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United States Government Accountability Office:
GAO: 

Report to Congressional Requesters: 

December 2011: 

Risk Retention Groups: 

Clarifications Could Facilitate States' Implementation of the 
Liability Risk Retention Act: 

GAO-12-16: 

GAO Highlights: 

Highlights of GAO-12-16, a report to congressional requesters. 

Why GAO Did This Study: 

Congress authorized the creation of risk retention groups (RRG)-—a 
group of similar businesses that creates its own insurance company to 
insure its risk—-to increase the affordability and availability of 
commercial liability insurance. Through the Liability Risk Retention 
Act (LRRA), Congress partially preempted state insurance laws to allow 
RRGs licensed in one state (the domiciliary state) to operate in all 
other states (nondomiciliary states) with minimal additional 
regulation. In a 2005 report (GAO-05-536), GAO noted concerns with the 
adequacy of RRG regulation. This report (1) describes changes in the 
financial condition of the RRG industry from 2004 to 2010; (2) 
examines the regulatory treatment of RRGs across domiciliary and 
nondomiciliary states; and (3) examines changes to federal and state 
regulatory practices regarding RRGs since 2004. GAO analyzed RRG 
financial data, surveyed state insurance regulators (96 percent 
response rate), and interviewed RRG industry representatives. 

What GAO Found: 

Certain indicators suggest that the financial condition of the RRG 
industry in aggregate generally has remained profitable. In 2003, RRGs 
wrote about $1.8 billion, or 1.17 percent of commercial liability 
insurance. In 2010, RRGs continued to comprise a small percentage of 
the total market, writing about $2.5 billion-—or about 3 percent of 
commercial liability coverage. Other financial indicators, such as 
ratios of RRG premiums earned compared to claims paid—also suggest 
profitability. In addition, the number of RRGs has increased since 
2004, with the most growth occurring in health care-related lines. In 
2010, more than 80 percent of RRGs were domiciled in Vermont, South 
Carolina, the District of Columbia, Nevada, Hawaii, and Arizona, but 
RRGs wrote about 95 percent of their premiums outside their state of 
domicile. Evidence suggests that RRGs may choose to domicile in a 
particular state, partly due to some financial and regulatory 
advantages such as lower minimum capitalization requirements. RRG 
representatives opined that RRGs have expanded the availability of 
commercial liability insurance-—particularly in niche markets—-but 
differed in their opinions of whether RRGs have improved its 
affordability. 

Different interpretations of LRRA have led to varying state regulatory 
practices and requirements in nondomiciliary states and disputes 
between state regulators and RRGs in areas such as registration 
requirements, fees, and types of coverage RRGs may write. For example, 
while some states have interpreted LRRA to permit RRGs to write 
contractual liability coverage, others have not, and therefore may not 
allow RRGs to write this coverage in their state. RRGs have challenged 
requirements established by nondomiciliary states that RRGs assert are 
not permitted by LRRA. However courts also have differed in their 
interpretations of LRRA. Some regulators with whom GAO spoke indicated 
that their actions toward nondomiciled RRGs reflect an effort to use 
their limited regulatory authority to protect insureds in their states 
as well as address concerns about RRG solvency. 

Some state regulatory practices for RRGs have changed since 2004, and 
federal legislation has been proposed. In 2005, GAO recommended 
implementation of more uniform, baseline state regulatory standards, 
including corporate governance standards to better protect RRG 
insureds. The National Association of Insurance Commissioners (NAIC) 
has since revised its accreditation standards to more closely align 
with those for traditional insurers which are subject to oversight in 
each state in which they operate. For example, all financial 
examinations of RRGs that have commenced during or after 2011 should 
use the risk-focused examination process. NAIC also has begun 
developing corporate governance standards that it plans to implement 
in the next few years. Proposed legislation would amend LRRA to allow 
RRGs to provide commercial property insurance and also include a 
federal arbitrator to resolve disputes between RRGs and state 
insurance regulators. While some RRG representatives and state 
regulators supported this legislation, others expressed concerns about 
whether RRGs would be adequately capitalized to write commercial 
property insurance and about federal involvement in state regulation. 

What GAO Recommends: 

To further facilitate states’ implementation and help reduce the 
varying interpretations of LRRA, Congress should consider the merits 
of clarifying certain LRRA provisions regarding registration 
requirements, fees, and coverage. NAIC concurred with this matter for 
congressional consideration. 

View [hyperlink, http://www.gao.gov/products/GAO-12-16] or key 
components. To view the e-supplement online, click [hyperlink, 
http://www.gao.gov/products/GAO-12-17SP]. For more information, 
contact Alicia Puente Cackley at (202) 512-7022 or cackleya@gao.gov. [End of section] 

Contents: 

Letter: 

Background: 

RRGs Generally Reported Increased Profitability and Continue to Write 
the Majority of Their Business in Nondomiciliary States: 

Varying Interpretations of LRRA Result in Different Regulatory 
Treatment of RRGs across States: 

NAIC Actions Address Some Regulatory Concerns, While Recent Federal 
and State Proposals May Affect Future RRG Operations: 

Conclusions: 

Matter for Congressional Consideration: 

Agency Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comments from the National Association of Insurance 
Commissioners: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Figures: 

Figure 1: RRG Premiums Written by Percentage of RRGs Writing Specified 
Dollar Amounts, 2004-2010: 

Figure 2: Direct Premiums Written for the Overall Commercial Liability 
and Medical Professional Liability Industries, 2007-2010: 

Figure 3: RRG Industry Average Net Written Premium, as a Percentage of 
Policyholder Surplus, 2004-2010: 

Figure 4: RRG Average Return on Equity, 2004-2010: 

Figure 5: RRG Industry Average Combined Ratio, 2004-2010: 

Figure 6: Number of RRGs, and Percentage of Total RRGs with Combined 
Ratios above 100, 2006-2010: 

Figure 7: Percentage of Overall RRG Gross Premiums by Business Line, 
2004 and 2010: 

Figure 8: RRGs Licensed by Business Line, 1991, 1996, 2001, 2004, and 
2010: 

Figure 9: Number of Active RRGs Domiciled by State, 2004 and 2010: 

Figure 10: Number of Operating RRGs by State, 2004 and 2010: 

Figure 11: Percentage of Premiums RRGs Wrote in Nondomiciliary States 
(Shown by Domiciliary State), 2004 and 2010: 

Abbreviations: 

GAAP: generally accepted accounting principles: 

LRRA: Liability Risk Retention Act: 

NAIC: National Association of Insurance Commissioners: 

NRRA: National Risk Retention Association: 

PLRRA: Product Liability Risk Retention Act: 

RBC: risk-based capital: 

ROE: return on equity: 

RRG: risk retention group: 

SAP: statutory accounting principles: 

View GAO-12-16 Key Component: 

* Risk Retention Groups: Survey of State Regulators [hyperlink, 
http://www.gao.gov/products/GAO-12-17SP], December 2011), an E-
supplement to [hyperlink, http://www.gao.gov/products/GAO-12-16]. 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

December 8, 2011: 

The Honorable Michael Capuano:
Ranking Member:
Subcommittee on Oversight and Investigations:
Committee on Financial Services:
House of Representatives: 

The Honorable John Campbell:
House of Representatives: 

Responding to shortages that constrained the availability and 
affordability of commercial liability insurance, Congress passed the 
Product Liability Risk Retention Act of 1981 (PLRRA) to authorize 
creation of risk retention groups (RRG)--similar businesses with 
similar risk exposures that create their own insurance company to self-
insure their commercial liability risks on a group basis.[Footnote 1] 
In 1986 Congress amended PLRRA by passing the Liability Risk Retention 
Act of 1986 (LRRA), which allows RRGs to extend coverage beyond 
product liability into most of the commercial liability market and 
establishes a regulatory framework that partially preempts state 
insurance laws.[Footnote 2] 

LRRA allows an RRG to be regulated primarily by its chartering 
(domiciliary) state, even when it sells insurance in other 
(nondomiciliary) states.[Footnote 3] With one regulator, RRGs differ 
from "traditional" insurers, which are subject to licensing and 
oversight by regulators in each state in which they operate. While 
LRRA requires RRGs to provide to nondomiciliary state regulators 
copies of the RRG's business plan or feasibility study and annual 
financial statements, it neither explicitly permits nor prohibits 
nondomiciliary states from requesting additional documentation or 
charging fees.[Footnote 4] LRRA preempts the laws of nondomiciliary 
states to oversee RRGs selling insurance in their states except in 
specified circumstances.[Footnote 5] 

Congress intended for the regulatory framework established by LRRA "to 
strike a balance between the RRGs' need to be free of unjustified 
requirements and the public's need for protection from insolvencies." 
[Footnote 6] The legislative history indicates that Congress viewed 
RRGs as having incentives to practice effective risk management both 
in their own businesses and the RRG because the RRG is owned by 
insureds, who may have business assets at risk should the RRG become 
insolvent. To further encourage RRG members to establish adequate 
premiums and reserves, LRRA prohibits RRGs from participation in state 
guaranty funds.[Footnote 7] According to recent data from the National 
Association of Insurance Commissioners (NAIC), eight RRGs became 
insolvent from 2004 to year-end 2010.[Footnote 8] 

Our 2005 report on RRGs noted that RRGs played a small but important 
role in increasing the availability and affordability of commercial 
liability insurance in niche markets, but that they operated in a 
regulatory environment characterized by varying state standards due to 
the partial preemption of state insurance laws by LRRA.[Footnote 9] We 
found that RRGs might not consistently protect the best interest of 
owners/insureds due to a lack of uniform corporate governance 
standards. Our report was prompted by a rise in the formation of RRGs 
coupled with the failure of several large RRGs--22 RRGs failed between 
1987 and 2003--which raised questions about the adequacy of the RRG 
regulatory environment and safeguards to protect RRG members/insureds 
and consumers.[Footnote 10] We recommended that the NAIC develop and 
implement a set of broad-based, uniform, baseline standards for RRG 
regulation. These standards should include regularly filing financial 
reports using a uniform accounting method, because both NAIC and some 
nondomiciliary states reported difficulty assessing the financial 
condition and solvency of RRGs reporting under generally accepted 
accounting principles (GAAP) as compared with the condition of RRGs 
reporting under statutory accounting principles (SAP).[Footnote 11] We 
also recommended establishing minimum corporate governance standards, 
such as independent members on an RRG's board of directors. 

