Throughout the challenges the insurance industry has thrown at business owners, one of the toughest problems has been security against future claims, and another is regulatory approval. These challenges are becoming intertwined in a titanic struggle in the insurance industry which plays out as the Feds vs. the states.

To clarify, all insurance policies must provide to regulators sufficient evidence of ability to pay claims in order to operate in a given jurisdiction. All would agree that this is a good thing. This certitude can be in the form of the public strength of the issuing admitted and rated insurance carrier, or from letters of credit or other forms of security. Many professionals spend a great deal of brain power and time to be certain that there is a reasonable probability of those payments being made.

Inasmuch as fronting (a risk-sharing partnership between a licensed primary carrier and a captive) continues to be a challenge to everyone in the captive community, we are seeing more prospects investigate risk retention groups. RRGs, while a form of captive, do not require a risk-sharing partner as a front.

RRGs were created under the 1981 Product Liability and Risk Retention Act, revised in 1986. The act contains exclusions, exceptions and exemptions to state insurance statutes and regulations. State regulators often have a problem with these exemptions and exclusions. A particularly troublesome exemption is from state insurance taxes and fees for supporting pools and assessments.

While not new, risk retention groups have not been as attractive a solution as captives because of inherent limitations on lines of coverage in the act. RRGs are not permitted to cover workers' compensation, personal lines, health insurance or property exposures among other limitations. The original intent of Congress was to address a product liability crisis of the late 1970s and early 1980s. RRGs did address that crisis.

When the act was passed by Congress, it was a significant move into the longtime protected practice of state regulation of insurance companies. The urgency of gaining some rational response to excessive litigation in regard to liability for the manufacture and sale of products prompted the move. The act saved companies and jobs.

But the states rights lobby is a powerful and compelling one, so Congress stayed away from additional excursions into the regulation of insurance companies (more or less) until recently when under pressure from many insurers unhappy with regulatory delays and bureaucratic morasses. The Gramm-Leach-Bliley Act was passed to force states to produce some consistency in regulation and pace of approvals.

The states were given two years to comply, and compliance was set as a majority of the states by number. That number was met in a timely fashion, with 35 states complying by the deadline. However, the states not complying include the states with the most policyholders: New York, Pennsylvania and California, among others.

As these roadblocks to commerce have arisen, RRGs have become a reasonable alternative, particularly for the medical professions. Several states have developed expertise in licensing RRGs, and as a solution the RRG model provides a good choice. But with the limitations on lines of coverage and the burden of letters of credit against projected future losses, and now mounting state regulatory interference, again commercial consumers must face problems not of their making.

In order to exist, an RRG must receive approval from one state and then be accepted to do business by all other states. This is not always enthusiastically accepted.

Beyond the tax issue, some regulators have legitimate concerns about the ability of some creatively formed RRGs to pay claims against the policies issued by the RRG. In order to be certain of claims paying ability, the regulators require a rigorous procedure culminating in acceptance to do business in our state. If this procedure is replaced by a federal act, however, the regulators perceive a loss of control.

The unfortunate and very public demise of an automobile warranty RRG, operating under grandfather provisions from the Cayman Islands, has exacerbated this debate. In my view the failure of the RRG being discussed had nothing to do whatsoever with structure or domicile, but it enables others to have a wonderful platform to urge restrictions or reforms on RRGs, depending on their bias. I would expect to see something come out of Congress this year, although insurance is not a great sound bite in an election year.

As the coming battle moves toward a more open forum, some states have taken more aggressive postures. One prominent state with many policyholders and numerous insurance challenges has decided to compel RRGs to have a very large amount of capital–$18 million–and a rating from A.M. Best & Company in order to operate. I will leave other, more qualified people to determine the legitimacy and sustainability of this restrictive move, but in terms of another burden to legitimate risk finance, this is a very destructive choice.

The looming battle for regulatory rights carries the potential for yet another impediment to legitimate and rightful commerce. If traditional carriers have chosen to retreat from some lines of coverage and types of risk such as anything to do with medical or professional malpractice–which is certainly their right and duty to shareholders–then it would seemingly behoove regulators to foster alternatives rather than create obstacles.

At the National Association of Insurance Commissioners meeting this month, the organization representing state regulators, there will be considerable discussion about these issues. We can only hope that fostering commerce will be at the heart of the agenda.

Michael R. Mead, CPCU, is director and a former chairman of the Captive Insurance Companies Association as well as vice president and director of the Arizona Captive Insurance Association. He also is president of Crusader Captive Services, a newly formed alternative risk consulting company, a member of the Crusader International Group, comprised of several domicile managers and intermediaries. See www.crusadercaptiveservices.com for more information..

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, March 12, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.