Group solutions-Part II

Rough Notes, Jul 2002 by Moody, Michael J

ENTERPRISE RISK MANAGEMENT

Growth of new options allows more small firms to access the alternative market

Last month we looked at one of the most viable group risk financing approaches for dealing with the (current hard market-the risk retention group (RRG). While the original federal legislation authorizing the use of RRGs was enacted in 1981 and amended in 1986, the current hard market is ideally suited to further RRG formations. The current lack of fronting carriers should serve to greatly increase the attractiveness of the RRG option, since RRGs do not need fronting carriers. It is generally believed that interest in RRGs will be greatly increased should Congress expand their scope to include property exposures.

Risk purchasing groups

As favorable as the federal RRG legislation has been, RRGs represent only half of the available solutions under the federal statutes. The same federal law that allows risk retention groups also allows for the formation of risk purchasing groups (RPGs).

And as successful as RRGs have been, implementation of RPGs would have to be considered wildly successful. The January 2002 Monthly Update from the Risk Retention Reporter notes that there are currently 758 RPGs.

Differences between the risk retention groups and risk purchasing groups are significant. However, some of the underlying concepts are the same.

Exposures for either group are limited to public liability, and either group alternative must be comprised of businesses with similar insurable risks (i.e., homogeneous risks).

However, while the RRG requires the formation of a licensed insurance company including capitalization and regulatory approval, the RPG does not require similar commitments.

Any homogeneous group or association that wants to purchase its liability coverage on a group basis can form an RPG. Once the group has been formed, it contacts a traditional insurance company and agrees to have the insurer offer coverage to the members. Additionally, the RPG notifies each state's regulatory authority of its intention to purchase liability insurance as a group; however, there is no regulator approval to be obtained.

Since the RPGs were included in the federal RRG legislation, insurance companies are free to offer groups pricing advantages that are available only via group purchasing power. Additionally, carriers are able to bypass many state rate and form requirements, as well as other intrusive state regulations. At the end of the day, by banding together via an RPG, businesses with similar liability exposures can obtain pricing concessions that are typically reserved for only the largest accounts. This formula has proven successful over the past 15 years; and, given the ease of entry and lack of capital commitment required, one would expect RPGs to continue to flourish in the upcoming months and years.

Rent-a-captive

As smaller firms began to consider group captives, it soon became obvious that some of these companies would not be in a position to make the commitment needed to be a member of a group captive concept. While a few of these companies liked many of the aspects of the captive concept, they did not have the ability to make the financial commitment, or be involved in the active management, etc. While this would normally preclude them from the captive option, they found they had other options to consider such as the "rent-acaptive" alternative. Several enterprising organizations were able to see interest in the captive concept, as well as the inability by some companies to move to captives, and decided to capitalize on it. Accordingly, they formed their own captives and "rented out" their capacity to interested third parties. Interest in this "rent rather than buy" concept ran high when it was originally introduced. While the general liability and property insurance markets have managed to sustain soft pricing over the past 15 years, the workers compensation market experienced market hardening several times through that 15-year period. And during that time, rent-a-captives (RAC) gained a number of insureds.

The RAC concept is quite simple. An unrelated, third party forms a captive insurance company with the expressed purpose of "renting" its capacity to outside risks. For the insureds that participate in the RAC, the decision becomes a classic "rent vs. buy" financial equation. While RACs were formed by a number of different organizations, most were formed by brokers, insurance companies, financial services providers, and other insurancerelated, third-party vendors. While several of the early RACs came to the attention of the market, one group obtained the lion's share of the new business. The group, Mutual Risk (MRM), and its sister company, Legion Insurance Company, developed an approach that required them to work through independent agents.

Their proposals and presentations were well documented and delivered and were typically well received.

However, the prolonged soft market required Mutual Risk to provide competitively priced premiums, and recently they have encountered serious problems with their reinsurance recoverables. As a result, both Legion and MRM are inactive in this arena at the current time.