As we also reported in 2005, some states may have modified policies 
and procedures to attract RRGs to domicile in the state, such as 
lowering statutory minimum capital and surplus requirements. Some 
regulators also expressed concerns over aspects of RRGs' operations 
that they would not be able to influence, such as minimum capital and 
surplus requirements for RRGs operating in but not domiciled in their 
state. The various interpretations of LRRA by state insurance 
regulators have led to disputes and in some cases litigation between 
RRGs and states.[Footnote 12] More recently, legislation has been 
proposed to develop a federal mechanism to arbitrate disputes between 
RRGs and states as well as to permit RRGs to offer commercial property 
coverage in addition to commercial liability coverage.[Footnote 13] 
Some state insurance regulators expressed concerns about the capital 
adequacy of RRGs wishing to incorporate commercial property coverage 
into their business lines. 

In light of regulatory and industry concerns, as well as recent 
proposals to expand LRRA, you asked us to update our analysis from our 
2005 report. This report (1) describes changes in the financial 
condition of the RRG industry from 2004 through 2010; (2) examines the 
regulatory treatment of RRGs across domiciliary and nondomiciliary 
states; and (3) examines changes to federal and state regulatory 
practices regarding RRGs since 2004. 

To determine the financial condition of the RRG industry, we analyzed 
data on the commercial liability insurance market such as trends in 
the types of coverage provided, concentration of domiciled RRGs, and 
financial ratios based on data from NAIC. We also reviewed 
documentation from 2004 through 2010 from NAIC and the Risk Retention 
Reporter, a trade journal and industry data source. We determined that 
the data were sufficiently reliable for the purposes of our report. To 
evaluate the differences in regulatory treatment of RRGs across 
states, we reviewed and analyzed LRRA and its legislative history. We 
conducted a web-based survey of insurance regulators in the 50 states 
and the District of Columbia (96 percent response rate) and 
interviewed 13 domiciliary and nondomiciliary state insurance 
regulators from a nonstatistical sample.[Footnote 14] States were 
selected based on the number of domiciled RRGs or the amount of 
premiums written by RRGs and perceived differences in regulatory 
treatment of RRGs in these states. We held two discussion groups with 
multiple RRG representatives that volunteered to participate and 
interviewed representatives from a nonstatistical sample of 11 RRGs. 
These RRGs were selected based on the amount of premiums written, 
state of domicile, number of states in which they operated, and type 
of insurance coverage provided. We are not able to generalize results 
from this sample to the entire RRG industry. Further, we interviewed 
representatives of two industry associations on their members' 
regulatory experiences operating in domiciliary and nondomiciliary 
states. We reviewed correspondence from state insurance regulators to 
RRG representatives about topics such as registration processes and 
fees charged to RRGs. To examine changes in regulatory practices since 
2004, we analyzed documentation on and interviewed NAIC officials 
about changes to the accreditation process affecting RRGs and measures 
to develop corporate governance standards for RRGs. We also asked 
representatives of RRGs and state insurance departments, as well as an 
actuarial expert, about the potential impact of these efforts. Our web-
based survey also asked about regulatory changes. Finally, we reviewed 
key legislation concerning RRGs that had been introduced at the 
federal and state levels since 2004. We conducted this performance 
audit from October 2010 to December 2011 in accordance with generally 
accepted government auditing standards. Those standards require that 
we plan and perform the audit to obtain sufficient, appropriate 
evidence to provide a reasonable basis for our findings and 
conclusions based on our audit objectives. We believe that the 
evidence obtained provides a reasonable basis for our findings and 
conclusions based on our audit objectives. Appendix I provides 
additional details about our objectives, scope, and methodology. 

Background: 

Traditional insurance companies sell insurance to the public and are 
subject to the licensing requirements and oversight of each state in 
which they operate. The licensing process allows states to determine 
if an insurer domiciled in another state but operating in their state 
meets the nondomiciliary state's regulatory requirements before 
granting the insurer permission to operate in their state. According 
to NAIC's uniform application process, which has been adopted by all 
states, an insurance company must show that it meets the 
nondomiciliary state's minimum statutory capital and surplus 
requirements, identify whether it is affiliated with other companies 
(that is, part of a holding company system), and submit biographical 
affidavits for all its officers, directors, and key managerial 
personnel. After licensing an insurer, regulators in nondomiciliary 
states can conduct financial examinations, issue an administrative 
cease-and-desist order to stop an insurance company from operating in 
their state, and withdraw the company's license to sell insurance in 
the state. In addition, most nondomiciliary states have "seasoning 
requirements" that call for an insurance company to successfully have 
operated in its state of domicile for anywhere from 1 to 5 years 
before it can qualify for a license. 

Regulatory Framework for RRGs: 

Although RRGs have some regulatory relief due to the lead state 
regulatory framework established under LRRA, they still are expected 
to comply with certain other laws administered by nondomiciliary 
states.[Footnote 15] For example, RRGs must pay applicable taxes on 
premiums and other taxes imposed by nondomiciliary (as well as 
domiciliary) states.[Footnote 16] LRRA also imposes other measures 
that offer protections or safeguards to RRG members including the 
requirement that each RRG must submit to the domiciliary state 
insurance regulator a plan of operation or feasibility study that 
includes the coverages, deductibles, coverage limits, rates, and 
rating classification system for each line of insurance the RRG 
intends to offer.[Footnote 17] The RRG must (1) provide a copy of the 
plan or study to the insurance regulator in the nondomiciliary states 
in which the RRG intends to conduct business before it can write any 
insurance coverage in that state;[Footnote 18] (2) provide a copy of 
the group's annual financial statement (certified by an independent 
public accountant) to the insurance commissioner of each state in 
which it is doing business (the financial statement should include a 
statement of opinion on loss and loss adjustment expense reserves by a 
qualified loss reserve specialist or actuary);[Footnote 19] and (3) 
submit to an examination by a nondomiciliary state regulator to 
determine the RRG's financial condition, if the domiciliary state 
regulator has not begun or refuses to begin an examination.[Footnote 
20] Nondomiciliary, as well as domiciliary, states also may seek an 
injunction in a "court of competent jurisdiction" against RRGs that 
they believe are in hazardous financial condition.[Footnote 21] 

Other Self-Insurance Structures: 

RRGs are not the only form of self-insurers. "Captive insurance 
companies" (captives), also chartered and regulated by states, are 
established by single companies or groups of companies to self-insure 
their own risks. States chartering captives offer some regulatory 
relief to these companies based on the presumption that owners of 
captive companies have sophisticated knowledge about managing their 
risks and would protect their own interests. States can charter RRGs 
under regulations intended for traditional insurers or for captives. 
Non-RRG captives exist largely to cover the risks of their parent, 
which can be one large company (pure captive) or a group of companies 
(group captives). Group captives share certain similarities with RRGs 
because they also comprise several companies, but group captives, 
unlike RRGs, do not have to insure similar risks. Further, captives 
may provide property coverage, while RRGs currently may not. 
Regulatory requirements for captives generally are less restrictive 
than those for traditional insurers. However, non-RRG captives, like 
traditional insurance companies, generally cannot conduct insurance 
transactions in any state except their domiciliary state, unless they 
become licensed in that other state. 

NAIC and State Coordination: 

State insurance regulators that oversee both traditional insurers and 
RRGs participate in NAIC's voluntary accreditation program for the 
regulation of insurers' financial solvency.[Footnote 22] NAIC 
accreditation is a certification given to a state insurance department 
once it has demonstrated it has met and continues to meet an 
assortment of legal, financial, and organizational standards. 
According to NAIC officials, all 50 state insurance departments and 
the District of Columbia were accredited as of March 2011. NAIC 
developed its Financial Regulation Standards and Accreditation Program 
in 1989 and adopted its formal accreditation program in June 1990. The 
mission of the program is to establish and maintain standards to 
promote sound insurance company financial solvency regulation. To 
execute this mission, NAIC assesses how each state insurance 
department reviews and monitors the solvency regulation of multistate 
insurance companies and RRGs to ensure states have (1) adequate 
solvency laws and regulations to protect consumers, (2) effective 
financial analysis and examination processes, and (3) appropriate 
organizational and personnel practices. 

RRGs Generally Reported Increased Profitability and Continue to Write 
the Majority of Their Business in Nondomiciliary States: 

Premiums Written by RRGs Generally Increased, Particularly in Health 
Care-Related Lines: 

Based on data reported by RRGs to NAIC since 2004, RRGs in aggregate 
have shown an increase in premiums written and in their share of the 
broader commercial liability market.[Footnote 23] In 2005, we reported 
that RRGs wrote about $1.8 billion of commercial liability coverage, 
which constituted about 1.17 percent of the overall market in 
2003.[Footnote 24] According to NAIC data, in 2010 RRGs wrote about 
$2.5 billion in premiums, which was about 3 percent of the total $92 
billion of commercial liability insurance coverage written 
industrywide.[Footnote 25] An analysis of direct written premiums by 
dollar amount indicates that between 2004 and 2010, the largest 
percentage of RRGs (31 to 37 percent) wrote premiums between $1 
million and $5 million (see figure 1). 

Figure 1: RRG Premiums Written by Percentage of RRGs Writing Specified 
Dollar Amounts, 2004-2010: 

[Refer to PDF for image: stacked vertical bar graph] 

 Color A Color B Color C Color D Color E Color F Color G   

Year: 2004; 
Negative: 0; 
$0: 5%; 
$0 to $500,000: 11%; 
$500,000 to $1 million: 7%; 
$1 million to $5 million: 37%; 
$5 million to $10 million: 16%; 
$10 million to $25 million: 13%; 
$25 million to $50 million: 7%; 
More than $50 million: 3%. 

Year: 2005; 
Negative: 0; 
$0: 6%; 
$0 to $500,000: 9%; 
$500,000 to $1 million: 6%; 
$1 million to $5 million: 36%; 
$5 million to $10 million: 19%; 
$10 million to $25 million: 13%; 
$25 million to $50 million: 8%; 
More than $50 million: 3%. 

Year: 2006; 
Negative: 0; 
$0: 7%; 
$0 to $500,000: 9%; 
$500,000 to $1 million: 7%; 
$1 million to $5 million: 35%; 
$5 million to $10 million: 20%; 
$10 million to $25 million: 13%; 
$25 million to $50 million: 7%; 
More than $50 million: 4%. 

Year: 2007; 
Negative: 3%; 
$0: 7%; 
$0 to $500,000: 11%; 
$500,000 to $1 million: 10%; 
$1 million to $5 million: 31%; 
$5 million to $10 million: 18%; 
$10 million to $25 million: 13%; 
$25 million to $50 million: 6%; 
More than $50 million: 3%. 

