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For much of the past decade, life for Pamela Davis and her list of nonprofit clients has been convoluted, far more complicated than need be.

That's in part because every time a client renews an insurance policy, they have to consider three separate documents: one to cover liability risks, another to cover property exposures and yet a third to insure auto physical damage.

"It's a very convoluted way to do business," she says. "It makes it look like a shell game when all we're trying to do is to cover our clients." She also estimates that the fronting arrangement with property carriers costs her between 5 percent and 10 percent of the premium.

Davis heads the Alliance of Nonprofits for Insurance, a risk retention group. Dozens of clients are small nonprofit organizations, and the minimum premium for coverage is as low as $100.

If Davis had just one wish, it would be for her risk retention group to be able to write property and auto physical damage along with liability. There would be no fronting fee, and the three agreements could be boiled down to one contract.

But that would require broadening the Liability Risk Retention Act, passed by Congress in 1986.

"From our perspective, if they expand the law, it would enhance our operations tremendously because spread of risk is really good." Long-tail lines would be mixed with short-tail lines, says Davis, giving her a more robust book of business.

Davis isn't alone in her desire to have the Liability Risk Retention Act expanded to include property coverage. Just ask Robert W. Minto, president and CEO of ALPS Corp., a Montana-based insurance services company that represents about 8,000 legal firms.

Sure, he has a vested interest in expanding the law, as it would mean more business for his firm, particularly if it chose to write property coverage. But it would also mean his clients would come out winners too.

"We found in the 1980s that when they let risk retention groups write liability, it offered a broader spectrum to consumers," says Minto, who is also president of Lawyers Reinsurance Co.

Like Davis, he can offer property coverage only through a fronting arrangement, "but it's a lot of headache," Minto says, and fronting carriers charge between 7 percent and 10 percent of premium, he says.

Then there's Larry Smith, vice president for risk management at MedStar Health Inc., which formed the MedStar Liability Ltd. Risk Retention Group to cover doctors in case of malpractice suits. Smith has more than one reason to fight to include property under the Liability Risk Retention Act.

There's plenty of expensive equipment in MedStar Health's seven hospitals in the Baltimore-Washington, D.C., area--MRIs, for one, state-of-the-art backup generators and lighting systems for another. Hospital risk managers might well find plenty of economies of scale if their risk retention group could cover property exposures along with liability risks.

But there's another reason, dating back to the fall of 2001, to expand the act to include property, says Smith.

With property renewals slated to kick in on Oct. 1 of that year, the company had tentative offers from the insurance marketplace "for about $550,000 worth of premium." After the Sept. 11 attacks, premiums for his annual October renewals skyrocketed to $1.8 million.

"I'm not asking anyone to cry for us, but that gets your attention," says Smith. "So now I'm starting to look at the premium associated with property in our business much differently than I did before."

And Smith hasn't even mentioned the deductibles. Those went up too--and they've not yet come down.

In the old days, before the existence of risk retention groups and self-insurance, premiums in the commercial market were relatively modest, he says.

But once carriers became concerned about losses, however, they raised premiums and deductibles. Smith says his deductibles were $50,000 for the general property damage claim in 2001. Then they shot up to $500,000, and that's cheap compared with deductibles for water damage. Those have swelled to $1 million.

Smith says it's time for risk managers to start thinking about how to finance those higher deductibles in such as a way that will allows his bosses to plan and budget for them properly. Expanding the law to include property would allow him to do that, he says.

"I don't see any downside to it, so why not expand it?" adds Brian Donovan, president of the risk retention group STICO Mutual Insurance Co. and chairman of the National Risk Retention Association, which represents more than 60 risk retention groups. The act, he says, did exactly what it was supposed to do when it was passed. So, why not expand it?

SOLVENCY RISKS

Financial analyses of the performance of risk retention groups show that, as a whole, they've performed better than the property/casualty insurance sector.

Yet they are a very small group of companies and don't operate on the scale of large commercial carries. In 2003, for example, risk retention groups accounted for $1.8 billion, or just 1.17 percent, of all commercial liability insurance.

You'd expect such a small universe of companies to operate under a uniform set of rules, and that they'd be easy to regulate. Not so--and there's the rub.

Auditors from the Government Accountability Office say one weakness of the Liability Risk Retention Act is that its partial pre-emption of state laws has "resulted in a regulatory environment characterized by widely varying state standards."

That has made risk retention groups difficult to police properly, allowing for some spectacular failures, like HOW Insurance Co. RRG in 1994 and National Warranty RRG in 2003. Because there are more risk retention groups than ever before, some regulators are nervous about expanding the law.

Government auditors, in a report published last year calling for more regulatory standards and better protection for members of RRGs, say another concern is that insureds don't have the proper authority over the management of risk retention groups.

"For example, LRRA does not explicitly require that the insureds contribute capital to the RRG or recognize that outside firms typically manage RRGs," authors of the report wrote.

"Thus," they wrote, "some regulators believe that members without 'skin in the game' will have less interest in the success and operation of the RRG and that RRGs would be charted for purposes other than self-insurance, such as making profits for entrepreneurs who form and finance an RRG."

Nebraska Insurance Director Tim Wagner says that, while he believes RRGs should be allowed to write property insurance, he cautions that some risk retention groups might not meet lending requirements, making their long-term survival all that more difficult.

"Many lenders would require a certain financial rating to accept a loss-payable clause from a risk retention group, and even a bonding indenture may have some requirements regarding a (A.M.) Best rating, and I fear that may be a fairly strong impediment for all except the strongest RRGs," he says.

Risk retention groups that are poorly capitalized groups are bad news all around, particularly in a soft market.

"There are some RRGs formed in the U.S. that are undercapitalized, and as we move into a soft market, which is where we are, if you can't get rate and if you're going to use your RRG to underprice things, it's going to give RRGs a bad name," says Tim Padovese, president and CEO of the risk retention group Ophthalmic Mutual Insurance Co., who spoke at an August seminar on the issue of health-care captives and risk retention groups.

Capitalization issues aside, Wagner says another concern is the writing of financial guarantees as contractual liability policies. In that case, a member of a risk retention group sells warranties for a profit and then, through a contractual liability policy, passes on the risk to the RRG.

"You may be insured but only as an excess policy and only in the event the member is financially unable to meet its obligations," Wagner says. That's what got National Warranty into trouble. "That's probably what a couple of others are doing today," he adds.

Losses incurred by the National Warranty fiasco are estimated to have been between $58 million and $74 million, according to the GAO report, citing figures issued by liquidators of the company.

The current state of affairs regarding RRGs operating under the auspices of LRRA is still not enough for insurance regulators in California, Wisconsin and Washington. The regulators in those states have called for amendments to the law to preclude RRGs from offering such contractual liability insurance.

Other regulators are not as nervous, particularly when it comes to larger groups that have operated in the marketplace for years.

"I have no problem with expanding LRRA for the big buying communities," says one well-respected regulator. "It's not an issue at all. They have a lot of experience and expertise in the field. If you give carte blanche to smaller risk retention groups, that's what makes me nervous."

Just how much latitude regulators and lawmakers are willing to give risk retention groups will have to wait, however. Congress isn't expected to consider changes to the law before 2007 at the earliest, says Donovan.

CYRIL TUOHY is managing editor of Risk & Insurance®.

September 15, 2006

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