Risk Retention Groups Owning Up to Success

Due to the restricted coverages available in the market today, risk retention groups (RRGs) have experienced a significant amount of rapid growth over the past year. At a time when the industry is facing what is perhaps the most serious availability crisis for many types of coverage, risk retention groups represent a viable option to those unable to obtain liability coverage.

“This has been a historical period of growth because of the unavailability and unaffordability of liability insurance,” Karen Cutts, publisher and managing editor of the Risk Retention Reporter, said.

With the medical malpractice crisis nearing its boiling point, risk retention groups can appear to some as the light at the end of the tunnel. However, despite their attractiveness, RRGs are not for everyone. As with any program, many factors must be considered in determining whether RRGs provide the best solution.

A rising trend
2002 was a phenomenal year for risk retention groups in terms of growth. According to the Risk Retention Reporter, nationwide, 21 new formations occurred, with no retirements for the first year ever, bringing the total number of RRGs to 90 at the end of 2002. To date in 2003, six additional RRGs have been formed, Cutts said. She noted that the only other years in which formations reached the double digits were in the 1980s. Moreover, for the first time since the passage of the Liability Risk Retention Act (LRRA), 2002 saw no retirements.

The current medical malpractice crisis served as a catalyst for the formation of many of these new RRGs. As Timothy Padovese, president and CEO of the Ophthalmologic Mutual Insurance Company (OMIC), explained, the five biggest med-mal carriers went under in the past 18 months. St. Paul, Reliance, Legion, PHICO and MIIX all fell under the skyrocketing cost of claims and the tort liability. “What happened is you had all of the physicians across the United States, all of a sudden their carriers stopped writing and they had to find new insurance,” Padovese said. “The total premium associated with those five carriers is around a billion dollars.

“What you had was a real market restriction,” he added. “So these physicians have to look for alternative insurance. They’re now going to the existing companies that are out there, and there are not a whole lot of new companies that want to get into the insurance business right now. What you basically had is all the other insurance writers or carriers out there trying to absorb all of these physicians and not a whole lot of new capital coming in to the market.”

Enter the risk retention groups. Many insureds turned to RRGs as the alternative to traditional insurance at the peak of the liability crisis.

“In the last 10 years prior to 2001, I think we probably [domiciled] two or three RRGs in say, six or seven years. Now all of a sudden, here it is one year, and we’re doing 11. It’s availability of insurance. It’s just tougher to get, the prices are higher,” Leonard Crouse, director of Captive Insurance in Vermont, said. “The medical malpractice and hospital liability crisis in this country is unbelievable, with Pennsylvania, Florida, Texas and various states now, it’s become very critical with the doctors not being able to get insurance at fair prices. Of the 11 group programs that we did license this year, I believe nine of them were involved in hospital liability.”

OMIC, a RRG based in San Francisco, is a direct writer of medical liability coverage specifically for ophthalmologists. “We have definitely seen rapid growth over the last year and a half,” Padovese said. OMIC currently writes about 30 percent of the market share for ophthalmologists in the U.S., up from 20 percent about two years ago. OMIC was formed in 1987, during the hard market of the mid-80s, immediately following the passage of the LRRA. The company is domiciled in Vermont.

Minneapolis-based States Self-Insurers RRG Inc. was also formed in 1987. It writes public entities and acts as a facility for excess liability insurance. “There was obviously a real growth of risk retention groups at that time because the commercial insurance market was again unable to respond to the needs of commercial insureds,” Robert Esenberg, president and CEO, said. “So the commercial insureds had to develop the mechanisms to find that kind of financial protection they needed. Captives and RRGs clearly were a very good alternative market to the commercial market that either didn’t have coverage available for various lines of risk or it was so expensive that it was financially inappropriate to simply continue to rely on the commercial marketplace. We’re seeing that type of hard market again.

“This market, I think, is going to be much more protracted simply because of the current status of the world economy,” Esenberg continued. “There’s no indication that there’s going to be any rapid improvement to the economy. We certainly hope that it will gradually improve, but as long as the overall economy is like it is and the financial institutions worldwide are suffering from that, I think that this type of market is going to continue.”

States Self-Insurers insures approximately 50 public entities; two of those being pools of insureds. One is a pool of school boards in Virginia, and the other is a pool of counties in Montana. “There are multiple entities in each of those pools,” Esenberg said. The pools represent unique challenges due to their size. But Esenberg explains that the key is to make sure the pools are following the same practices as the individual insureds. “We make certain that the pool management has a good philosophy again with regards to loss control, claims management and that they have in place mechanisms to ensure that their members follow appropriate loss control and claims management.”