Year: 2008; 
Negative: 2%; 
$0: 6%; 
$0 to $500,000: 11%; 
$500,000 to $1 million: 10%; 
$1 million to $5 million: 32%; 
$5 million to $10 million: 18%; 
$10 million to $25 million: 14%; 
$25 million to $50 million: 5%; 
More than $50 million: 2%. 

Year: 2009; 
Negative: less than 1%; 
$0: 7%; 
$0 to $500,000: 12%; 
$500,000 to $1 million: 6%; 
$1 million to $5 million: 34%; 
$5 million to $10 million: 18%; 
$10 million to $25 million: 14%; 
$25 million to $50 million: 5%; 
More than $50 million: 3%. 

Year: 2010; 
Negative: 1%; 
$0: 8%; 
$0 to $500,000: 9%; 
$500,000 to $1 million: 7%; 
$1 million to $5 million: 33%; 
$5 million to $10 million: 21%; 
$10 million to $25 million: 13%; 
$25 million to $50 million: 5%; 
More than $50 million: 3%. 
         
Source: GAO analysis of NAIC data. 

Note: According to NAIC, negative premiums may be due to premiums 
returned to the purchasers of the policy after cancellation or the 
company writes little business and the direct written premiums are 
uncollectible. 

[End of figure] 

Of the almost $92 billion of commercial liability insurance written 
industrywide in 2010, about $10.6 billion was written in the medical 
professional liability line--also known as medical malpractice. In an 
analysis of the premiums written for the medical professional 
liability line, RRGs had a higher share of this specific market 
compared with their share of the overall commercial liability market. 
RRGs wrote about 13 percent ($1.4 billion of the total $10.6 billion) 
of medical professional liability insurance in 2010 (see figure 2). We 
further discuss growth in the number of RRGs offering health care-
related insurance later in this section. 

Figure 2: Direct Premiums Written for the Overall Commercial Liability 
and Medical Professional Liability Industries, 2007-2010: 

[Refer to PDF for image: illustrated horizontal line graph] 

All liability: 

Year: 2007; 
All liability: 
Industry: $106.3 billion; 
Risk retention group: $2.5 billion; 
RRG percentage: 2.37%; 
Medical profession: 
Industry: $11.7 billion; 
Risk retention group: $1.3 billion; 
RRG percentage: 11.30%. 

Year: 2008; 
All liability: 
Industry: $100.8 billion; 
Risk retention group: $2.6 billion; 
RRG percentage: 2.53%; 
Medical profession: 
Industry: $11.2 billion; 
Risk retention group: $1.4 billion; 
RRG percentage: 13.03%. 

Year: 2009; 
All liability: 
Industry: $93.5 billion; 
Risk retention group: $2.6 billion; 
RRG percentage: 2.75%; 
Medical profession: 
Industry: $10.8 billion; 
Risk retention group: $1.4 billion; 
RRG percentage: 13.03%. 

Year: 2010; 
All liability: 
Industry: $91.8 billion; 
Risk retention group: $2.5 billion; 
RRG percentage: 2.71%; 
Medical profession: 
Industry: $10.6 billion; 
Risk retention group: $1.4 billion; 
RRG percentage: 13.23%. 

Source: NAIC. 

Note: Premiums written for workers' compensation insurance were 
excluded from this analysis as RRGs cannot provide this coverage. 
Separate data were not available for RRG direct written premiums for 
the medical professional liability line from 2004-2006. 

[End of figure] 

Certain Indicators Suggest the RRG Industry Generally Has Remained 
Profitable: 

Based on several measures of financial strength or profitability, the 
RRG industry as a whole generally reported year-to-year gains from 
2004 to 2010 (see figure 3). A key factor in determining an insurer's 
overall financial strength is capital and surplus--also known as 
policyholder surplus--which reflects the amount by which an insurer's 
assets exceed its liabilities. Regulators require insurers to maintain 
adequate surplus so that an insurer can remain solvent even in the 
face of greater losses than predicted or lower earnings than 
projected. One of the indicators used to measure the adequacy of 
policyholder surplus is the ratio of an insurer's premiums written to 
its policyholder surplus, which measures an insurer's ability to pay 
claims given the volume of premiums written. A lower ratio of premiums 
written to surplus means an insurer has more net assets available 
relative to the amount of premiums written. According to the NAIC's 
Financial Analysis Handbook-Property/Casualty Edition and other 
general benchmarking guidelines from NAIC officials, the net written 
premium-to-surplus ratios for property/casualty insurers in general 
would receive regulatory scrutiny for excessive leverage risk concerns 
for ratios greater than 250 to 300 percent, depending on the 
particular line of insurance[Footnote 26]. If an insurer's ratio 
exceeds this range, a state regulator may conduct additional analyses 
of the insurer's financial solvency. According to NAIC officials, 
there is not an established benchmark for an acceptable premium-to-
surplus ratio for the RRG industry. An analysis of NAIC data shows 
that on average, the industry's net written premium to policyholder 
surplus declined from 2004 to 2010, indicating that the financial 
strength of the industry during this time period has likely either 
improved or remained stable (see figure 3[Footnote 27]). 

Figure 3: RRG Industry Average Net Written Premium, as a Percentage of 
Policyholder Surplus, 2004-2010: 

[Refer to PDF for image: line graph] 

Year: 2004; 
Percentage of Policyholder Surplus: 104.9%. 

Year: 2005; 
Percentage of Policyholder Surplus: 99.9%. 

Year: 2006; 
Percentage of Policyholder Surplus: 87.6%. 

Year: 2007; 
Percentage of Policyholder Surplus: 82.6%. 

Year: 2008; 
Percentage of Policyholder Surplus: 62.7%. 

Year: 2009; 
Percentage of Policyholder Surplus: 59.2%. 

Year: 2010; 
Percentage of Policyholder Surplus: 68.7%. 

Source: GAO analysis of NAIC data. 

Note: Analysis includes RRGs with positive net written premiums. RRGs 
with negative and zero written premiums are excluded. The average 
annual ratios are unweighted averages, that is, we computed ratios for 
individual RRGs and used these to determine an average ratio for all 
RRGs. 

[End of figure] 

Another indicator of financial strength is return on policyholder 
surplus, or return on equity (ROE).[Footnote 28] ROE is generally 
calculated as the ratio of net income to equity, or in the case of 
insurers, policyholder surplus. From 2004 to 2010, the average ROE in 
the RRG industry fluctuated, with a high of 13.4 percent in 2008 and a 
low of 5.1 percent in 2010 (see figure 4). While no clear trend was 
visible over the 7-year period we analyzed, the average ROE for each 
year generally indicated profitability for the RRG industry. 

Figure 4: RRG Average Return on Equity, 2004-2010: 

Year: 2004; 
RRG Average Return on Equity: 5.5%. 

Year: 2005; 
RRG Average Return on Equity: 9.9%. 

Year: 2006; 
RRG Average Return on Equity: 12.2%. 

Year: 2007; 
RRG Average Return on Equity: 9.3%. 

Year: 2008; 
RRG Average Return on Equity: 13.4%. 

Year: 2009; 
RRG Average Return on Equity: 7.8%. 

Year: 2010; 
RRG Average Return on Equity: 5.1%. 

Source: GAO analysis of NAIC data. 

Note: Analysis includes RRGs with positive net written premiums. RRGs 
with negative and zero written premiums or without ROE data as 
provided by NAIC are excluded. The average annual ratios are 
unweighted averages, that is, we computed ratios for individual RRGs 
and used these to determine an average ratio for all RRGs. 

[End of figure] 

The combined ratio is another measure of an insurer's financial 
strength and profitability.[Footnote 29] This ratio shows the claims 
and related expenses incurred by an insurer as a percentage of the 
premiums earned. According to NAIC officials, a combined ratio of less 
than 100 indicates an underwriting profit (gain)--that is, premiums 
collected were higher than the claims paid and related expenses--while 
a combined ratio above 100 can be an indicator of an unprofitable 
insurer that could be in a hazardous financial condition. An analysis 
of NAIC data shows that the average combined ratio for RRGs that filed 
financial statements ranged from a high of 92.6 percent in 2005 to a 
low of 88 percent in 2008 (see figure 5). The average combined ratio 
in 2010 was 90.2. 

Figure 5: RRG Industry Average Combined Ratio, 2004-2010: 

Year: 2004; 
RRG Industry Average Combined Ratio: 90.1%. 

Year: 2005; 
RRG Industry Average Combined Ratio: 92.6%. 

Year: 2006; 
RRG Industry Average Combined Ratio: 88.8%. 

Year: 2007; 
RRG Industry Average Combined Ratio: 91.6%. 

Year: 2008; 
RRG Industry Average Combined Ratio: 88.0%. 

Year: 2009; 
RRG Industry Average Combined Ratio: 89.2%. 

Year: 2010; 
RRG Industry Average Combined Ratio: 90.2%. 

Source: GAO analysis of NAIC data. 

Note: The combined ratio for each year is based on the number of RRGs 
that filed financial statements with NAIC. According to NAIC 
officials, RRG financial statements generally are filed using GAAP or 
modified GAAP and are reconciled to SAP. NAIC calculates the ratios 
using the data from financial statements as filed by the insurers. 
NAIC's formulas and benchmarks for financial ratios are based on SAP. 

[End of figure] 

Also based on NAIC data, the percentage of RRGs with a combined ratio 
above 100 fluctuated from 2006 to 2010 (see figure 6). For example, 36 
percent of the RRGs writing premiums in 2006 had a combined ratio 
above 100. These percentages increased from 2007 to 2009, with a high 
of 43 percent in 2009, and decreased to about 37 percent in 2010. 
Together, these data indicate that while most RRGs appear to have been 
profitable in any one year, a sizeable but relatively stable 
percentage in each year could have experienced some financial 
challenges. 

Figure 6: Number of RRGs, and Percentage of Total RRGs with Combined 
Ratios above 100, 2006-2010: 

[Refer to PDF for image: stacked vertical bar graph] 

Year: 2006; 
RRGs with a combined ratio greater than 100: 36.2%; 
Total number of RRGs: 229. 

Year: 2007; 
RRGs with a combined ratio greater than 100: 38.2%; 
Total number of RRGs: 246. 

Year: 2008; 
RRGs with a combined ratio greater than 100: 40.2%; 
Total number of RRGs: 254. 

Year: 2009; 
RRGs with a combined ratio greater than 100: 43.1%; 
Total number of RRGs: 246. 

Year: 2010; 
RRGs with a combined ratio greater than 100: 37.3%; 
Total number of RRGs: 249. 

Source: GAO analysis of NAIC data. 

