Bill Hodson of Gulfstream Risk Advisors, Derrick White of SRS, and Chris Payne of CLIC RRG talk to Rebecca Delaney about the advantages and challenges in using an RRG, as well as how members can ensure stability
As companies look to cover their own liability exposures, risk retention groups (RRGs) in the US operate under the guidelines of the Federal Liability Risk Retention Act (LRRA) of 1986. This legislation allows group self-insurance plans and group captives to form an insurance company to cover their liability exposures on a multi-state basis with a single domicile license.
The state in which an RRG is domiciled is primarily responsible for regulating and monitoring the group, explains Chris Payne, treasurer of CLIC RRG. A report by financial analysis firm Demotech found that in 2020, Vermont led with 84 RRGs, followed by South Carolina and District of Columbia with 36 and 31 groups, respectively.
With ownership limited to the policyholders of the RRG, these structures insure industries with professional liability, such as medical providers, product manufacturers, law enforcement officials and contractors. An RRG can support these industry sectors with insurance solutions for unique exposures where the traditional insurance market fails to do so.
While the soft market conditions of the 2000s prompted some carriers to underprice some liability exposures to maintain market share (which was detrimental to the RRGs directly competing with these carriers), the more recent hardening market, social inflation and rising carrier rates for many liability lines has benefitted RRGs.
This is affirmed by Bill Hodson, managing member at Gulfstream Risk Advisors. He observes that the main drivers of RRG formations in 2021 were the sustained unfavourable traditional market conditions (pricing, capacity and coverage restrictions) for specialty liability coverages, such as medical professional liability and commercial automobile liability.
“As traditional insurers and reinsurers continue to lick their various wounds from unprofitable underwriting and inadequate reserving, we have seen many insureds with clean, well-managed risks be penalised by unsustainable policy pricing and untenable terms and conditions that gut the coverage they really need,” Hodson explains.
Derick White, managing director of the governance, risk and compliance practice at Strategic Risk Solutions, identifies that SRS formed a couple of RRGs in 2021, the primary reason being the prolonged hard market.
He explains: “While single-parent captives can quickly organise their needs and form a pure captive, RRGs take longer to gather members and organise the RRG. As we would expect, new RRGs will form a year or so after a confirmed hard market.”
Hodson adds that recently there has been an emerging trend of RRG formations to write coverage for cyber liability that is both affordable and comprehensive, as well as emerging industries such as last mile delivery (concerning supply chain management and transportation) and cannabis operations.
“These recent trends follow the classic reason why the RRG industry evolved (lack of available or affordable coverage), and entrepreneurs willing to disrupt the traditional industry model,” Hodson notes.
Advantages
As specialty carriers, the homogeneous membership of RRGs provides inherent advantages as it means they are well-positioned to better serve the specific policy coverage and provision needs of their member-insureds compared to large multi-line carriers.
White explains the benefits of risk sharing: “Similar to any group captive, the RRG structure allows each member to participate in levels of coverage they could not sustain alone. Another advantage is that many RRGs offer policies tailor-made for the group along with good collaboration among members allowing for the sharing of risk management practices.”
Payne notes that as a cheaper alternative to the commercial insurance market, RRGs are more attractive to small- and mid-sized companies. As another financial advantage, the structure allows for the payment of dividends to member-insureds over time as a reward for collective profitability.
Although vulnerable to the same challenges as the commercial insurance marketplace, the flexibility and customisable nature of an RRG means it can overcome these issues with a streak of innovation the traditional market often lacks.
According to Hodson, the most significant advantage of an RRG compared to other self-insurance structures is speed-to-market, as it can be formed to meet market needs and become operational quickly and more efficiently owing to the unique regulatory provisions.
He explains: “With RRGs’ federally-mandated advantage of merely having to inform the regulatory authority in each jurisdiction where they issue a policy, rather than having to go through a formal licensing and approval process prior to issuing a policy, RRGs can respond to their member-insureds’ needs and expand their operational footprint very quickly.”
Challenges
The common issues associated with operating an RRG vary across risk types and geography, but a frequent obstacle is startup capital. Payne contends that coordinating all members to contribute their capital at the same time, and explaining the risks and rewards of self-insurance, poses a potential difficulty.
Hodson adds that, similar to the captive industry as a whole, there is simply a lack of education or understanding within the wider insurance industry about the niche of RRGs and how they operate. Therefore, RRGs that depend on the traditional broker network for business do not tend to receive many applications that are ‘perfect-fit’ risks for them to write, he observes, because the brokers that market the risks may be unaware that the RRG exists, or else hold a bias against them.
With this lack of comprehensive long-term understanding, SRS’ White notes that members may leave the RRG during softer market conditions when the commercial market poses a cheaper option, then seek to return when commercial rates rise once again.
This threatens the inherent stability of an RRG. “A trait of RRGs that have been around for a long time is having the support of its members, members with historical knowledge of the cyclical nature of the commercial insurance market,” says White.
Another challenge to the stability of an RRG, Hodgson suggests, is the potential misalignment of a member-insured’s risk management and insurance purchasing philosophy with the RRG mechanism, or the RRG itself.
He explains: “If an insured does not share the same long-term business relationship goals inherent in the RRG mechanism, and is merely a price-sensitive buyer of coverage, then they are better suited to continuing to buy from the traditional market.”
Stability
In ideological terms, therefore, an RRG can ensure stability by establishing and maintaining a coherent mission and vision. It is also important to have ongoing communications with the home regulator and integrate the owners of the captive company into the RRG’s board.
This is affirmed by Hodson, who adds that the long-term success of an RRG is also dependent on regulation, as well as the regulators themselves. He says: “The service providers guiding the formation or redomestication of an RRG should diligently match the purpose, structure, operational objectives and management to the domicile and regulators for the best long-term fit.”
Elaborating on the importance of robust corporate governance, Hodson continues: “On the surface, having and adhering to sound and battle-tested risk selection, underwriting and claims handling guidelines can provide an RRG with stability — but in my experience, the root of RRG stability is sound and consistent corporate governance. Even the smallest RRG needs to have the same stringent corporate governance mechanism as a large traditional insurance company.”
While it is also important for an RRG to adapt its policy language and value-added services to best address the ever-evolving market landscape, CLIC RRG’s Payne argues the stability of an RRG ultimately depends on a strong capital base and profitable underwriting.
This is affirmed by White, who reiterates that an RRG can ensure member retention during soft market conditions by requiring multi-year commitments, either by contract or by the ability to retain capital contributions for a few years after a member departure.
Looking at likely future trends in RRG formations, Payne anticipates that both RRGs and the wider captive industry will continue to flourish as they capitalise on the benefits of prolonged hard market conditions.
In agreement that the hard market will see an increase in RRG formations, White adds that he expects that “new and creative uses of the LRRA will come about with expanded use of ‘contractual liability’ coverages within RRGs”.
“In 2022, I expect a continuation of RRG formations in the areas of medical professional liability, assisted living and delivery logistics, as well as increased investigation into formations for cannabis-related operations. I am also not holding my breath for Congress to amend the LRRA to allow first-party coverages anytime soon,” concludes Hodson.