The Alliance of Nonprofits for Insurance Risk Retention Group (ANI-RRG), operating out of California, writes various liability coverages, including general liability, business auto, improper sexual conduct, umbrella, directors & officers, and more for 501(c)(3) nonprofit organizations. According to president & CEO Pamela Davis, ANI-RRG is modeled after the Nonprofits Insurance Alliance of California (NIAC), a liability insurance pool also providing insurance for 501(c)(3) nonprofits.

Domiciled in Vermont, ANI-RRG presently serves about 360 nonprofits. The group formed in 2000, but had a bit of a slow start with the events of Sept. 11. “[It] really got going during late first quarter of 2002,” Davis said. “At the end of the year last year, we had written $3.7 million in premium, while we had projected $2.5 million.

“Nonprofits typically have been poorly served by the insurance industry and NIAC has been extremely successful in California, so that’s why we thought a RRG for other states would be a good idea,” Davis said. “We really felt this [the hard market] was coming, so we decided to be proactive.”

The upside of RRGs
RRGs present many advantages that traditional insurance companies cannot offer. For starters, RRGs provide much needed liability coverage at a time when it seems that no other options are available. “They give insurance buyers an option that is very crucial right now,” Cutts said.

Another key benefit RRGs can bring to insurance buyers is long-term stability, Cutts added. This allows insureds to obtain liability insurance coverage at more predictable rates and terms than they can get from traditional insurers. RRG members can also gain control of their insurance programs, providing effective risk management and loss control that is often not available from traditional insurers.

Another beneficial aspect that gives RRGs an edge over traditional insurance companies is the fact that RRGs are mandated to be homogenous. This important aspect allows RRGs to give their insureds an insight on the particular vocation that they are representing that no one else will have.

“As a RRG you must write organizations that are of a similar type, so you’re forced to really understand and serve that particular niche because that’s all you do,” Davis said. “It’s not like if we don’t do a good job with non-profits, we can go start underwriting gas stations. We don’t have an option to not do well in our chosen area.

“When we handle claims and when we work with our members, we’re on the same side. We don’t have that adversarial relationship that so frequently exists between policyholders and the company. I think that’s a real plus. It helps us to get better resolutions to claims than if there was an adversarial relationship with our policyholders,” Davis added.

In addition, Davis noted that, once domiciled in a particular state, the ability to write business nationwide is very beneficial and conducive to conducting business. “We are in about 10 states now. We are adding six new states this year,” she said.

Esenberg likes the fact that, under federal law, the insureds actually have to own the insurance company. “With States, we do that through a mechanism where the insureds become members of a trust. They really are the people that set the direction of the company. As an insured you have a voice in what the company is doing and certainly the company is much more responsive than you’ll find in the commercial market marketplace.”

Along with ownership, Esenberg added, another advantage is the shared success of the company. “They’re not putting the revenues or profits in the pockets of unknown stockholders or shareholders,” he said. “They’re actually the ones that will enjoy the success of the company.

“So the insureds generally are more attuned to good quality loss control and claims management activities and they tend to benefit financially from the relationship,” Esenberg continued. “It’s much more cost-effective in the long run.”

As an agent, Christine Riddell of Torrance, Calif.-based Manning Riddell Insurance Agency, likes the stability RRGs offer. “What I would like as an agent is to have something that I know is stable, something that I know is successful, and it’s going to be for the long term.” Riddell currently works with purchasing groups, providing errors and omissions coverage for life insurance agents, but is looking to transfer that group into an RRG.

Most RRGs boast impressive retention rates. ANI-RRG’s is about 95 percent, Davis said. “I think once business goes to the alternative market, it’s much less likely to go back to the commercial market,” she said. “Part of that is because insureds think about whether they are going to join a RRG, what that means, and they make a commitment to doing that. Once they do, if the RRG treats them well, and gives them the kind of service that they expect, then they stay and become advocates and proud of the fact that they have this organization that looks out for them.”

The downside
Of course, with all of its benefits, RRGs will inevitably pose some challenges. Among them, according to Cutts, is that insureds must come up with significant capital to begin RRG operations. A downside for some potential insureds is that in the event of an insolvency, there is no guaranty fund protection, as federal law prohibits RRGs from participating in state guaranty funds. An additional downside for some potential members is that the RRG will typically have to wait three to five years before being eligible for an A.M. Best Rating.

To that effect, financial instability is a big concern to RRGs, which is why effective management is crucial to the RRGs success. “Obviously it’s like any organization,” Esenberg said. “It really depends on the quality of the management of the program. Those that failed have generally been due to mismanagement more than any problems with the design or function of the risk retention group.”

However, Esenberg pointed out that “based on the number of RRGs and the number of insurance companies, there have been very few failures by RRGs. I think as long as you’re careful and selective in who’s going to manage the affairs of the company, and that the board that is selected by the membership maintains good vigilance on what’s going on, I think that RRGs are extremely sound and financially beneficial.”