Note: The percentage is based on the total number of active RRGs each 
year with positive net premiums written. 

[End of figure] 

Although the reported financial condition of RRGs appeared favorable 
in most years since 2004, according to NAIC officials, the recent 
financial crisis also affected the RRG industry. Capital sources for 
RRGs became more constrained as banks became more stressed and 
tightened their lending practices, prompting concern by state 
regulators about the financial condition of some RRGs. Industry 
participants with whom we spoke said that some RRGs may have found the 
experience especially challenging, particularly in instances in which 
the RRGs were in part capitalized by letters of credit from financial 
institutions adversely affected by the recent financial crisis. 
[Footnote 30] An NAIC official said that similar to the rest of the 
insurance industry, RRGs have earned less income on their investments. 
In addition, one insurance regulator said that some RRGs had invested 
in the real estate market, and the resulting devaluation of these 
assets affected their balance sheets, particularly those of smaller 
RRGs. 

The Total Number of RRGs Increased Since 2004, with Most Growth 
Occurring in Health Care-Related RRGs: 

In 2004 and 2010, most RRGs were concentrated on health care-related 
lines of business. According to data from the Risk Retention Reporter, 
in both years the top four business lines for RRGs in terms of gross 
premiums were (1) health care; (2) professional services; (3) 
government and institutions; and (4) property development (see figure 
7).[Footnote 31] 

Figure 7: Percentage of Overall RRG Gross Premiums by Business Line, 
2004 and 2010: 

[Refer to PDF for image: horizontal bar graph] 

Business line: Leisure; 
2004: 0%; 
2001: 1%. 

Business line: Environmental; 
2004: 2%; 
2001: 1%. 

Business line: Manufacturing and commerce; 
2004: 4%; 
2001: 1%. 

Business line: Transportation; 
2004: 3%; 
2001: 4%. 

Business line: Property development; 
2004: 7%; 
2001: 4%. 

Business line: Financial; 
2004: 0%; 
2001: 4%. 

Business line: Government and institutions; 
2004: 10%; 
2001: 10%. 

Business line: Professional services; 
2004: 25%; 
2001: 16%. 

Business line: Healthcare; 
2004: 49%; 
2001: 59%. 

Source: GAO analysis of Risk Retention Reporter data. 

Note: Percentages are rounded to the nearest whole number. In 2010, 
the actual percentage for the financial business line was 3.6 percent 
and for transportation, 3.8 percent. 

[End of figure] 

The majority of RRGs licensed in 2004 and 2010 offered health care-
related insurance (see figure 8). According to our analysis of data 
from the Risk Retention Reporter, 148 of the 153 health care-related 
RRGs (97 percent) wrote medical malpractice coverage in 2010. The 
medical malpractice industry generally has been characterized as 
volatile because of the risks associated with providing this line of 
insurance. Health care providers sought alternative sources of 
insurance after some of the largest medical malpractice insurance 
providers exited the market because of declining profits, partly 
caused by market instability and high and unpredictable losses--
factors that contribute to the high risk of providing medical 
malpractice insurance.[Footnote 32] 

Figure 8: RRGs Licensed by Business Line, 1991, 1996, 2001, 2004, and 
2010[A]: 

[Refer to PDF for image: illustrated horizontal bar graph] 

Year: 1991; 
Business line: Health care; 
Number of RRGs: 23; 
Business line: Manufacturing and commerce; 
Number of RRGs: 12; 
Business line: Government and institutions; 
Number of RRGs: 10; 
Business line: Professional services; 
Number of RRGs: 9; 
Business line: All other RRGs[B]; 
Number of RRGs: 25. 

Year: 1996; 
Business line: Health care; 
Number of RRGs: 27; 
Business line: Manufacturing and commerce; 
Number of RRGs: 7; 
Business line: Government and institutions; 
Number of RRGs: 10; 
Business line: Professional services; 
Number of RRGs: 11; 
Business line: All other RRGs[B]; 
Number of RRGs: 18. 

Year: 2001; 
Business line: Health care; 
Number of RRGs: 23; 
Business line: Manufacturing and commerce; 
Number of RRGs: 12; 
Business line: Government and institutions; 
Number of RRGs: 9; 
Business line: Professional services; 
Number of RRGs: 12; 
Business line: All other RRGs[B]; 
Number of RRGs: 16. 

Year: 2004; 
Business line: Health care; 
Number of RRGs: 105; 
Business line: Manufacturing and commerce; 
Number of RRGs: 20; 
Business line: Government and institutions; 
Number of RRGs: 21; 
Business line: Professional services; 
Number of RRGs: 11; 
Business line: All other RRGs[B]; 
Number of RRGs: 25. 

Year: 2010; 
Business line: Health care; 
Number of RRGs: 153; 
Business line: Manufacturing and commerce; 
Number of RRGs: 17; 
Business line: Government and institutions; 
Number of RRGs: 23; 
Business line: Professional services; 
Number of RRGs: 19; 
Business line: All other RRGs[B]; 
Number of RRGs: 34. 

Source: GAO analysis of Risk Retention Reporter data. 

[A] Data for 1991, 1996, 2001, and 2004 are as reported in GAO-05-536. 
Data for 2010 are as of April 2010. 

[B] For each year, we show only the business lines with the highest 
number of RRGs. RRGs that were not in these business lines are 
included in the "All other RRGs" category. 

[End of figure] 

According to an RRG industry representative, although the overall 
liability insurance market currently is soft--which may be described 
as a period during which premiums are low, capital and competition are 
high, and demand for RRGs is lower--the RRG industry has continued to 
grow, especially in the area of medical malpractice coverage. Nine of 
the 13 state insurance regulators we interviewed affirmed that the 
majority of RRGs domiciled or operating in their states provide 
insurance for various health care-related lines, such as medical 
malpractice and liability insurance for nursing homes. 

Although Most RRGs Are Domiciled in One of a Few States, They Wrote 
the Majority of Business Outside Their State of Domicile: 

Although they conducted business nationwide, similar to what we 
reported in 2005 more than 80 percent of active RRGs in 2010 were 
domiciled in five states and the District of Columbia[Footnote 33]. 
Based on an analysis of data from NAIC, the states with the most 
domiciled RRGs as of 2010 were Vermont, South Carolina, the District 
of Columbia, Nevada, Arizona, and Hawaii (see figure 9). Montana, 
which was not one of the leading domiciliary states when we reported 
in 2005, accounted for about 16 percent of the increase of domiciled 
RRGs in 2010. As of 2010, 24 states had domiciled RRGs. 

Figure 9: Number of Active RRGs Domiciled by State, 2004 and 2010: 

[Refer to PDF for image: 2 illustrated U.S. maps] 

2004 (total: 180): 

0: 
Alaska: 
Arkansas: 
California: 
Connecticut: 
Idaho: 
Kansas: 
Louisiana: 
Maine: 
Maryland: 
Massachusetts: 
Michigan: 
Minnesota: 
Mississippi: 
New Hampshire: 
New Jersey: 
New Mexico: 
New York: 
North Carolina: 
North Dakota: 
Ohio: 
Oregon: 
Pennsylvania: 
Rhode Island: 
South Dakota: 
Utah: 
Washington: 
West Virginia: 
Wisconsin: 
Wyoming: 

1 to 10: 
Alabama: 1; 
Colorado: 2; 
Delaware: 4; 
Florida: 1; 
Georgia: 1; 
Illinois: 1; 
Indiana: 2; 
Iowa: 2; 
Kentucky: 2; 
Missouri: 1; 
Montana: 4; 
Nebraska: 1; 
Oklahoma: 1; 
Tennessee: 1; 
Texas: 1; 
Virginia: 1. 

11 to 20: 
Arizona: 11; 
District of Columbia: 17; 
Hawaii: 15; 
Nevada: 12. 

More than 30: 
South Carolina: 33; 
Vermont: 66. 

2010 (total: 249): 

0: 
Alabama: 
Alaska: 
Arkansas: 
California: 
Connecticut: 
Idaho: 
Kansas: 
Louisiana: 
Maine: 
Maryland: 
Massachusetts: 
Michigan: 
Minnesota: 
Mississippi: 
New Hampshire: 
New Jersey: 
New Mexico: 
New York: 
North Carolina: 
North Dakota: 
Ohio: 
Oregon: 
Pennsylvania: 
Rhode Island: 
South Dakota: 
Washington: 
Wisconsin: 
Wyoming: 

1 to 10: 
Alabama: 1; 
Colorado: 2; 
Delaware: 6; 
Florida: 1; 
Georgia: 2; 
Illinois: 1; 
Indiana: 2; 
Iowa: 1; 
Kentucky: 4; 
Missouri: 1; 
Nebraska: 1; 
Oklahoma: 1; 
Tennessee: 1; 
Texas: 1; 
Utah: 1; 
Virginia: 1; 
West Virginia: 1. 

11 to 20: 
Arizona: 18; 
Hawaii: 17; 
Montana: 15; 

21 to 30: 
Nevada: 24. 

More than 30: 
District of Columbia: 33; 
South Carolina: 35; 
Vermont: 79. 

Source: GAO analysis of NAIC data; map (MapInfo). 

Note: U.S. territories (American Samoa, Guam, Northern Mariana 
Islands, Puerto Rico, and the Virgin Islands) and Canada are excluded. 

[End of figure] 

RRGs may decide to domicile in a particular state for one or more 
reasons. First, RRGs are more likely to domicile in a state that 
permits their formation as a captive, which may not be one of the 
states in which the RRGs write the majority of their business. Some 
states allow RRGs to be chartered as captives because they only 
provide coverage to their owners and do not sell insurance to the 
public. Further, regulatory requirements for captive insurers 
generally are less restrictive than those for traditional insurers. 
According to the Risk Retention Reporter, about 20 states charter and 
regulate RRGs under captive legislation.[Footnote 34] Second, 
according to NAIC officials with whom we spoke, states that allow RRGs 
to operate under captive laws often have less stringent financial 
requirements. NAIC officials also said that RRGs tend to gravitate to 
states that have lower capitalization requirements and in which the 
regulators are looking to promote the RRG industry as a source of 
revenue for the state. Finally, according to 9 of 13 state insurance 
regulators we interviewed, in addition to lower minimum capital and 
surplus requirements, RRGs may choose to domicile in certain states 
because of the state's expertise with regulating RRGs and knowledge of 
the industry. 

