Leane Rafalko, audit manager at RH CPAs, explains how risk retention groups work and the benefits they can offer over other forms of insurance

Risk retention groups are booking right now with the level of formations not seen in decades. Indeed, for good risks they can assist with lower premiums, especially in a hardening market as we are experiencing and they can allow for easier third-party marketing, inherently not subject to the rules captives are subject to in regards to related risk.

Definition of an RRG

A risk retention group (RRG) refers to a domicile or state-chartered liability insurance company that is owned by its members.

The members of the RRG can be called the purchase group, in which we find businesses, professionals or cities entitled to the insurance offered by the RRG.

As provided by the Liability Risk Retention Act, an RRG must have a chartered state, which is the state in which it is domiciled.

RRGs base their modes of operations in accordance to the laws of the Liability Risk Retention Act, which limit coverages RRGs may write.

The RRG industry has been booming recently as markets have hardened and insureds with good risks look to minimise premium increases and potentially receive a dividend or premium reduction. RRGs do not participate in state guarantee funds, therefore there is more risk to policyholders.

If a policyholder buys a policy from a commercial carrier and the commercial carrier goes bankrupt, then the state-guarantee fund steps in to ensure policyholders are protected.

RRGs look, feel and act like commercial carriers but they are primarily regulated under state captive statutes.

However, the National Association of Insurance Commissioners (NAIC) which regulates the state domiciles has model regulation which must be followed to maintain accreditation.

• RRGs differ from commercial carriers, from an accounting standpoint. They can fi le under ‘generally accepted accounting principles’ (GA AP) which typically provide for a higher surplus than statutory reporting principles.
• RRGs don’t contribute to a state-guarantee fund and the insureds can’t benefit from the same funds.
• RRGs are not required to obtain a licence from the states in which it writes such as commercial carriers, but they must notify the state it is writing in.
• RRGs are examined by its domiciliary state similar to commercial carriers. How can RRGs work? Sometimes a managing general agent (MGA) recognises they are assisting in putting forth programmes with low loss ratios.

Therefore, the MGA recognises the opportunity to sponsor an RRG, thus adding value to the member in the way of lower premiums or perhaps dividends. An RRG may market to complete third parties (who become owners/members), dissimilar to traditional captives which require some relationship to the insured.

This then makes the RRG some kind of hybrid between commercial carriers and captive insurance companies, which is one of the reasons there is a flavour of account and regulation of both.

Sometimes, a single operating company, such as a hospital system, may form an RRG to write insurance in the multiple states the company operates in, and sometimes, with a non-profit, the RRG does not qualify as an insurance company on the basis there is no risk transfer from an Internal Revenue Service standpoint.

The RRG is then simply used to facilitate self-insurance from a regulatory standpoint. Non-profit organisations tend to use this model as there is likely no risk transfer, therefore there will be insurance for regulatory purposes but not for Internal Revenue Service purposes.

A group of homogeneous type risks can also sometimes get together and decide they are better to insure themselves and, just as with the RRG model, better than a group captive. However, the end insurance result is just the same.

The typical payment to an RRG consists of two components, one is a capital contribution and the second is an insurance premium.

Essentially, if you have a $20,000 total outlay, only 90% may be an insurance premium and the remaining 10% is an equity contribution.

This can be different from one risk retention group to another, though. On the insured’s financial statements, those two items should most likely be treated in different ways, the equity contribution component, assuming it can be redeemed, should be treated as an asset as opposed to an expense, and the insurance premium component as an expense.

These classifications are governed by the document which discusses how a member may redeem his capital upon exiting the risk retention group or when one is shutting down. This distinction, we believe, is often overlooked.

Conclusion

When a group of companies can assist in financing their risk together, much like mutual fire insurance companies did at the beginning of insurance, and do so at a better rate than commercial carriers, insurance costs are less.

One challenge in these types of primarily homogeneous pools is ensuring members are doing a good job in their risk management/loss limitation strategies.

It is kind of a no brainer that if 20 companies in similar industries can come together, each having a historically low loss ratio, they should ensure themselves, and get the benefit of a lower premium or dividend, where in a commercial carrier the good risks simply assist in funding the commercial carriers’ ability to write poorer risks.

And perhaps, most importantly, the ability to control claims costs rests with the board of directors and management, which provides additional control over claim costs.