Risk retention groups (RRGs) emerged in the mid-1980s as American business owners faced a hard insurance market. Underwriting capacity – the maximum amount of liability an insurer will assume from all its underwriting activities – can affect an insured’s ability to procure coverage.
Stung by high premiums and an inability to find coverage, business owners lobbied their legislators. Congress responded with the passage of the 1981 Product Liability Risk Retention Act, amended in 1986, allowing businesses to form their own groups to self-fund their liability risks.
Today, businesses in the same industry, such as physicians, non-profits and governmental entities, may want to avoid the inevitable premium swings and the underwriting demands of the insurance industry. The answer may lie in the formation of a risk retention group. An RRG forms as a liability insurance company to self-insure. All members of an RRG must engage in a comparable business or a similar activity that includes a similar risk profile. For example, all hotels face similar risks. All real estate investors do, as well.
What is an RRG?
All RRGs must follow the laws of at least one state, known as its state of domicile or its charter state. RRGs are unable to write workers compensation risks, but all other liability risks are fair game. For example, some RRGs cover environmental liabilities, hospitality, healthcare and transportation. The real estate industry forms RRGs to manage commercial real estate risks, for example, one RRG domiciled in Illinois provides excess liability and environmental impairment liability. For property risks, there are other alternatives to RRGs such as purchasing groups and shared limits/deductibles.
You may hear RRGs referred to in a general sense as the alternative risk transfer (ART) market. In its broadest sense, ART allows business owners with a strong understanding of risk management and risk financing to avoid most insurance companies and form their own RRGs to administer and manage their own risk and risk financing.
RRGs are somewhat like PGs, which are purchasing groups formed by similar businesses to purchase insurance. PGs require less regulation than RRGs. For a brief discussion of the differences between the two, visit the State of New Jersey of Banking & Insurance. This discussion is sometimes quoted in expert opinions in litigation.
How are Risk Retention Groups Formed?
All owners of the RRG must be insured under the RRG. Before similar businesses owners can form an RRG, they must submit a feasibility plan to its licensing or domicile state that includes the liability lines of coverage the RRG will offer. The plan must also disclose the deductibles, the coverage limits, the rates and the rating classification categories. As part of the feasibility plan, the RRG also must submit a filing with its licensing state that describes each state in which the entity intends to operate.
Most RRGs are captive insurers and all must domicile here in the United States. A captive insurer or RRG operates primarily to finance business risk and operates under the licensing state’s captive regulatory rules. A risk retention group can operate with less capital than insurers that underwrite the general public. This is because the business owners who manage the RRG understand the unique risks associated with self-financing their insurance. The states do not consider the public at large as sophisticated buyers of insurance. The public cannot bear the same level of risk as large businesses or public entities.
RRGs must arrange capital, determine their self-insured retention and arrange adequate layers of reinsurance. Reinsurance is a method of spreading layers of risk to other insurers, avoiding the potential of catastrophic claims payouts after large losses.
RRGs must file annual statements with their chartering state’s regulatory body and with any other jurisdictions in which they operate. A certified public accountant must certify an RRG’s financial statement, and a member of the American Academy of Actuaries or a qualified loss reserve specialist must also provide a statement on the adequacy of loss reserves. Fiscal solvency is important because RRG members do not find safe harbor after insolvency in the state’s guarantee fund, which covers only admitted insurers in that state. The states in which an RRG operates do not consider the RRG an “admitted” insurance carrier.
Why Form a Risk Retention Group ?
While the past decade has seen a softer insurance market, we are entering, without doubt, a period of increasing rates and stricter underwriting scrutiny. Higher rates and tougher underwriting are the perfect soil for the growth of RRGs. According to The Center for Insurance Policy and Research, a 2018 report revealed $2 billion in direct written premiums in the RRG market. In 2012, RRGs represented 3% of the overall liability insurance market and there were 238 active RRGs in 2018 throughout the US. Experts predict that in the US the current number risk retention groups will grow as the insurance market continues to harden.
One of the most important benefits of an RRG over traditional insurance is the ability, according to the National Association of Insurance Commissioners, to dovetail the insurance language in the contract to meet the needs of the RRG member. For example, if a class of business owners face long-tail claims that are not reported until many years later, the group may choose to cover these claims while the traditional insurance market would not.
Next, because all members of the RRG face substantially the same risks, the group can develop loss-specific risk mitigation programs and claims-management strategies specific to their loss exposures. For example, grocery stores in RRGs develop safety programs designed to target the most common risks facing retail establishments. Medical malpractice RRGs retain attorneys highly skilled in defending complicated medical malpractice claims.
Access to insurance at a stable rate, especially as the insurance market hardens, is another significant benefit of the RRG over traditional insurance. What business owner wouldn’t like some control over premium swings and the changing requirements of underwriters?
Should I Consider Membership in an RRG?
Although safe harbor from high product liability insurance rates created the formation of the first risk retention groups, their popularity is on the increase, and as the liability insurance market continues to firm, RRG growth will increase.
This article is the first part of two parts of a risk retention group discussion, including some of the benefits of an RRG. In the next part, we will discuss some potential limitations of RRGs and whether an RRG or other similar risk transfer approaches might be right for your commercial real estate risks.