Evidence from our interviews and survey of state insurance regulators 
also suggests that lower capitalization requirements were a factor in 
RRGs choosing to domicile in those states. For example, in our 
interviews with insurance regulators representing 8 of the top 10 
domiciliary states, 4 regulators reported that the minimum amount of 
capital required to domicile in their state was $500,000, 3 regulators 
reported a minimum requirement of $1 million, and 1 regulator reported 
$400,000. However, six of the regulators also reported that additional 
capital could be required.[Footnote 35] Our interviews and state 
regulator survey also indicated that two domiciliary states reduced 
their minimum capital and surplus requirement since our 2005 report. 
For example, one domiciliary state's minimum capital requirement 
decreased from $500,000 to $400,000, while another state's decreased 
from $700,000 to $500,000. While RRGs tend to domicile in a few 
states, they operate and write business in all 50 states and the 
District of Columbia (see figure 10). Collectively, between 2004 and 
2010, the number of operating RRGs increased by about 50 percent. 

Figure 10: Number of Operating RRGs by State, 2004 and 2010: 

[Refer to PDF for image: 2 illustrated U.S. maps] 

2004: 

1 to 20: 
North Dakota: 19; 
Hawaii: 20. 

21 to 40: 
Alabama: 34; 
Alaska: 21; 
Arkansas: 33; 
Connecticut: 40; 
Delaware: 34; 
District of Columbia: 21; 
Idaho: 32; 
Iowa: 37; 
Kansas: 38; 
Louisiana: 32; 
Maine: 30; 
Massachusetts: 40; 
Michigan: 40; 
Minnesota: 29; 
Mississippi: 32; 
Montana: 32; 
Nebraska: 35; 
New Hampshire: 30; 
New Mexico: 31; 
Oklahoma: 34; 
Rhode Island: 28; 
South Carolina: 37; 
South Dakota: 21; 
Utah: 38; 
Vermont: 31; 
West Virginia: 39; 
Wisconsin: 33; 
Wyoming: 27. 

41 to 60: 
Arizona: 44; 
California: 55; 
Colorado: 48; 
Florida: 44; 
Georgia: 42; 
Illinois: 59; 
Indiana: 53; 
Kentucky: 46; 
Maryland: 50; 
Missouri: 45; 
Nevada: 42; 
New Jersey: 47; 
New York: 49; 
North Carolina: 45; 
Ohio: 55; 
Oregon: 44; 
Tennessee: 45; 
Virginia: 47; 
Washington: 43. 

More than 60: 
Pennsylvania: 72; 
Texas: 61. 

2010: 

21 to 40: 
Alaska: 35; 
District of Columbia: 40; 
Hawaii: 32; 
North Dakota: 28; 
Rhode Island: 38; 
South Dakota: 30; 
Wisconsin: 38; 
Wyoming: 39. 

41 to 60: 
Alabama: 60; 
Arkansas: 51; 
Connecticut: 56; 
Delaware: 52; 
Idaho: 50; 
Iowa: 56; 
Louisiana: 59; 
Kansas: 44; 
Maine: 42; 
Massachusetts: 57; 
Minnesota: 44; 
Mississippi: 46; 
Montana: 46; 
Nebraska: 44; 
New Hampshire: 45; 
New Mexico: 53; 
Oklahoma: 59; 
Oregon: 60; 
South Carolina: 60; 
Utah: 51; 
Vermont: 45; 
West Virginia: 51. 

More than 60: 
Arizona: 72; 
California: 89; 
Colorado: 65; 
Florida: 75; 
Georgia: 69; 
Illinois: 85; 
Indiana: 66; 
Kentucky: 61; 
Maryland: 66; 
Michigan: 62; 
Missouri: 63; 
Nevada: 64; 
New Jersey: 82; 
New York: 87; 
North Carolina: 69; 
Ohio: 77; 
Pennsylvania: 104; 
Tennessee: 68; 
Texas: 84; 
Virginia: 73; 
Washington: 68. 

Source: GAO analysis of NAIC data; map (MapInfo). 

Note: RRGs that operate on a multistate basis are counted more than 
once. 

[End of figure] 

NAIC data also show that more than half of the RRGs in both 2004 and 
2010 wrote premiums in two or fewer states, and two-thirds of the RRGs 
wrote premiums in fewer than 10 states in both years. Of all the 
direct premiums written by RRGs, about 97 percent and 95 percent were 
written outside the state of domicile in 2004 and 2010, respectively 
(see figure 11). The nondomiciliary states in which RRGs wrote most of 
their business in 2004 were Pennsylvania ($308 million), New York 
($226 million), California ($210 million) and Massachusetts ($114 
million). In 2010, RRGs again wrote the majority of their business in 
these states: $369 million in Pennsylvania, $366 million in New York, 
$230 million in California, and $172 million in Massachusetts. In 
2005, we noted that, according to NAIC, 73 of 115 RRGs active in 2003 
(63 percent) did not write any business in their state of domicile. 
According to data from NAIC, 168 of the 249 RRGs active in 2010 (67 
percent) did not write any business in their state of domicile. 
[Footnote 36] 

Figure 11: Percentage of Premiums RRGs Wrote in Nondomiciliary States 
(Shown by Domiciliary State), 2004 and 2010: 

[Refer to PDF for image] 

2004 (97% written outside state of domicile): 

Not applicable (no premiums written): 
Alaska: 
Arkansas: 
California: 
Connecticut: 
Idaho: 
Kansas: 
Louisiana: 
Maine: 
Maryland: 
Massachusetts: 
Michigan: 
Minnesota: 
Mississippi: 
New Hampshire: 
New Jersey: 
New Mexico: 
New York: 
North Carolina: 
North Dakota: 
Ohio: 
Oklahoma: 
Oregon: 
Pennsylvania: 
Rhode Island: 
South Dakota: 
Utah: 
Virginia: 
Washington: 
West Virginia: 
Wisconsin: 
Wyoming: 

0% written outside state of domicile: 
Alabama: 
Florida: 

More than 0% to 20% written outside state of domicile: 
Kentucky: 3%. 

More than 40% to 60% written outside state of domicile: 
Delaware: 49%; 
Texas: 46%. 

More than 60% to 80% written outside state of domicile: 
Nebraska: 64%. 

More than 80% to 100% written outside state of domicile: 
Arizona: 96%; 
Colorado: 98%; 
District of Columbia: 100%; 
Georgia: 100%; 
Hawaii: 100%; 
Illinois: 97%; 
Indiana: 94%; 
Iowa: 92%; 
Missouri: 94%; 
Montana: 82%; 
Nevada: 87%; 
South Carolina: 100%; 
Tennessee: 98%; 
Vermont: 100%; 

2010 (95% written outside state of domicile): 

Not applicable (no premiums written): 
Alaska: 
Arkansas: 
California: 
Connecticut: 
Idaho: 
Iowa: 
Kansas: 
Louisiana: 
Maine: 
Maryland: 
Massachusetts: 
Michigan: 
Minnesota: 
Mississippi: 
New Hampshire: 
New Jersey: 
New Mexico: 
New York: 
North Carolina: 
North Dakota: 
Ohio: 
Oregon: 
Pennsylvania: 
Rhode Island: 
South Dakota: 
Virginia: 
Washington: 
Wisconsin: 
Wyoming: 

0% written outside state of domicile: 
Alabama: 
Florida: 

More than 0% to 20% written outside state of domicile: 
Utah: 7%; 
West Virginia: 7%. 

More than 20% to 40% written outside state of domicile: 
Kentucky: 30%; 

More than 40% to 60% written outside state of domicile: 
Georgia: 51%. 

More than 60% to 80% written outside state of domicile: 
Arizona: 79%; 
Delaware: 66%; 
Nebraska: 61%; 
Texas: 71%; 

More than 80% to 100% written outside state of domicile: 
Colorado: 99%; 
District of Columbia: 99%; 
Hawaii: 100%; 
Illinois: 90%; 
Indiana: 98%; 
Missouri: 93%; 
Montana: 87%; 
Nevada: 89%; 
Oklahoma: 98%; 
South Carolina: 99%; 
Tennessee: 96%; 
Vermont: 100%. 

Source: GAO analysis of NAIC data; map (MapInfo). 

[End of figure] 

Nondomiciliary state insurance regulators we interviewed expressed 
concerns about the amount of RRG business in their states and their 
limited authority to regulate RRGs providing coverage to their state's 
insureds. In our 2005 report, some nondomiciliary regulators expressed 
concerns that domiciliary states were lowering their regulatory 
standards to attract RRGs for economic development purposes. 
Similarly, NAIC officials we interviewed said that when RRGs write the 
majority of their business outside their state of domicile, the 
domiciliary state regulator does not have "skin in the game" and 
cannot protect insureds who might be affected if an RRG became 
insolvent. According to an NAIC official, these states may allow 
actions that RRGs find favorable, but that are not in the best 
interest of the insureds. 

Industry Participants' Views Differed on the Impact of RRGs on the 
Availability and Affordability of Commercial Liability Insurance: 

Based on our interviews and survey of state insurance regulators, RRG 
industry participants had different views about the effects RRGs have 
had on the availability and, to a lesser extent, the affordability of 
commercial liability insurance. RRG representatives with whom we spoke 
generally believed that RRGs have increased the availability of such 
insurance. According to industry participants, RRGs have been 
providing coverage in niche markets in which consumers otherwise might 
not be able to obtain insurance (that is, from traditional insurers). 
However, one insurance regulator with whom we spoke said that 
commercial liability insurance has been readily available through 
traditional insurers, and therefore questioned the need for mechanisms 
such as RRGs to obtain this type of insurance. Our survey of state 
insurance regulators further suggests that regulators generally had 
different views than RRG representatives about the impact of RRGs on 
availability. In our survey, 17 out of the 49 state insurance 
regulators who responded (35 percent) said that RRGs have expanded the 
availability of commercial liability insurance for groups that would 
otherwise have difficulty obtaining coverage. Conversely, 8 of the 
regulators (16 percent) responded that RRGs have not expanded 
availability, while 24 regulators (49 percent) did not have an 
opinion.[Footnote 37] 

Industry participants were unsure of the impact of RRGs on the 
affordability of commercial liability insurance. Some industry 
participants with whom we spoke said that RRGs would not continue to 
exist if their rates were not affordable. Other industry participants 
said that it was difficult for them to assess the impact of RRGs on 
affordability, but acknowledged that RRGs played a role in the 
insurance market. NAIC officials with whom we spoke said that the 
affordability of rates offered by RRGs has not been determined, as 
RRGs are not required to file their premium rates with nondomiciliary 
state regulators. Therefore, an analysis has not been conducted to 
compare RRG rates to those of traditional insurers. In addition, an 
actuarial expert with whom we spoke said that the rates and language 
included in each policy written by traditional commercial insurers and 
by RRGs would need to be obtained to make a true comparison, because 
this information differs among insurers and among RRGs. In our survey, 
13 of 48 respondents (27 percent) said that RRGs have improved 
affordability of commercial liability insurance for groups that would 
otherwise have difficulty obtaining coverage. Nine regulators (19 
percent) responded that RRGs have not improved affordability while 27 
regulators (54 percent) did not have an opinion. 

