On their own: risk retention groups provide coverage and stable costs for physicians and hospitals facing higher insurance premiums.

The popularity of risk retention groups, a type of captive owned by its policyholders and authorized to write only liability insurance for its owners/policyholders, is growing in the health-care industry, where doctors and medical facilities have been facing sharply higher rates for professional and general-liability insurance.

Most noteworthy is the rising wave of risk retention groups formed for physicians who are seeking alternative-risk solutions to paying sometimes higher medical-malpractice premiums. "The physician RRG growth has been outpacing the risk retention groups for health-care facilities," said Robert Allen, vice president of operations for health care at Zurich North America. "While health care as a whole has been struggling, the medical professional-liability needs of physicians seem to be more critical than those of the other classes."

Nationwide, 49 new medical-liability risk retention groups were formed in 2003, and two later became inactive, according to The Risk Retention Reporter. Of these, 17 were formed in Vermont, said Molly Lambert, president of the Vermont Captive Insurance Association.

Converging Issues

Fueling this increase are the same factors now affecting many other lines--availability and affordability, Allen said. "For physicians, there have been a number of carriers exiting from that class of business," he said. "For hospitals, especially those in high-risk venues, affordability is really the driving concern. And long-term-care facilities have been struggling with both availability and affordability for some time."

The American Medical Association has declared 19 states to be in a medical-liability "crisis," with rising premium rates forcing doctors to move to other states, drop such risky specialties as neurosurgery and obstetrics or quit practicing medicine altogether.

Brian Engel, senior vice president of Benfield Group and head of its health-care practice group, is involved in placing reinsurance for companies that write medical professional-liability business. His clients range from stock and mutual insurance companies, to risk retention groups, reciprocals and other captives. Engel, too, has seen more demand from doctors and hospitals for help in forming risk retention groups. In some cases, this is due to the steady narrowing of the medical-malpractice market, with a number of large companies, notably St. Paul Cos. and Farmers Insurance, as well as regional insurers, opting to exit this line.

At the same time, Engel said, rate levels have risen dramatically in response to loss experience. With that, a lot of the current carriers that are active also are stretched, he said. "They're basically saying they've got rate increases but at the same time they can't write all the business that they might want to because of financial constraints," Engel said. "A lot of those carriers have become much more selective in what they're doing-only writing business in certain states or only for certain types of physician specialties, or not writing hospitals anymore, or only writing large hospitals, or only small hospitals."

This has meant that many physicians, surgeons, hospitals and nursing homes have found themselves simply without a carrier or, if they have a carrier, the coverage is extremely expensive, he said. "They're looking for an alternative, and risk retention groups are a possible alternative," Engel said.

For Zurich North America, the growth in risk retention groups in health care means finding new program structures to help its clients' assumption or appetite for risk, Allen said. The company sees this as a positive trend. "From our perspective, the risk assumption means that there's more attention being paid to the loss activity," Allen said, "and obviously a facility that pays attention to reducing losses could be considered a preferred risk."

With some of the recent submissions, Zurich North America has noted more premium involved. Instead of considering, say, a single hospital in Pennsylvania as a candidate for a risk retention group, Zurich North America is seeing interest by a group of 10 hospitals in that same venue and the premium and loss implications associated with that. "From an operations perspective, it's meant fine-tuning our guidelines of working with captives and understanding their financials, or at least understanding the credit risk associated with unique structures," he said.

For years, Zurich North America has been working with hospitals that have dedicated trust funds as well as single parent captives. During the past couple of years, that involvement has expanded into segregated cell captives off shore and risk retention groups domiciled in the United States. In this regard, the company can provide the issuance of compliance policies--or primary policies that might be mandated by a state insurance department--the reinsurance of captives and traditional excess insurance for members in any risk retention group.

