The National Association of Insurance Commissioners is "really interested in RRGs and changing the way captive domiciles regulate RRGs," he said. "Many states never accepted the federal Risk Retention Act and have even ignored it." Those same states, he said, have argued that the intent of the federal law was to regulate RRGs as traditional insurers rather than as captives.

Captive domiciles, on the other hand, have regulated RRGs as captives–using different standards for captives and RRGs than for standard, state-licensed insurers–"which these states say violates the spirit, if not the intent, of the federal law," he said.

Mr. Sheppard explained that some insurance regulators are attempting to change RRG standards to those applied to traditional insurers through the NAIC's accreditation process, which rewards states for adhering to a group of core NAIC model laws and penalizes those that do not.

Instead of going back to Congress to modify the law authorizing RRGs, which could give them a result they may not be happy with, state insurance regulators are taking "a back-door approach by saying to states, 'If you are going to continue to be accredited and be in good standing with the NAIC, you are going to have to regulate RRGs more like traditional companies,'" he said.

Tim Wagner, director of the Nebraska Insurance Department and chair of the NAIC's Property-Casualty Insurance Committee, said he has nothing against RRGs, but that RRGs need uniform regulatory standards. As it stands, RRGs are granted "national access with minimal regulation," he said.

Mr. Wagner noted he has an issue with RRGs that are not owned by their members. One example was National Warranty, he said, which owned 99 percent of the stock of the RRG and controlled the board. The remaining members, more than 500, owned only 1 percent. Nebraska was severely affected by National Warranty Company's failure, which he called "the crowning blow" to current RRG regulation.

National Warranty acted as a third-party administrator for its members' program. It was regulated by the Cayman Monetary Authority under the 1981 Risk Retention Act and declared insolvency in 2003. The 1986 Risk Retention Act mandated that RRGs be domiciled in the United States.

Mr. Wagner added that there are other instances where "interests of the management of the RRG and the interests of the members may not be the same." He cited failed medical malpractice RRGs in Tennessee and Virginia, where losses "will be $200 million," he said. "Who will pay that?"

Mr. Wagner said he personally believes in RRGs, surmising that the insurance industry "will be capital starved." He added: "We need to have as many mechanisms to handle risk as we can find. There is a perception that because you want standards that you're against something, and that is simply not true."

The standards in question include accounting methods and various ratios–such as a requirement that no one risk can represent more than 10 percent of the entity's surplus. "Those things where we tend to be more flexible on the captive side, they want us to impose stricter, more conservative NAIC standards," Mr. Sheppard said.

The big area for RRG owners is GAAP versus statutory accounting, Mr. Sheppard noted. "Because in many of the captive states, we use a modified GAAP, where you can organize a company with letters of credit and surplus notes, but you can't use surplus notes and letters of credit to provide the initial capitalization for a traditional company," so by strict statutory accounting standards this would not be permitted, he explained.

Another area is deferred acquisition costs. In statutory accounting, all start-up costs must be expensed the first year of operation. Under the GAAP method, however, those costs can be expensed over a period of time. Other changes eyed by the NAIC include risk-based capital calculations and the credit for reinsurance law.

Washington's position, he said, is that "in some areas we would be willing to agree to more uniform standards. But the three big areas for us, where we would like to see flexibility, are the use of GAAP accounting, credit for reinsurance and flexibility with some of the ratios, including the risk-based capital calculation."

The NAIC currently is in the process of going through each of the standards to "come up with the ones that should apply to captives and the ones that shouldn't," he said. He noted that the majority of the commissioners want to move away from captive-style regulation to traditional regulation of RRGs. "There is a lot of momentum and it looks like this will happen," he said.

If this does become a reality, he noted, some of the benefits that "risk retention groups now enjoy would be done away with."

Many RRGs, he said, are just now getting involved in this issue. RRGs need to come up with alternative ideas, voice their concerns and let the NAIC know "how these changes could impact the way they operate." These changes would most affect doctors, nursing homes, hospitals, builders and the transportation industry–"all of the industries that still have a hard market, that have turned to RRGs for relief," he said.

The best way for RRG owners to get involved is at the association level, he said, adding that it is important for owners to be heard. "It's one thing to hear it from an attorney or manager who makes a living this way," but it's another thing for an owner to say, "'RRGs have provided solutions in many of the hard markets,'" he added.

Flag: Recap

Head: What's The Beef?

Those who oppose greater state regulation of risk retention groups say there are some areas where they would be willing to live with more uniform standards. Opponents, however, draw the line on three points:

1 The use of GAAP accounting, with particular concern about the use of surplus notes and letters of credit to provide initial capitalization, as well as treatment of deferred acquisition costs.

2 Credit for reinsurance.

3 Flexibility with some of the benchmark ratios, including risk-based capital.