How does a Risk Retention Group work?

Risk Retention may bridge the gap for those suffering high liability costs.

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If you’re finding reasonably priced liability insurance difficult to obtain, you may be both frustrated and concerned. That’s where Risk Retention Groups come in.

What are Risk Retention Groups?

Risk Retention Groups were founded in order to provide a marketplace solution for businesses who were having trouble getting insurance coverage. They differ from traditional insurance companies in that they need not obtain a license to operate in any state other than the one in which they are chartered. Since these are member-owned mutual companies, they can either be licensed as a standard mutual insurer or a captive insurer, meaning that they are wholly owned and controlled by those they insure.

First legislated in 1981, Risk Retention Groups were initially limited to covering completed operations risks and product liability. The concept was later expanded in 1986 when the country was in the middle of an insurance crisis blocking many businesses from getting liability coverage—the Liability Risk Retention Act was passed to give buyers greater marketplace control.

This act created two groups:

• Risk Retention, a member-owned conglomerate that must be based in a specific state.
• Purchasing, a cluster of buyers joining forces to purchase liability coverage from an insurance firm.

While both groups mandate that members be involved in similar professional activities, the major difference is that risk retention members are responsible for issuing policies and thereby taking on risk. Meanwhile, purchasing groups buy their coverage from an insurance firm, which takes on the risk itself. Additionally, members of Risk Retention Groups finance their company, while purchasing members need not do this. Finally, the groups are regulated differently under state and federal law.

How do Risk Retention Groups differ from traditional insurance?

While Risk Retention Groups work in ways that are reminiscent of traditional insurance firms, consumers need to be aware of the differences between the two. These include:

• Ownership. While regular insurance companies are independently owned and operated, Risk Retention Groups are created and controlled by businesses. In turn, those businesses receive coverage and are empowered to handle their individual risk management issues.
• Regulatory oversight. Typical insurance policyholders are covered by a suite of legal protections, but members of Risk Retention Groups do not enjoy the same security. Other than the laws of the state in which it is based, Risk Retention Groups are exempt from all laws, rules, regulations, or orders that would control their activities.
• Financial responsibility. Owners of Risk Retention Groups must provide sufficient funds to cover losses and are required to provide its home state with written evidence of financial history, insurance coverages, and underwriting processes, among other information, in order to get a license.

Risk Retention Groups usually form in industries that face extremely high risks, such as malpractice. In fact, medical malpractice coverage currently makes up the bulk of Risk Retention Group activity.

Example:

• A group of 400 medical businesses are finding it difficult to obtain liability insurance coverage. Under a combination of federal and state laws associated with the Liability Risk Retention Act, they form a Risk Retention Group based in the state of Missouri. By pooling their resources, the businesses obtain the liability coverages that were difficult to find in the traditional insurance marketplace.

What are the advantages and disadvantages of Risk Retention Groups?

Risk retention groups can be advantageous to members in several ways:

• While policyholders must put up the finances to cover claims, they also retain all profits, rather than insurance companies.
• Renewals won’t result in unexpected premium increases or decreases.
• If your business is licensed in more than one state, you won’t need to get multiple insurance licenses.
• Built-in flexibility means your policy can more closely meet your needs.
• Severe losses are limited by the presence of reinsurance, which limits risk.

However, you should be aware of some of the disadvantages:

• If one business suffers a loss, it may raise premiums throughout the rest of the group.
• If a risk retention group fails, businesses may lose their funds regardless of whether they are involved in a given claim.
• Property insurance is not offered.
• Compliance issues may arise if home states cannot monitor group activity in other states.
• Businesses may have trouble getting their hands on the funds they’ve invested in groups.
• Lacking a certified insurance rating may make it difficult to prove you as a business are financially responsible.
• You as a business may not wish to share your information with others.

Example:

• A group of 250 physicians pools its resources to launch a risk retention group. However, not long after the group is founded, one member loses a medical malpractice suit in which the physician is accused of improperly diagnosing a cancer patient, thereby shortening said patient’s life. The loss results in premiums increasing by 2 percent throughout the group—and if it is catastrophic enough, it could result in the closure of the group, causing members to lose the funds they have contributed. Medical malpractice suits are a leading cause of risk-retention group failures.

