RRG Challenges

 RRG Challenges

The objective of the Federal Risk Retention Act was for a RRG to be regulated in its domiciliary state, with the right to operate in any state in which it registers. Over the years this has caused concerns among local state regulators, as non domiciliary states had very little control over RRGs operating in their states. Some put up road­blocks in requesting information. Others ignored registration re­quests, leaving the RRG unsure if it was licensed to write insurance in that state. The non domiciliary states' concerns have focused on inconsistent regulation of RRGs by the domiciliary state, including:

• Inconsistent reporting: RRGs are required to produce the stan­dard yellow blank filing, although some states allow RRGs to use a modified version.
• Captive vs commercial statutes: Some RRGs were licensed under traditional insurance laws with minimum capital of $2 million - $5 million. Others were licensed under captive laws with much lower minimum capital requirements.
• GAAP vs Statutory accounting: statutory accounting is used by traditional insurers and focuses on the claims paying ability of the insurer. Captives use GAAP, which looks at the business from the investor's perspective as a going concern.
• Other differences in accepted practices, for example Letters of Credit, Surplus Notes, Reserve Discounting, etc. None of these practices are normally accepted by regulators for traditional insurers, but they often are for RRGs licensed as captives.

The growth in RRGs in the past 6-7 years combined with the emer­gence of new US captive domiciles have added to the concerns. A large percentage of RRGs have been formed in the new domiciles, where the regulatory environment for captives is relatively imma­ture. RRG failures have added to the concerns, although the failure rate has been no greater than that of commercial insurers. 21 RRGs became insolvent between 1990 and 2003. This represents 6% of the total number of RRGs formed. RRGs licensed under captive laws have had a much lower failure rate than those licensed under captive laws.

GAO Report - In 2003 The House Finance Committee on Finan­cial Services asked the GAO to determine the impact RRGs have had and whether they are working as intended. This was a compre­hensive report with the findings issued in August 2005 in the report 2005 titled "Common Regulatory Standards and Greater Member Protections are Needed". The key findings from the report were:

• Although they represent a small part of the overall insurance market, RRGs have increased the availability and affordability of insurance for their members as was intended by the Act.
• There is a lack of common regulatory standards for RRGs across domiciliary states.
• The Act's provision for ownership control and governance may not be sufficient to protect the interests of the policyholders.

The problems of ownership control and governance were high­lighted by the GAO in some of the more notable RRG failures. In each of these cases, the common theme was the lack of control over the RRG by the policyholders.

•  Charter RRG Insurance Company (1987-1992): The managers of this group undercharged premiums to sell more policies and increase their own compensation. Individual Board members also had ownership interests in the manager and reinsurer. 
• Professional Mutual Insurance Co (1987-1994): The president was the sole owner of the marketing company and agency that had sole rights to sell to the RRG. Exorbitant commissions were paid for services which were never performed. 
• Nonprofits Mutual RRG, Inc. (1991-2000): It was alleged that the manager charged excessive fees. The manager was also in a position to exert influence as the principals loaned the RRG the start-up capital. The management contract was for 5 years with a one-year notice period. 

The GAO concluded that the problems of ownership control and common regulatory standards should be addressed by the states through the NAIC before Federal intervention.

NAIC Involvement - The NAIC responded by creating two com­mittees: the RRG (C) Working Group under the property and casu­alty insurance committee and the RRG (E) Task Force under the financial condition committee.

The RRG (C) Working Group focused on the ownership and gov­ernance issue. Its recommendations included:

• Boards should have a majority of independent directors. A poli­cyholder is considered an independent director.
•  The term of any material service provider contract cannot ex­ceed 5 years. 
• The regulator has 30 days to disapprove a service provider con­tract if it feels it is not in the best interests of the policyholders.
• The RRG must set up an audit committee. The regulator can waive, for example if there are only a couple of members. 
• The Board must adopt a code of business conduct and ethics. 
  

These recommendations were adopted by the parent committee but have never been implemented.The RRG (E) Task Force is focused on consistent regulatory stan­dards and is using the NAIC accreditation process as the platform. This process, which is voluntary, was set up in the early 1990s to establish a common set of regulatory standards across the states. They were created in response to a series of failures of commercial insurers in the 1980s and early 1990s. There are three parts to the accreditation process:

A.    Model Laws: 18 model laws were identified, including items such as audits, the need for actuarial opinions, minimum capital requirements, the right to examination, etc.
B.    The standard of the examinations and analysis conducted by the state regulators
C.    Staffing: whether the state has the appropriate regulatory staff.

Parts B & C were adopted for both traditional insurers and RRGs. Part A was not adopted for RRGs and the task force is re-examining the applicability of the Model Laws to RRGs. The task force is also looking at other regulatory standards beyond the 18, including items such as the use of risk based capital and the acceptance of reinsur­ance. The task force is about to issue a white paper for comment.

Through the Committee and Task Force the NAIC is addressing both the ownership and control issue and providing common regula­tory standards. Non domiciliary states, including the larger states sit on the NAIC committees and task forces and are having a say. This provides a mechanism to raise concerns and have them addressed. Problems can still occur and there have been a few recent cases in which non domiciliary states, particularly California, have chal­lenged an RRG's registration. Notwithstanding these cases, the work of the NAIC should make it easier for well run RRGs to regis­ter in non domiciliary states.