Health-care institutions rely on a company like Zurich for several reasons, Allen said. As start-up insurance ventures, they're not going to have the financial wherewithal to provide high limits for each member. So the financial demands to provide those excess limits usually steer them toward commercial markets. Also, in some states, health-care institutions are mandated either by an insurance department or a health department to provide primary insurance through regulated insurance carriers that are domiciled in that state or at least within the United States, Allen said. A basic policy might cover $200,000 per claim, or $600,000 aggregate, within the primary layer. "The offshore captive cannot provide that policy," he said. "In some cases, it may just be a matter of maintaining coverage through a highly rated commercial carrier for anything from keeping their bond ratings at a certain level, to loan covenants or maybe even lease obligations."

How They Work

Risk retention groups are authorized under the Federal Liability Risk Retention Act of 1986, and membership in these groups is limited to similar businesses exposed to similar risks. The purpose is to assume and spread liability exposure to group members and to provide an alternative risk-financing mechanism for liability.

"The beauty of the risk retention group is that it is a federal law that preempts state law, making it unnecessary to have a front carrier," said Dow Walker, chairman of Willis Group's health-care practice group. Fronting is an arrangement a captive insurance company makes with a licensed commercial insurer so admitted coverage can be issued to the insured. The risk is then transferred from the fronting carrier to the captive through a reinsurance agreement.

The front carrier must be a state-approved primary carrier with a financial rating acceptable to hospitals or other facilities. Most hospital bylaws state the limits of liability that staff physicians must have and require them to have coverage from a highly rated insurer, Walker said. A pure captive won't meet those criteria, so there needs to be an approved carrier in front of the captive to issue the paper, he said.

But the number of insurers actively fronting for captives has decreased. The biggest players, according to a 2002 survey by Captive Insurance Companies Association, are Ace, American International Group Inc., Liberty Mutual and Old Republic. Reliance Insurance Co. and Frontier Insurance Co. had an active fronting business, but both of those insurers were taken over by regulators in 2001.

The few insurers willing to front these days are demanding higher collateral, making it almost prohibitive to find a front, Walker said. "Physician groups or physicians that want to sell: insure or form their own company are looking to the risk retention group because it eliminates that first step of having a fronting company, which can be very difficult to negotiate," he said.

Walker crafts this scenario: Several hundred doctors on staff at the same hospital determine that their coverage is inadequate or too expensive. They decide to create their own insurance facility. They have the option to form a captive insurance company, either onshore or offshore, but that would require an admitted front to issue the paper, with the captive reinsuring that carrier in order to provide the quality paper that their hospital requires. The alternative is to form a risk retention group, which only needs to meet the requirements of the federal law with respect to being approved in one state, in order to be admitted in other states.

He pointed out that the saving grace of risk retention groups isn't necessarily lower premiums, at least not at first. "There's no silver bullet to forming a risk retention group with respect to immediately reducing the cost," Walker said. Forming one of these groups requires start-up capital. There also are organizational and administrative costs, as well as the need to purchase reinsurance, he said.

"What it does do, though, is create availability, create stability and a long-term hold on their future," Walker said. "The primary objective for an individual physician is to create a long-term asset, that is, ownership in a company that's going to provide stable coverage for him and not let him get caught in market vacillations in the soft and hard market, with increases and decreases in premium."

Long term, there should be lower premiums for the insureds in a risk retention group if part of the goal is to provide insurance at cost or something close to cost, Engel said. But a problem exists in that medical professional liability is hard to price because an insurer may not know its losses in this line for four to six years or even longer, Engel said. "If you have a commercial insurer, they want a fairly big profit load in their premium, which shouldn't normally be there with a risk retention group," he said. "But in the short term, no one has a good feel for whether their premiums are really right or not."

Walker and others acknowledged that a soft market and the prospect of federal medical-liability reform could lure some physicians in risk retention groups back to the traditional insurance fold. First off, risk retention groups are apt to take advantage of the softening of the market by buying down their retentions or getting more favorable reinsurance rates, said Brenda Olson, president of ORG Captive Management in Bigfork, Mont. "If they can buy down the RRG's retention from $250,000 to $100,000 at the same price they're paying for coverage in excess of $250,000, they'll probably do that," she said.

