Summary
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.
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.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change
from "In process" to "Implemented" or "Not implemented" based on our follow up work.
Director:
Team:
Phone:
Richard J. Hillman
Government Accountability Office: Financial Markets and Community Investment
(202) 512-8678
Matters for Congressional Consideration
Recommendation: To assist NAIC and the states in developing and implementing uniform, baseline standards for the regulation of RRGs, Congress may wish to consider setting a date by which NAIC and the state insurance commissioners must develop an initial set of uniform, baseline standards for the regulation of RRGs.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendation: To assist NAIC and the states in developing and implementing uniform, baseline standards for the regulation of RRGs, Congress may wish to consider, after that date, making LRRA's regulatory preemption applicable only to those RRGs domiciled in states that have adopted NAIC's baseline standards for the regulation of RRGs.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendation: To strengthen the single-state regulatory framework for RRGs and better protect RRG members and their claimants, while at the same time continuing to facilitate the formation and efficient operation of RRGs, Congress also may wish to consider strengthening LRRA by requiring that insureds of the RRG qualify as owners of the RRG by making a financial contribution to the capital and surplus of the RRG, above and beyond their premium.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendation: To strengthen the single-state regulatory framework for RRGs and better protect RRG members and their claimants, while at the same time continuing to facilitate the formation and efficient operation of RRGs, Congress also may wish to consider strengthening LRRA by requiring that all of the insureds, and only the insureds, have the right to nominate and elect members of the RRG's governing body.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendation: To strengthen the single-state regulatory framework for RRGs and better protect RRG members and their claimants, while at the same time continuing to facilitate the formation and efficient operation of RRGs, Congress also may wish to consider strengthening LRRA by establishing minimum governance requirements to better secure the operation of RRGs for the benefit of their insureds and safeguard assets for the ultimate purpose of paying claims. These requirements should be similar in objective to those provided by the Investment Company Act of 1940, as implemented by SEC; that is, to manage conflicts of interest that are likely to arise when RRGs are managed by or obtain services from a management company, or its affiliates, to protect the interests of the insureds. Amendments to LRRA could (1) 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; (2) 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 (3) 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.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendation: To better educate RRG members, including the insureds of organizations that are sole owners of an RRG, about the potential consequences of self-insuring their risks, and to extend the benefits of this information to consumers who purchase extended service contracts from RRG members, Congress may wish to consider expanding the wording of the current disclosure to more explicitly describe the consequences of not having state guaranty fund protection should an RRG fail, and requiring that RRGs print the disclosure prominently on policy applications, the policy itself, and marketing materials, including those posted on the Internet. These requirements also would apply to insureds who obtain their insurance through organizations that may own an RRG.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendation: To better educate RRG members, including the insureds of organizations that are sole owners of an RRG, about the potential consequences of self-insuring their risks, and to extend the benefits of this information to consumers who purchase extended service contracts from RRG members, Congress may wish to consider developing a modified version of the disclosure for consumers who purchase extended service contracts from providers that form RRGs to insure their ability to meet these contractual obligations. The disclosure would be printed prominently on the extended service contract application, as well as on the contract itself.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendations for Executive Action
Recommendation: In the absence of a federal regulator to ensure that members of RRGs, which are federally established but state-regulated insurance companies, and their claimants are afforded the benefits of a more consistent regulatory environment, the states, acting through the National Association of Insurance Commissioners (NAIC), should develop and implement broad-based, uniform, baseline standards for the regulation of RRGs. These standards should include, but not be limited to, filing financial reports on a regular basis using a uniform accounting method, meeting NAIC's risk-based capital standards, and complying with the Model Insurance Holding Company System Regulatory Act as adopted by the domiciliary state. The states should also consider standards for laws, regulatory processes and procedures, and personnel that are similar in scope to the accreditation standards for traditional insurers.
Agency Affected: National Association of Insurance Commissioners
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
