How Risk Retention Groups Differ from Captives

Editor's Note: Hylant Global Captive Solutions contributes this Thought Leadership article examining risk retention groups and how they differ from captive insurance companies.

The four anesthesiologists had been good friends in med school, so it was more than just a coincidence they settled in cities an hour or two apart. They continued to get together regularly to kayak, argue about sports, and share their frustrations with someone who understood them.

Malpractice insurance was a regular gripe. The four had all joined established practices, and while the doctors' practices faced just a handful of claims each year—many of them frivolous—all four were astounded at the regular jumps in their malpractice premiums. They had heard the explanations about insurers having to foot nuclear verdicts, but nobody in the four practices had ever faced that kind of judgment.

While talking with a colleague at a conference, one learned about forming a risk retention group (RRG) to cover most of their malpractice risk exposure. In legal terms, an RRG is a risk-bearing entity for writing liability insurance that can be created under the federal Liability Risk Retention Act (LRRA, or, as an insurance pro calls it, “Lara”). Put in more practical terms, an RRG is a risk management vehicle created by companies or professionals who face the same insurance risk. The RRG insures a portion of malpractice risk at a more favorable rate and can access the reinsurance market to find affordable coverage for unusually large claims.

Creating RRGs helps companies and professionals deal with two of the major challenges of the current insurance market. First, a well-structured RRG provides a comfortable level of coverage at a lower cost than comparable coverage on the market. Second, the RRG makes it easier for participants to obtain coverages that may be difficult to purchase from traditional insurers or extend beyond the limits those insurers are willing to cover. Additionally, RRGs give participants an incentive to reduce claims activity by emphasizing issues such as workplace safety.

It's important to note that depending on the state, an RRG may be considered a captive. Traditional captive arrangements generally involve a single parent insuring its risks and those of any of its affiliates. A captive can be structured to cover several types of risks, but an RRG is created around one common risk exposure (or common lines of risk). RRGs are owned by their insureds.

Unlike traditional insurance companies, RRGs are subject to less stringent regulation and capital requirements, as well as fewer consumer protection mechanisms. An RRG is allowed to register and operate in multiple states without facing the same compliance requirements of traditional admitted insurers domiciled in each state. They're only considered domestic insurers in the state where the RRG has been established and is domiciled. In most other states, where they're viewed as foreign insurers, they only have to register and pay necessary taxes.

That doesn't mean RRGs operate free from compliance. The legal requirements are different and there is greater scrutiny of specific aspects of the way they're managed. However, the RRG laws simplify the overall structure and give companies greater flexibility by being able to do business in all 50 states.

In addition to malpractice professional liability insurance, RRGs may be used for other forms of liability coverage, from transportation liability to general liability. The LRRA-extended RRG offers a long list of potential liability covers, including multiple perils, commercial, ocean marine and inland marine, auto and commercial auto liability, and farm owners. It's also possible to create an RRG to address group or individual medical, dental, and vision coverages.

What constitutes a "group" under the law? It's surprisingly flexible. A hospital system might form a group, as might the owner-operators who contract with a particular motor carrier. Independent contractors who operate under contract for large national transportation companies might band together with their peers in other markets.

A key advantage of the group approach is the knowledge and experience of the members. That gives actuaries a real-world picture of risks and claims activity, so they're better able to structure a vehicle focused on specific needs. The group approach allows for hyperfocused risk management and claims handling to address the liability insurance covered in the RRG. Many RRGs engage with experts to support driving down loss costs.

Keep in mind that the RRG's owners must be insured parties, and vice versa. Participants have an ownership interest in the RRG, and, depending upon how the group is structured, there is potential for the owners to receive annual dividends in years when total claims and expenses are below projections. That provides an incentive to keep claims low by encouraging loss prevention strategies.

Suggesting the creation of an RRG gave the four anesthesiologists a way to help their partners address liability requirements and provide peace of mind, all for less money than their malpractice insurers were extracting. In turn, it helped them keep the cost of their much-needed services lower for their patients and their communities.