But while Olson sees the potential for losing those members who are out to find the lowest price regardless, she questions if these risk retention groups will go out of business. "When it comes to the health-care field, so many of these providers are just fed up with the commercial insurance market, because the prices go up and the prices go down" she said. "I believe there still will be a sizable segment of the market that wants to take matters into their own hands."

Walker thinks that those who have formed a risk retention group for the "right reasons"--to create availability and stability and not to try for lower premiums--will probably stay with the group even after the market softens, he said. "When the market turns, they'll benefit from lower reinsurance terms, and they'll probably remember that the reason they created this vehicle was for long-term stability, not just to get a first-year, second-year lower premium," he said. "They did it so that in 10 years when the market turns again, they won't have to worry about it. So if they create the risk retention group for the right reasons, and they have the right motivation, these risk retention groups will stay, they will be successful and these physicians will be taken out of the commercial market forever."

That has been the story for the physician-owned mutuals started by medical associations in the late 1970s, he said. Now these companies provide about 60% to 70% of the U.S. malpractice business, according to the American Insurance Association.

"The truth of the matter is, the commercial carriers have totally abandoned the market for individual physicians and small groups," Walker said. "They're saying this is just not something they can do, because one of the most important elements in understanding physician coverage is territory, understanding the locale, understanding the practice of medicine within a state or region, and being able to maintain your premiums"

Time Factor

One advantage to risk retention groups is the relative ease with which they can be established, Engel said. They are indeed easier to form than a traditional insurance company, Lambert agreed. In Vermont, for example, those who wish to form risk retention groups must first find a management company to work with to create a business plan and carry out a feasibility study, before meeting with one of Vermont's regulating team to obtain a license. Once an application is filed, Vermont generally can move on it within 45 days, she said. However, that doesn't take into account the time needed to make the decision that a risk retention group is the appropriate risk-management mechanism to meet the needs of the insureds. "It's not a quick thing," she said. "The formation of a captive insurance company or risk retention group is a long-term strategy."

As popular as Vermont is for domiciles, some groups are finding the waiting lists there and in South Carolina, another favored domicile, to be fairly long, Olson said. That means that states like hers, Montana, one of the second-tier captive domiciles, may now be attracting more interest.

That was true for 16 long-term-care facilities in Pennsylvania and Ohio that recently decided to create a risk retention group in Montana. The group, managed by ORG Captive, became licensed by Aug. 1, 2003. They formed a risk retention group because they were facing increases as high as 220% in professional- and general-liability insurance rates, Olson said.

Now, with their new structure, they are relying on their own resources. "They love the amount of control that they have over the risk management process and the claims process," she said. "And one of the things they tend to say quite frequently is, 'It's such a relief to know that we'll never get a cancellation notice in the mail.'"

Olson said interest in risk retention groups is picking up in Montana. A year ago, she wasn't getting any inquiries, but lately she's been receiving them at the rate of one a week. She has been involved in helping other risk retention groups in the formation process, and their licensing is still in the works, she said.

Those who succeed in forming a risk retention group are, in effect, becoming insurers, Lambert said. "You are much more heavily invested in the outcome of that insurance company than you would be in the traditional market," she said. "So becoming astute and knowledgeable about how to be a good member of a risk retention group is probably a time-consuming challenge, but once done, there are enormous benefits in the long term."

Of 140 risk-retention groups in the United States, 70 are domiciled in Vermont. In that total, the state's 40 risk-retention groups writing medical-malpractice primarily provide coverage for the first $500,000 or $1 million of liability. "That layer obviously is easier to predict and it limits RRGs' exposure to large, unexpected claims," Lambert said.