Are Risk Retention Groups stable?

According to the Analysis of Risk Retention Groups: Third Quarter 2018 report by the Demotech rating agency, risk-retention groups’ liabilities, cash, and assets have all increased since the second quarter of 2017.

Among the other findings:

• Throughout the year between third quarter 2017 and third quarter 2018, policyholders’ surplus increased 4.2 percent, or $202.4 million, while at the same time liabilities decreased 0.6 percent. Demotech argued that that these results show that Risk Retention Groups have adequate capital in the face of a turbulent economy or increased losses.
• While the total number of active Risk Retention Groups fell from 261 in 2012 to 238 in 2014, premium levels stayed consistent, and that number began increasing again by 2018.
• As measured by liabilities to cash and invested assets, Risk Retention Group liquidity for third quarter 2018 was 67.3 percent. Demotech notes that any value less than 100 percent is considered positive as it is indicative of more than a dollar of net liquid assets to each dollar of liability.
• However, Risk Retention Groups were seen as unprofitable through third quarter 2018 with regard to underwriting gains and losses. Collectively, an aggregate underwriting loss of $66.7 million was reported, with a net investment gain of $205.9 million and a net income of $132.3 million. This translated to a loss ratio of 77.8 percent through third quarter 2018.

Overall, Demotech concludes that Risk Retention Groups are a good bet despite uncertainty in the political and economic realms, with reasonable financial ratios given fluctuations over time.

How is a Risk Retention Group created?

A feasibility study is a major first step in creating a Risk Retention Group. Here, the participating businesses’ current insurance solutions are evaluated, collecting information including:

• Premiums, losses, and deductibles for current insurance choices
• Business information such as staff numbers and locations
• Evaluations as to whether a minimum group size and minimum premium (usually around $5 million) may be reached in order to make the group viable

Within the feasibility study lies a comparative analysis. This is a breakdown of average losses versus premiums over the past five years or more as compared to costs associated with a new Risk Retention Group. Should premiums for the group exceed the marketplace, forming a new Risk Retention Group may be considered inefficient.

From there, service providers are appointed—specifically, an underwriting management firm and reinsurance company.

An underwriting manager:

• Collects premiums
• Issues policies
• Deals with claims
• Creates an underwriting manual and guidelines
• Manages accounting
• Recommends other service providers
• Negotiates with reinsurers and reinsurance intermediaries

The reinsurance intermediary:

• Designs the reinsurance program to meet risk transfer goals
• Processes claims and premiums
• Helps gather information for reinsurers
• Crafts presentations to hone reinsurance coverage
• Is responsible for the relationship between the reinsurer and the risk retention group

Other associated service providers often include consultants, auditors, and loss control specialists.

How are Risk Retention Groups regulated?

Risk Retention Groups are exempt from all state rules, regulations, and laws other than the state in which they are chartered. Additionally, Risk Retention Groups do not need to register under federal securities laws or state Blue Sky laws.

That said, any U.S. state has the right to require a Risk Retention Group to:

• Follow claim settlement practices
• Accept financial examination by other state commissioners should the home state not already have started the process
• Comply with state laws on trade practice
• Cooperate with delinquency or dissolution orders
• Pay applicable taxes and premiums

However, states in which Risk Retention Groups are not domiciled have no say over insurance-related services, investment activities, management, operation, rates and coverages, forms, or claims and loss control administration.

Conclusion

Risk Retention Groups exist to address the difficulty some businesses may encounter when it comes to getting liability insurance. While they are advantageous in that they provide a marketplace solution for these businesses, particularly in times when insurance is either challenging to afford or simply hard to find, keep in mind that they are still subject to certain state regulations such as anti-fraud or nondiscrimination clauses. In addition, Risk Retention Groups often find themselves on the hook to provide a deeper look into their financial picture to prove their solvency. In other words, let the buyer beware.

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