Esenberg finds educating the buyers about RRGs to be the most difficult. “We’re having to spend a lot of time and effort educating the buyers. Some risk managers are not familiar with RRGs,” he said. “A lot of the risk managers that are out there right now have never lived through a hard market.”

To some, the fact that the RRG is so closely regulated by its domiciled state can be a definite turn-off. And of course, the obvious restriction to just liability insurance can leave those looking for scarce homeowners insurance down and out. There has even been talk about extending coverage to other lines currently in crisis, according to Crouse.

Davis found the attitude of the industry towards RRGs discouraging. “This is an industry that is very adverse to change; it’s very entrenched in it’s way of doing business,” she said. “There is a lot of misinformation about RRGs and how they operate. Those from the traditional side of the insurance industry sometimes assume that because the concept is relatively new and different that RRGs are not as strong as other commercial carriers. When people really understand us and work with us and get to know us, they realize that the differences are all positive. But initially, it’s sometimes a negative simply to be different in an industry that’s so traditional.”

Another concern for agents or brokers placing business with an RRG is whether or not they are covered for E&O exposures. “Whether an agent is covered by his/her policy for E&O exposures related to placing business in an RRG depends on the policy,” Cutts explained. “My understanding is that most insurers exclude the coverage, but that an endorsement to the policy can be purchased by the agent. The best advice for any agent placing coverage in an RRG is to first check with his/her E&O insurer to determine whether such coverage is included or excluded. If it is excluded, then the agent should see if the insurer will cover it via a policy endorsement.”

Agents and brokers should take heed: not all RRGs place business through brokers; in fact, many of them are direct writers. Check with the Risk Retention Reporter online at www.rrr.com to research RRGs before approaching them.

Regulating an RRG
While RRGs may be domiciled in any of the 50 states, many are drawn to states that already have captive laws, Cutts said. According to the Risk Retention Reporter, in 2002, 43 of the 90 RRGs were domiciled in Vermont, with Hawaii following at 16. South Carolina had 10, and Tennessee, Colorado, Illinois, Indiana, Montana, Nevada, Delaware, Iowa, Missouri, Nebraska and Texas served as domiciles for the remaining RRGs.

Vermont remains to be the most popular state for RRGs to be domiciled in, and for good reason. “Vermont has a strong reputation for being prudent and experienced in its regulation,” Cutts said. Vermont passed its captive laws back in 1981, and has been working with captives for the past 21 years, and with RRGs since passage of the LRRA in 1986. Because Vermont is such a small state the revenue generated by the captive insurance program is very beneficial to the state’s economy, Crouse explained.

“Vermont is one of only a handful of states that this is their area of expertise,” Padovese added. “They understand RRGs, they understand the LRRA, they have a very strong legal system that understands and supports them. They build very good relationships with the RRGs across the U.S. They are very professional.”

“The reason they come here is because we have good, fair regulation,” Crouse said. “We have laws. We follow regulations. We also try to make it a business-friendly atmosphere.

“We have to do a good job regulating,” Crouse continued. “These people that come here understand that we do a quarterly surveillance on their programs. They file quarterly statements with us and we do an analytical review of what’s going on. We prioritize those reviews anywhere from one to four based on what we see. That’s all for internal purposes.

“We examine the RRGs every three years just like they do for a regular traditional insurance company,” he added. “On top of that, our RRGs have to file a loss certification every single year which has to be done by an independent actuary.”

It doesn’t end there. Crouse requires any changes to an RRG’s program to be pre-approved before it goes into effect. “That way we know at any given time exactly what programs are doing,” he said.

Crouse explained that many other states have begun to pass captive insurance laws or are in the process of doing so. “They see the success of states such as ours and they see the revenue that has generated,” he said. “But, it takes a long time to develop a good captive program and generate enough revenue to make it worthwhile.”

Good times, bad times
Despite the significant growth of RRGs over the past year, and their reputation for being a stable vehicle for insureds, RRGs are not immune to the market conditions. Like insurance companies, RRGs see their fair share of tough times.

“You’ve got the perfect storm,” Padovese said. “You’ve got a bunch of companies that have pulled out of the market. You have frequency on the rise. You have severity on the rise in terms of claims. You have investment portfolios of RRGs and insurance companies in general down. You have the cost to run the company going up because of reinsurance costs are going up. Everything is converging at once. It makes for a very tough market.”

The lessons of the hard market apply to everyone involved in the industry. “Obviously insurance companies are learning now that they have to underwrite for a profit rather than relying on alternative income sources such as interest and monies generated in the stock market or wherever,” Esenberg added.

For RRGs, the perils of the hard market reaffirm the stringent underwriting standards, claims management and loss control practices that they abide by.

“I think that agents and brokers who really are looking to the future need to pay attention to these alternative market companies,” Davis added. “They should evaluate them as rigorously as they would evaluate any insurance company, but don’t discount them simply because they’re different.”

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