September 16, 2005

Better State Regulation Needed for Liability Risk Retention Groups: GAO

Government Accountability Office GAO-05-536: "RISK RETENTION GROUPS: Common Regulatory Standards and Greater Member Protections Are Needed" (August 2005)

Over two decades ago, Congress passed laws allowing businesses to group together and form their own liability insurance company. The goal was to provide an alternative to commercial insurance in a time of limited availability of affordable insurance. During "hard markets," these Liability Risk Retention Groups (LRRG) have increased in number, offering a useful addition to insurance capacity.

Loose regulations in some states that host LLRGs have also allowed short-sighted, negligent or corrupt managers to abuse the trust of the LLRG members, according to allegations by government regulators. See Unintended Consequences: Buffett Cooperation Illuminates Racketeering Suit and Spitzer Investigations. In recent years, this abuse has led to some troubling insolvencies that have proved costly to LRRG members and their claimants. Many times those claimants are individual consumers of members' services, including hospital patients, doctors and nurses.

Recent LRRG failures include the 2003 collapse of Reciprocal of America (ROA), which left hundreds of doctors and lawyers with no malpractice coverage and many with six-figure unsatisfied judgments. See Unintended Consequences: Impact of Reciprocal of America on Mainstreet Professionals.

Risk Retention Reporter identified $2.2 billion in 2004 premium flowing to LLRGs, up from $1.7 billion in 2003. See Unintended Consequences: RRG premium tops $2 B in wake of hard market. If Hurricane Katrina constricts the capital available for insurance generally (as did the 9/11 disaster), a hard market in liability insurance as well as property insurance may follow, increasing the motivation for businesses to form LLRGs. And increasing the opportunties for entrepreneurs to form LLRGs to meet the increased demand.

The GAO has performed an audit of the LRRG system and made recommendations for changes in the regulatory scheme. They found instances of conflicts of interest between LRRG managers (often entrepreneurs with no financial interest in the solvency of the LRRG) and its members. They also found that some states treat LLRGs as "captive insurers," for which relaxed capitalization standards are appropriate. As a "new item," the 120-page full report is available HERE (PDF).

Among its recommendations is greater and more standardized state regulation of LRRGs.

(read more)

From the GAO Results in Brief:


In 1981, in response to recurring shortages of liability insurance, Congress passed the Product Risk Retention Liability Act, now known as the Liability Risk Retention Act (LRRA), which 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 with similar risk exposures, such as educational institutions or building contractors, which create their own insurance company to self-insure their risks on a group basis.

RRGs have had a small but important effect in increasing the availability and affordability of commercial liability insurance for certain groups with limited access to insurance. In 2003, according to NAIC estimates, RRGs provided about $1.8 billion or 1.17 percent of all commercial liability insurance. While the overall impact on the liability market has been small, most state regulators we surveyed believed that RRGs have increased the availability and affordability of insurance for groups that have had difficulties obtaining affordable coverage such as healthcare providers, building contractors, and commercial trucking firms.

According to state regulators and RRG industry representatives, members have benefited in several important ways by using RRGs to self-insure their risks. These benefits include controlling their costs by targeting their coverage to the specific needs of members and designing programs to reduce risks. The representatives indicated that RRGs might not always benefit from the lowest insurance prices but could benefit from prices that remained stable over time.

In recent years, a shortage of affordable liability insurance also prompted the creation of many new RRGs. From 2002 through 2004, 117 RRGs were formed, more than the total formed over the previous 15 years. In particular, a shortage of affordable medical malpractice insurance prompted healthcare providers to form about three-quarters of the new RRGs. As a result, more than half of all currently operating RRGs provide insurance in healthcare-related areas.

LRRA’s partial preemption of state insurance laws has resulted in a regulatory environment characterized by widely varying state standards and limited regulator confidence in the system.

The circumstances surrounding more than half of past RRG failures we examined suggest that management companies or managers have promoted their own interests at the expense of the insureds—for example, by charging excessive management fees or promoting transactions unfavorable to the RRG. Regulators knowledgeable about these failures said that the insureds likely were more interested in obtaining affordable insurance than assuming the responsibilities of owning an insurance company. Consequently, even though an insured’s insurance policy may have stated that the RRG lacked guaranty fund coverage, the insureds may not have been fully aware of this restriction or the consequences of lacking such protection.

Further, LRRA does not require RRGs to disclose to prospective claimants, those who submit claims for loss, that the RRGs would not benefit from guaranty fund protection should they fail. This can be of special consequence to certain claimants—consumers who purchase extended service contracts from the insureds of RRGs—because contracts issued by these insureds take on the appearance of insurance when, in most cases, they are not.

This report contains recommendations for the states, as well as matters for congressional consideration that, if implemented, would create a more consistent regulatory framework for overseeing the chartering and management of RRGs, provide more reliable information about the financial condition of RRGs, and provide RRG members needed protections to help ensure that companies managing RRGs operate in the insureds’ best interests. In addition, enhancing the availability and contents of the guaranty fund disclosure would provide RRG insureds, as well as consumers who purchase extended service contracts from RRG insureds, a better understanding of the lack of guaranty fund coverage.


Posted by dougsimpson at September 16, 2005 05:45 AM
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