Varying Interpretations of LRRA Result in Different Regulatory 
Treatment of RRGs across States: 

State Insurance Regulators and RRGs Have Differed on Registration 
Processes and Requirements LRRA Allows in Nondomiciliary States: 

Apart from the submission of required documentation, LRRA does not 
provide for a specific process for RRGs to register to conduct 
business in nondomiciliary states. States and RRGs have disagreed on 
issues relating to registration such as the level of documentation 
required and review and approval processes. 

Interpretations about what documentation can be required vary by 
state. Based on our analysis of interview and survey responses, some 
RRG industry representatives and state insurance regulators 
interpreted LRRA's failure to mention registration as an indication 
that submission of the specified documents in LRRA is all that can be 
required by a nondomiciliary state before allowing an RRG to operate 
in that state. Others interpreted LRRA's silence on registration in 
nondomiciliary states to mean that states can impose their own 
requirements. Responses to our survey of state insurance regulators 
indicate that states have varying registration requirements and 
practices, but respondents generally reported that RRGs must submit 
required documentation as outlined in LRRA. However, regulators also 
provided information on additional information and documentation their 
states required to fulfill individual state registration processes. 
For example, a few states will accept NAIC's uniform application form, 
while another state requires a state-specific registration form. An 
RRG representative with whom we spoke said that using NAIC's uniform 
application form instead of state-specific forms would simplify the 
registration process and make it more beneficial to RRGs. 

An RRG representative said that one state requires a listing of all 
other states in which the RRG is registering and the status of the 
registration in each state; copies of any condition or contingencies 
placed on the RRG by its domiciliary state; copies of requirements or 
restrictions placed on RRG members; copies of soliciting and marketing 
materials including membership and subscription agreements; and 
projected premiums for the next 3 years for the state in which the RRG 
is applying as well as nationwide, among other requirements. According 
to another RRG representative, one nondomiciliary state requires 
specific forms for biographical affidavits of officers and directors, 
including Social Security numbers. In documentation from state 
insurance regulators that we received from an RRG industry 
association, as a part of the registration process one state required 
the name, physical address and mailing address of all agents or 
brokers for the RRG, and a copy of each examination of the RRG, among 
other requirements. Representatives from the RRG industry maintain 
that state regulatory practices such as registration requirements 
beyond what is specified in LRRA "encroached" on LRRA's partial 
preemption of state insurance laws. 

RRG representatives said that there is a fear among RRGs that repeated 
objections to states' requests for information will lead to RRGs being 
targeted by state insurance offices. They also feared that providing 
information would lead to more onerous requests. However, one state 
insurance regulator with whom we spoke said that the additional 
document requests were intended to provide the regulators with 
necessary information to understand the operations of the RRGs 
providing coverage in their states. Further, the regulator stated that 
information requested is often the same information provided to the 
domiciliary state regulator and that domiciliary regulators may be 
slow to send the information or sometimes may not provide it. Two 
state insurance regulators said that sometimes the information 
requested is subject to a confidentiality agreement between the state 
and the RRG, which makes it challenging for regulators to share 
information. To alleviate this issue, one state insurance regulator 
suggested developing a mechanism that would allow for a central 
repository of RRG financial data for information-sharing purposes. 

States and RRGs also have disagreed about registration and approval 
processes. While some states require certain information in order to 
approve RRGs' registrations, RRG representatives with whom we spoke 
said that LRRA does not require RRGs to go through a regulatory review 
and approval process by state regulators to conduct business in 
nondomiciliary states. In 2009, the Risk Retention Reporter surveyed 
captive managers representing 260 RRGs to determine whether 
nondomiciliary states were "encroaching" on LRRA preemptions.[Footnote 
38] In the 2009 survey, 44 percent of RRGs responded that states made 
operation contingent upon regulatory review and approval, while 56 
percent found that states did not. Also in the 2009 survey, 47 percent 
of respondents said they were subject to "impermissible" requests for 
information, while 53 percent said that they were not subject to such 
requests. 

RRG representatives with whom we spoke said that even after completing 
the registration process for some nondomiciliary states, the RRG still 
may not be recognized as registered, or such recognition may take 
several years. For example, according to an RRG representative with 
whom we spoke, an RRG sent a letter to a nondomiciliary state in May 
2006 with notification of its intent to do business. The RRG did not 
receive a letter approving its registration until April 2008. Another 
RRG representative said that an RRG filed the documents required by 
LRRA to register in about 40 states. About one-third of the states 
responded affirmatively to the submissions for this RRG without any 
further questions. Another one-third of states responded to the RRG 
with additional questions before allowing the RRG to conduct business 
in those states. The remaining states did not respond to the RRG's 
registration filings. 

Some states have mandatory waiting periods before a traditional 
insurer, domiciled RRG, or nondomiciled RRG can begin writing business 
in their state. In our survey of state insurance regulators, 3 of 49 
states reported having such a waiting period. However, the waiting 
period can be longer for traditional insurers and domiciled RRGs than 
for nondomiciled RRGs. For example, one state reported that its 
mandatory waiting period for traditional insurers and domiciled RRGs 
was 90 to 120 days, and 15 to 30 days for nondomiciled RRGs. Another 
state did not have a minimum or maximum waiting period, but 
traditional insurers and domiciled RRGs could not write business until 
their state issued a license, and the waiting period for nondomiciled 
RRGs to begin writing business in the state was 60 days. A third state 
reported no waiting period for traditional insurers and domiciled RRGs 
and a waiting period of 30 to 60 days for nondomiciled RRGs. 

NAIC has not taken a position on the legality or utility of different 
state approaches to the interpretation of LRRA or state regulation of 
RRG activities. NAIC published its Risk Retention and Purchasing Group 
Handbook in 1999 to provide guidance to domiciliary states that have 
adopted NAIC's Model Risk Retention Act.[Footnote 39] The purpose of 
the handbook is to present advisory information on issues that have 
arisen or can be expected to arise when regulating RRGs under LRRA. 
For example, while the handbook provides information on the notice and 
registration process for nondomiciliary states, it does not take a 
position on different state approaches. 

As a result of state regulators' varying interpretations of LRRA, 
registration requirements may differ across states. As previously 
noted, some RRGs believe that some states have registration 
requirements that go beyond what is allowed under LRRA, and in some 
cases, these requirements have caused delays in an RRG's ability to 
begin operating in those states. Conversely, some state regulators 
believe such requirements are necessary as well as allowable under 
LRRA. These differing interpretations have resulted in an environment 
of uncertainty for both RRGs and regulators and, according to RRGs, 
are a potential regulatory burden not intended by LRRA. 

State Insurance Regulators and RRGs Differ on Their Interpretation of 
Fees Allowed under LRRA: 

LRRA allows nondomiciliary states to require RRGs to pay premium and 
other taxes but does not explicitly state whether nondomiciliary 
insurance regulators can or cannot charge fees. The silence of LRRA on 
fees has prompted state insurance regulators and RRG representatives 
to interpret the law differently. Both domiciliary and nondomiciliary 
state insurance regulators routinely charge RRGs one-time registration 
fees, annual renewal fees, and filing fees. Based on our survey of 
state insurance regulators, the amount of fees charged varies across 
states and may differ based on whether the RRG is domiciled in the 
state. Among the respondents, most reported that they charged RRGs 
(domiciled and nondomiciled) initial and annual fees to operate in 
their state. Specifically, among the 37 states identifying specific 
fees charged to insurers, most reported that they charged RRGs with 
some of the same types of fees applicable to traditional property/ 
casualty insurers. 

In addition, the responses indicated that premium taxes--which LRRA 
specifically authorizes--vary across states and in some cases have a 
complex structure. For example, premium tax rates may be different for 
domiciled or nondomiciled RRGs or for traditional property/casualty 
insurers. In addition, a few states reported incremental tax rates 
based on the volume of premiums written by the RRG. Further, some 
states implement a "retaliatory" premium tax rate--meaning a state 
taxes out-of-state insurance companies operating in its jurisdiction 
in the same way that the state's own insurance companies are taxed by 
other states. 

A majority of RRG representatives with whom we spoke said that varying 
fees other than premium taxes that nondomiciliary states charged RRGs 
were expensive and a financial burden and were also inconsistent with 
LRRA. For example, one RRG representative said that the insurer, which 
operates in 50 states and the District of Columbia with total national 
premiums of $124 million, paid in excess of $500,000 in combined state 
fees to conduct business outside its domiciliary state. A smaller RRG 
that wrote premiums of about $1 million said it paid $6,000 to $7,000 
in additional fees. Three RRG representatives said that their RRGs 
often "pay fees under protest," while other RRG representatives said 
that they often paid the fees because paying was less expensive than 
litigation against the states. 

RRGs have challenged requirements established by nondomiciliary states 
that RRGs believe are preempted, and therefore not permitted, by LRRA. 
For example, in National Risk Retention Association v. Brown, a U.S. 
district court found that LRRA does not authorize a nondomiciliary 
state to require RRGs domiciled in another state to pay annual, 
application, or policy form review fees as part of registration or 
examination requirements before being allowed to do business in that 
state.[Footnote 40] However, the court did not hold that all fees 
nondomiciliary states charged necessarily were prohibited but that the 
types of fees charged in that case were broader than those allowed by 
the registration and examination requirements enumerated in LRRA. In 
Attorneys' Liability Assurance Society, Inc. v. Fitzgerald the court 
also addressed the issue of fees.[Footnote 41] In that case, a state 
statute required nondomiciled RRGs to pay a fee of a certain 
percentage of their business written in that state. The court held 
that such a fee was not permitted, as LRRA permits only taxes by 
nondomiciliary states, and such a fee was not considered a tax. The 
fee in this case was to be used for regulatory purposes only, and 
therefore was considered an impermissible attempt to regulate an RRG 
by a nondomiciliary state. 

As a result of differing interpretations of LRRA, fee structures vary 
across states. While some RRGs believe some of these fees go beyond 
what is allowed by LRRA, state regulators believe these fees are 
permissible. While the impact on RRGs of fees charged in some states 
is not clear, several RRG industry participants with whom we spoke 
said that fees may be more challenging for smaller RRGs and RRGs 
operating in multiple states. In addition, this variation of fees 
across states also contributes to the uncertainty under which RRGs and 
state regulators operate. 

