the insureds. The combination of single-state regulation, growth in new domiciles, and wide variance in regulatory practices has increased the potential that RRGs would face greater solvency risks. As a result, GAO believes RRGs would benefit from uniform, baseline regulatory standards. Also, because many RRGs are run by management companies, they could benefit from corporate governance standards that would establish the insureds' authority over management.