State insurance regulators should adopt consistent standards for risk retention groups and Congress should consider continuing the RRG exemption from state insurance laws only in states that adopt the new standards. Congress should also establish minimum corporate governance standards for RRGs.
These recommendations are in a new report from the federal Government Accountability Office released today.
The report says that RRGs have had a “small but important effect in increasing the availability and affordability of commercial liability insurance” for certain groups. An RRG is a group of similar businesses that creates its own insurance company to self-insure its risks. RRGs accounted for about $1.8 billion or about 1.17 percent of all commercial liability insurance in 2003. 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, with about three-quarters of the new RRGs offering medical malpractice coverage.
The Liabiltiy Risk Retention Act, which authorized the formation of RRGs, exempts them from certain state regulations, a fact that the report says has led to “a regulatory environment characterized by widely varying state standards,” with some states chartering RRGs as captives. Because most captives are not subject to uniform solvency standards, state requirements in financial reporting also vary. For example, not all RRGs use the same accounting principles, which may make it hard for some regulators to assess the financial condition of RRGs operating in their state. Further, there is some evidence that domiciliary states may be relaxing chartering or other requirements to attract RRGs, according to the GAO report.
Also, the federal LRRA act allowing RRGs does not specify governance safeguards, meaning “RRGs can be operated in ways that do not consistently protect the best interests of their insureds.” The GAO cites as an example that the law 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,” the report states.
The federal law also lacks protections against 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 GAO found.
“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,” according to the report, which concluded that RRGs would benefit from uniform regulatory standards.
Also, because many RRGs are run by management companies, the GAO says they could benefit from corporate governance standards that would establish the insureds’ authority over management.”