Regulators, RRGs, and Courts Also Differed on the Types of Coverage 
That RRGs Can Offer and What Constitutes Discrimination as Prohibited 
by LRRA: 

LRRA allows RRGs to provide commercial liability insurance and 
provides a general definition of liability.[Footnote 42] However, 
beyond its general definition, LRRA is silent on the specific types of 
liability insurance that RRGs can provide, which has resulted in 
differences of interpretation by RRGs and state insurance regulators 
about the types of liability coverage permitted under LRRA. In our 
survey of state insurance regulators, 6 of 49 regulators responded 
that they had between one and five differences of interpretation with 
other state insurance regulators about the definition of commercial 
liability insurance in the last 24 months. One regulator reported more 
than 10 differences. In our interviews, five regulators said they 
believed that insurance lines such as contractual liability (for 
example, vehicle service or builder warranties) and stop-loss coverage 
were not permitted under LRRA.[Footnote 43] In some cases, 
nondomiciliary state insurance regulators have not allowed RRGs to 
provide insurance in their state that they believe does not fit the 
definition of liability under LRRA. For example, one nondomiciliary 
state regulator said it denied the registration of an RRG that planned 
to offer contractual liability insurance. In addition, an RRG 
representative reported its registration application was denied in 
five states because regulators did not believe contractual liability 
coverage fell within the definition of liability in LRRA. Further, one 
domiciliary state insurance regulator we interviewed said the state 
believed contractual liability coverage was permitted under LRRA; 
however, the state generally did not allow this coverage to be offered 
in the state to "avoid the politics of the issue." This regulator, 
along with three other regulators with whom we spoke, said that the 
RRG industry needed a clearer definition of contractual liability or 
the types of coverage permissible under LRRA. Differences in 
interpretation of the types of coverage permitted under LRRA have led 
to litigation between states and RRGs. 

States and federal courts also have differed in their interpretations. 
For example, in Auto Dealers RRG v. Steve Poizner, an RRG provided 
stop-loss insurance that covered liability by its members, employees 
of California automobile dealers that maintained self-funded employee 
benefit plans.[Footnote 44] The California insurance office issued a 
cease-and-desist order because it believed that the RRG was providing 
health insurance, not liability insurance as defined by LRRA. The RRG 
challenged the California insurance office's cease-and-desist order in 
federal court, and the court issued a preliminary injunction blocking 
the cease-and-desist order. However, the court never decided the case 
on its merits--that is, the court never decided whether the RRG was 
issuing valid liability insurance policies--because the RRG decided to 
stop pursuing the case and instead stopped issuing policies in 
California. In Attorneys' Liability Assurance Society, Inc. v. 
Fitzgerald (discussed previously), the court held that LRRA permitted 
an RRG to cover liability by its members for wrongful employment 
practices.[Footnote 45] The court held that while RRGs specifically 
were not to cover workers' compensation, the types of coverage 
provided by the RRG at issue in the case were permissible under the 
broad scope of LRRA. 

Federal courts have rendered varying decisions relating to what is 
considered prohibited discrimination per LRRA's state financial 
responsibility requirements. These financial responsibility 
requirements consist of state or local provisions that establish 
conditions for obtaining a license or undertaking certain activities. 
For example, many states require that anyone registering a motor 
vehicle demonstrate proof of financial responsibility (show that the 
owner of the vehicle has financial means sufficient to compensate any 
injured persons). State laws may provide that financial responsibility 
can be shown by coverage in a liability insurance policy by an insurer 
that is regulated by the state and protected by the state's guaranty 
fund. LRRA does not preempt state authority to apply financial 
responsibility standards as long as those standards do not 
discriminate against RRGs within the meaning of LRRA.[Footnote 46] For 
example, in National Warranty Insurance Company RRG v. Greenfield, the 
U.S. Court of Appeals for the Ninth Circuit held that LRRA preempted 
provisions of the Oregon Service Contract Act that required automobile 
dealers to obtain liability insurance from an insurer that was a 
member of the Oregon Insurance Guaranty Association.[Footnote 47] 
Because RRGs do not participate in state guaranty associations, the 
Oregon law effectively excluded RRGs from providing liability 
insurance to automobile dealers. Thus, the court held that Oregon 
could not exclude coverage from all RRGs because that would 
discriminate against RRGs. However, Oregon could exclude coverage from 
a particular RRG if it could show that the RRG was financially unsound 
or otherwise dangerous to those who relied on insurance purchased 
pursuant to the Oregon Service Contract Act. In another case, Charter 
Risk Retention Group Insurance Company v. Rolka, a U.S. district court 
noted similarly that discrimination against RRGs as a whole is 
prohibited under LRRA.[Footnote 48] However, state laws relating 
specifically to financial responsibility requirements could be valid, 
if they caused a particular RRG to be excluded if it lacked acceptable 
evidence of financial responsibility for a state license or permit, as 
long as they did not discriminate against RRGs as a whole.[Footnote 49] 

Other courts have interpreted the provisions of LRRA prohibiting 
discrimination against RRGs differently. In Ophthamalic Mutual 
Insurance Company v. Musser, the U.S. Court of Appeals for the Seventh 
Circuit affirmed a district court decision that LRRA does not preempt 
a Wisconsin requirement that health providers offer proof of financial 
responsibility to do business in the state by obtaining professional 
liability insurance coverage from insurers authorized to do business 
in Wisconsin, although it effectively excludes nondomiciliary RRGs 
from operating in that state.[Footnote 50] The court found that the 
challenged statute neither impermissibly regulated RRGs nor was 
intended to discriminate against them, and therefore is not preempted 
by LRRA. The court concluded that the Wisconsin requirement fit within 
the saving clause of LRRA providing that states are not bound by LRRA 
when crafting statutes concerning financial responsibility, as long as 
the statutes were not intended to discriminate against RRGs. 
Similarly, in Mears Transport Group v. State, the U.S. Court of 
Appeals for the Eleventh Circuit held that LRRA did not preempt a 
Florida law requiring owners or operators of for-hire passenger 
transportation vehicles to provide evidence of financial 
responsibility by having a motor vehicle liability policy issued by an 
insurer that is a member of the Florida Insurance Guaranty 
Association.[Footnote 51] Although RRGs effectively are disallowed 
from doing business in Florida under this law, as they are not 
permitted to be members of guaranty associations under LRRA, the court 
held that the Florida law does not single out RRGs for exclusion, as 
RRGs are one of many types of insurance carriers ineligible for 
membership in the guaranty association. Therefore, the court held that 
the Florida law was not intended to be discriminatory. Since the 
Florida law is "precisely the type of state financial responsibility 
law that Congress expressly exempted from the preemption provisions of 
LRRA," according to the court, it is allowed and not preempted by 
LRRA.[Footnote 52] 

Different interpretations of the types of coverage permitted under 
LRRA have resulted in the inability of some RRGs to provide coverage 
in certain states. And, in cases in which RRGs choose to pursue legal 
action when states deny their ability to provide that coverage, the 
RRGs may incur substantial legal fees. As previously noted, different 
interpretations by federal courts on issues such as permissible 
coverage types and what constitutes discrimination under LRRA can 
further contribute to an uncertain regulatory environment for RRGs and 
state insurance regulators. 

State Insurance Regulators Have Expressed Concerns about the 
Capitalization and Solvency of Some RRGs: 

Because LRRA does not comprehensively address the capitalization or 
solvency requirements of RRGs, states can develop their own statutory 
minimum capital and surplus requirements for RRGs domiciled in their 
state. According to some state insurance regulators with whom we 
spoke, these requirements are based on the type of insurance coverage 
offered, the volume of business the RRG intends to write, and other 
factors. Two nondomiciliary state insurance regulators with whom we 
spoke indicated concerns about the capitalization and solvency of RRGs 
operating in their states, and two regulators support increasing the 
minimum capital requirement. In addition, some states allow RRGs, 
unlike traditional insurers, to meet and maintain their minimum 
capital and surplus requirements in the form of an irrevocable letter 
of credit rather than cash. Data from NAIC show that as of June 2010, 
62 RRGs were capitalized with letters of credit. 

Although RRGs write most of their business outside their state of 
domicile, nondomiciliary state insurance regulators must rely on 
domiciliary regulators to establish minimum capitalization and 
solvency requirements for their domiciled RRGs--and ensure that the 
requirements are commensurate with the type of coverage provided and 
the volume of premiums written. Some RRG representatives with whom we 
spoke believed that there is a lack of confidence in the RRG 
regulatory environment or that some states prefer their own authority 
to regulate RRGs writing business in their state. Two state insurance 
regulators and four RRG representatives said they believed that some 
of these issues will be resolved through NAIC's efforts to develop 
uniform, baseline standards for the regulation of RRGs. 

NAIC Actions Address Some Regulatory Concerns, While Recent Federal 
and State Proposals May Affect Future RRG Operations: 

Revised Accreditation Standards Address Some Regulatory Concerns with 
RRGs' Financial Solvency Practices: 

Our 2005 report found that the wide variance in solvency regulation 
among domiciliary states, along with the growth of the RRG industry, 
increased the potential for future solvency risks. In response to 
recommendations from our 2005 report to provide a more uniform 
regulatory environment for RRGs, NAIC revised its accreditation 
standards to include standards for the way in which states regulate 
RRG solvency.[Footnote 53] These new standards went into effect on 
January 1, 2011. NAIC also began to address our recommendations to 
develop corporate governance standards concerning ownership and 
operational issues within RRGs. Initial discussions in 2005 led to the 
development of draft corporate governance standards by 2007, and later 
in 2010 NAIC working groups initiated steps toward integrating these 
standards into the RRG oversight process. In addition, NAIC has 
started the process to integrate corporate governance standards into 
its accreditation standards, so that states would be required to 
review RRG's corporate governance standards to be accredited. The 
groups' discussions were open to interested parties, including RRG 
representatives. For instance, the National Risk Retention Association 
(NRRA), told us it actively participated in NAIC working groups. The 
revisions to the financial accreditation standards for state insurance 
departments' oversight of domiciled RRGs more closely align the 
standards applied to the oversight of RRGs with those that are applied 
to traditional insurers. The revisions affect key areas of RRGs' 
financial solvency oversight, including revising accounting 
requirements for annual financial reporting and making financial 
examinations risk-focused. 

