Expansion of the Risk Retention Act of 1986

INTRODUCTION

Earlier this month bill HR 5792 was introduced that would expand the existing provisions under the Risk Retention Act of 1986 to allow Risk Retention Groups (RRG) and Risk Purchasing Groups (RPG) to include property risks in addition to liability risks already provided under the existing act. This will effectively be the third revision of this legislation that was originally passed in 1981 as the Products Liability Risk Retention Act and subsequently amended in 1986 to apply to all casualty risks except workers compensation. In the case of both the original legislation and its subsequent expansion in 1986, the catalysts for adoption were the lack of coverage availability or excessive cost through the commercial insurance market. It is this same market condition relative to property risks capacity that today gives rise to this new legislation. Importantly, this new legislation will also address some shortfalls in the prior legislation concerning governance and solvency matters not adequately covered in the prior legislation. In addition, it reaffirms the foundation that RRGs are exempt from laws of a State other than their chartering State.

PROPERTY RISK EXPANSION

The extension of the Risk Retention Act is officially known as “Increasing Insurance Coverage Options for Consumers Act of 2008”.While allowing commercial property risk coverage including excess insurance, business interruption and consequential damage, it also places some specific limitations. Namely, the RRG must comply with the “corporate governance standards” (contained in Section 8 paragraphs (1) through (7) see below) before any existing or new RRG or RPG could write property risks. In addition, states* may prohibit RRGs from “underwriting any single risk exposure, such as wind in a coastal region or earthquake coverage on a single fault that could impair the group’s capital” and ”may impose minimum standards for size or sophistication of members” and “establish solvency requirements” for RRGs.

*this would be the chartering state where the RRG is licensed and domiciled

NEW CORPORATE GOVERNANCE STANDARDS

The Act will impose business conduct and governance standards on all new or existing risk retention groups. The latter have 18 months to comply but to write property risks, the RRG must first establish a compliance program. A general description of the governance standards include the following:

• Board of Directors to have a majority of independent directors, generally meaning that to qualify as an independent director, he or she has no material service relationship (i.e. service provider) with the RRG;
• Service Provider Contract(s) generally must be limited to 5 years with approval of regulator in state of domicile (i.e. captive managers, auditors, lawyers, etc.);
• Written Charter by Board in form of Bylaws on performance standards;
• Creation of an Audit Committee with written charter and review;
• Governance Standards to include director elections, qualifications, responsibilities, compensation, etc.;

• Business Conduct and Ethics code to be adopted including disclosure process for conflicts of interest, fair dealing, confidentiality, etc.;
• Reporting Non-Compliance to state regulator;
• Enforcement by state of domicile against RRG or manager for violations of governance standards

The above governance matters were raised in August 2005 in a General Accountability Office (GAO) report (GAO-05-536) so Congress is trying to address these operational deficiencies at the same time it expands

the lines of coverage that RRG’s can write. The commercial insurance company market probably welcomes the former but will consider the latter a further encroachment on their business with an unfair competitive advantage.

OUTLOOK 

We would expect this legislation to pass Congress and become law. The current commercial “property crisis” has become less severe then 2 years ago and perhaps not as widespread as the “products liability crisis” that was the catalysts for the 1981 Act or the “general casualty crisis” that spawn the 1986 Act revision. However, the current legislation is aimed as much at addressing some of the perceived abuse of governance matters never considered in the 1981 or 1986 federal laws, as it is expanding the coverage for RRG and RPG development. We are now witnessing a less restrictive commercial property market with an outlook of even better terms ahead. Coastal exposed risks however, are still under less competitive terms so enactment could help those organizations. The governance standards will help to insure that the legacy of any RRG will be the real value created by and for the insured participants and not driven by the wealth of service fees, commissions and other costs that vendors and service providers earn in facilitating the operation of the RRG. This is much needed legislation so that RRG participants get the respect they deserve as a self-help mechanism.