In addition to increasing in number, risk retention groups also are being used by a wider variety of industries, Lambert noted. Two outstanding risk retention groups in Vermont include United Educators, which insures 1,200 colleges and universities for their liability risks, and the Housing Authority Insurance Group that insures housing authorities across the United States. "These groups are doing an enormous public good by supporting these types of industries," she said.

"Risk retention groups are a good way for like-minded industry members to be able to come together and gain the advantage that volume can provide," Lambert said. "It's a good opportunity for them to look at their risk management strategies differently."

The Other Side

But the biggest downside to risk retention groups is that the insureds do not have access to a state guaranty fund, meaning that if a group has financial difficulties and ultimately goes insolvent, the insureds can't look to their state fund for payment for some amount of the claim, Engel said. "They have to rely on the financial wherewithal of the RRG on its own, without any state backup," he said.

"The up-front costs to policyholders may be higher, the coverage is limited to liability insurance, the capital you have to invest is at risk," Lambert said, adding that one bad loss year could have repercussions. As with any significant decision about risk management, the pros and cons must be weighed with care, she said.

Olson pointed out that "as an owner, you carry some financial risk if the RRG has poor results. On the other hand, you also gain some benefits directly as an owner when the risk retention group does well," she said.

Insolvency is a concern with these groups because of the lack of state financial backing, but it remains rare. In fact, risk retention groups have performed comparably to licensed commercial insurers over the past 15 years, according to the Council of Insurance Agents & Brokers. Of the 142 risk retention groups formed between 1986 and the end of 2001, 15 became insolvent-12 of them between 1987 and 1989--a failure rate of about 1.5% a year, the CIAB said.

A recent example, which occurred in 2003, involved risk-retention groups that were part of Reciprocal of America and Reciprocal Group, based in Virginia. As regulators in Virginia moved forward with their proposed liquidation of Reciprocal of America and Reciprocal Group, Tennessee regulators acted to place three liability companies domiciled in that state under administrative supervision. The three--Doctors Insurance Reciprocal RRG, American National Lawyers Insurance Reciprocal RRG and Reciprocal Alliance--represent groups of professional-service providers who pooled resources to provide their own insurance. They solely write malpractice insurance and were reinsured by Reciprocal of America.

Another RRG collapse in 2003, that of National Warranty Risk Retention Group, which covered dealers and administrators for vehicle service contracts issued to buyers, has prompted an inquiry by the National Association of Insurance Commissioners. An NAIC working group is reviewing this insolvency and other issues related to state oversight of RRGs as proponents urge Congress to expand the scope of these captives to include property risks.

To Allen, risk retention groups hold no guaranteed advantages or disadvantages. "It's always going to depend upon the management group of the risk retention group," he said. "The idea of accessibility, the capital contributions, mandated coverage terms--these are going to vary from case to case. Sometimes they can be perceived as advantages; others could hamper long-term viability, especially for a smaller risk retention group."

In many ways, Engel noted, the basic components of risk retention groups resemble those of a regular stock company, mutual or reciprocal. "It still has to have sufficient capital, adequate rates, appropriate underwriting standards and good claims handling," he said. "If those things aren't there, then ultimately it's not going to be successful, just as other forms of insurance companies haven't been."

Risk Retention Group Premium

Risk retention group premium has been rising for the
pat 10 years.

($ Millions)

1994     $585.8
1995     $575.5
1996     $707.6
1997     $751.9
1998     $790.5
1999     $875.3
2000     $775.5
2001     $944
2002   $1,265.1
2003   $1,725.5

Source: The Risk Retention Reporter.

Note: Table made from bar graph.

Risk Retention Group Growth

The number of risk retention groups has almost
doubled in the past 10 years

1994    74
1995    68
1996    68
1997    68
1998    70
1999    67
2000    65
2001    69
2002    90
2003   141

Source: The Risk Retention Reporter

Note: Table made from bar graph.