Financial Reporting Requirements for RRGs Made More Similar to Those 
for Traditional Insurers: 

Among the recent revisions to NAIC's accreditation standards is a new 
requirement that applies to RRGs that do not file their annual 
financial statements using SAP: these statements must contain a 
reconciliation to SAP, effective January 1, 2011. According to NAIC, 
in 2010, 72 RRGs reported filing their financial statement using SAP 
and 177 reported using another accounting principle such as GAAP. The 
reconciliation is designed to indicate to regulators how the 
accounting principles used in financial statements result in figures 
different from those that SAP would have produced. RRGs can include 
this reconciliation in the footnotes to the financial statement. This 
new standard aims to address some of the challenges identified in our 
2005 report that arose from the use of different accounting 
principles, such as difficulties in assessing the financial condition 
of RRGs reported by some nondomiciliary state insurance regulators 
more accustomed to SAP. The new standards also move financial 
reporting requirements for RRGs closer to those of traditional 
insurers.[Footnote 54] Our survey responses from state insurance 
regulators showed that 32 state regulators reported requiring SAP for 
financial reporting, 14 reported requiring GAAP or a modified version 
of GAAP and 3 reported a choice of accounting principles within their 
requirements.[Footnote 55] 

Financial reporting practices for RRGs still vary and the choice of 
accounting method can produce different conclusions about a company's 
financial strength.[Footnote 56] NAIC analysts continue to report that 
allowing financial statements using different accounting principles, 
even when reconciled to SAP in the footnotes, diminishes the 
usefulness of their underlying data and analysis tools because the 
tools were designed around data extracted from financial statements 
based on SAP. Statements filed using other accounting principles can 
produce distorted results when looked at through traditional 
computerized analysis tools. As a result, NAIC must then revise the 
analyses to produce information useful to state regulators, which 
requires more staff resources. In prior reports we have noted that 
NAIC's solvency analysis is an important supplement to the overall 
solvency monitoring performed by states and can help states focus 
their examination resources on potentially troubled companies, 
including flagging financial ratios that are outside the usual range 
for additional regulatory attention.[Footnote 57] Further, the choice 
of accounting method can have important repercussions for certain 
RRGs. For example, representatives of two RRGs with whom we spoke 
reported letters of credit to be critical for some RRGs to meet 
minimum capitalization requirements; and as a result, they often 
preferred to file their financial statements using GAAP where letters 
of credit can, in some states, improve the RRG's appearance of 
financial solvency. 

Risk-Focused Examinations Already Required of Traditional Insurers, 
Now Required for RRGs: 

The revised accreditation standards also require all RRGs to have risk-
focused examinations in an effort to implement more uniform baseline 
standards for RRG regulation, applicable to all financial examinations 
of RRGs commencing on or after January 1, 2011. Risk-focused 
examinations emphasize reviews of higher-risk areas and tend to be 
more specialized and tailored to individual companies. Risk-focused 
examinations are already a regulatory requirement for traditional 
insurers. Nondomiciliary states have the right to review the results 
of these examinations for RRGs. 

Three representatives of RRGs with whom we spoke supported the move to 
risk-focused examinations because they believed more uniform 
regulatory activities among domiciliary states would result in more 
trust among state regulators and ultimately would benefit the RRG 
industry. However, six representatives also acknowledged some 
potential challenges in implementing risk-focused examinations for 
some RRGs, particularly the smaller ones. For example, they said it 
could increase financial costs and regulatory burden for these RRGs 
because state regulators might need to hire more specialized auditors 
for more detailed reviews, and pass on the associated costs to the 
RRGs in the form of examination fees. NRRA also expressed its concern 
about the efficiency and effectiveness of risk-focused examinations 
for small liability insurance companies, which compose the majority of 
RRGs. NRRA characterized the impact on small RRGs as excessively 
expensive without yielding commensurate benefit, and held that 
implementing risk-focused examinations for small RRGs would run 
counter to the intent of LRRA. In its letter to NAIC, NRRA questioned 
the cost-effectiveness of the more rigorous examinations for certain 
RRGs based on characteristics such as the RRG's size, its impact in 
nondomiciliary states, and the structure of its membership. 

Four state insurance regulators with whom we spoke also said that 
requiring risk-focused examinations might not be an efficient use of 
resources, particularly for small RRGs that represent the majority of 
the RRG population. Three state insurance departments we interviewed 
reported having already implemented risk-focused examinations for 
their domiciled RRGs. Based on its experience conducting risk-focused 
examinations, one domiciliary state regulator recommended that 
criteria be used to determine the efficiency and effectiveness of 
applying a risk-focused examination to an RRG. For example, the 
regulator recommended that risk-focused examinations should be 
required for RRGs with more than $10 million in direct written 
premiums, owned and operated by a group of shareholders with 
unrestricted membership, and registered to operate in at least 15 
states. Alternatively, the regulator suggested leaving it at the 
discretion of the domiciliary state regulator to decide whether the 
risk-focused approach would be the most efficient approach to oversee 
a particular RRG. 

According to NAIC officials, the possibility of exempting certain 
types of RRGs from the risk-focused examination requirement was 
considered in working groups. However, they also expressed concern 
about whether alternative examinations would qualify as full-scope 
examinations in accordance with NAIC's guidance on examinations as 
outlined in the Financial Condition Examiners Handbook. The guidance 
requires RRGs to undergo full-scope examinations at least once every 5 
years, or in accordance with the respective state law if it requires 
more frequent examinations.[Footnote 58] NAIC decided that the risk-
focused examination process was flexible enough to allow examiners to 
tailor examinations to fit the unique characteristics of RRGs. 

RRG Oversight Could be Affected by Future Developments with NAIC and 
Federal Legislation: 

NAIC Plans to Incorporate Risk-Based Capital Analyses into RRG 
Oversight, as Already Done for Traditional Insurers: 

NAIC's risk-based capital (RBC) system was created to provide a 
capital adequacy standard for traditional insurers that creates a 
financial safety net, is uniform among the states, and provides 
regulatory authority for timely action. The RBC formulas can be 
technical and involve a number of components. Each of the primary 
insurance types--such as property/casualty, life or health--has a 
separate RBC formula that emphasizes the material risks common for 
that particular insurance type. Regulatory actions may be triggered by 
the RBC calculation for an insurer, and actions may include requiring 
the insurance company to issue comprehensive financial plans, issue 
corrective orders, or authorize the take-over of the insurer.[Footnote 
59] 

NAIC officials said that they are pursuing the use of RBC calculations 
in the oversight of RRGs as part of the accreditation process. While 
regulators may voluntarily include RBC calculations in the financial 
examinations of RRGs, these calculations are not specifically 
required. According to NAIC officials, it is expected that RBC will be 
incorporated into the accreditation standards. If incorporated into 
the accreditation standards, regulators would be expected to 
incorporate RBC calculations into their broader financial analyses to 
determine whether any actions would be necessary, although, unlike 
traditional insurers, the RBC calculations for RRGs do not 
automatically trigger regulatory actions. 

While five RRG representatives we interviewed generally supported 
NAIC's revisions to the accreditation standards in the RRG industry, 
three representatives expressed some concern about how meaningful an 
RBC analysis would be as a requirement in RRG oversight. For example, 
they said that the use of RBC for small RRGs, which tend to use GAAP 
accounting and rely more heavily on letters of credit to meet their 
capitalization requirements, might not be useful. Five state insurance 
regulators we interviewed were also unsure of the usefulness of 
incorporating RBC calculations into the accreditation standards, 
particularly in situations in which otherwise healthy RRGs could fare 
poorly when RBC calculations were applied. An actuarial expert we 
interviewed also expressed concern that an RBC requirement could lead 
to an overemphasis on the RBC figures for regulators and undue 
pressure on otherwise sound RRGs to increase capital. According to an 
NAIC working group analysis, an RBC formula using figures based on 
GAAP could result in different numbers compared with RBC calculations 
using figures based on SAP, potentially changing the picture of that 
RRG's financial condition. However, the working group also said that 
using figures determined under GAAP might not unreasonably alter the 
RBC conclusions for most RRGs and still could be meaningful. 

NAIC Has Developed Corporate Governance Standards for RRGs, but Has 
Not Implemented Them: 

In response to our 2005 recommendations to establish minimum corporate 
governance standards for the RRG industry, NAIC developed such 
standards for RRGs but has not yet implemented them with a model act 
or through their accreditation standards. NAIC officials reported that 
they expect these corporate governance standards to be incorporated 
into the Model Risk Retention Act by the end of 2011. Further, the 
officials said that in 2012 they will consider adopting corporate 
governance standards as part of the accreditation standards. 

An RRG is often operated by a management company or another service 
provider that generally supplies key services. However, the potential 
for abuse arises if the interests of a management company are not 
aligned with the interests of the RRG insureds to achieve long-term 
solvency and obtain self-insurance at an affordable price. In our 2005 
report, we found behavior suggesting that management companies and 
affiliated service providers promoted their own interests at the 
expense of the RRG insureds in 10 of the 16 cases of RRG failures we 
examined. LRRA includes no provisions for governance controls that 
could help mitigate the risk to RRG insureds from potential abuses by 
other interests, such as their management companies, should these 
companies choose not to operate in the best interest of RRG insureds. 

In response to GAO's recommendations, NAIC's working groups have 
included corporate governance standards as part of their efforts to 
develop uniform baseline standards for RRGs. NAIC first adopted 
corporate governance standards for RRGs in June 2007 as a separate 
stand-alone guidance that was not incorporated into the accreditation 
standards. As of October 2011, the revisions to the Model Risk 
Retention Act that include corporate governance standards had been 
reviewed, but not yet approved, by the NAIC member states. As of 
November 2011 these revisions were approved and NAIC had adopted 
corporate governance standards into the Model Risk Retention Act. 
However, corporate governance standards are not yet a part of the 
accreditation standards and NAIC officials said that they will not 
begin discussions on adopting these standards into the accreditation 
requirements until 2012. 

Three state insurance regulators with whom we spoke expressed support 
for corporate governance standards as a requirement for RRGs because 
they felt it would improve transparency of the management of RRGs. 
While five regulators generally did not think implementing corporate 
governance standards would be burdensome for RRGs, one regulator did 
expect that some RRGs, depending on their size, could find the 
implementation of some standards, such as the requirement for an audit 
committee, to be a challenge. Representatives of two large RRGs with 
whom we spoke supported corporate governance standards as good 
business practice. However, four representatives of RRGs also 
expressed concern about the cost of implementing these standards for 
smaller RRGs, particularly those without their own internal counsel. 

Some Legislative Proposals Would Allow RRGs to Insure Commercial 
Property and Provide for Federal Arbitration and Governance Standards: 

Recent federal legislative proposals to amend LRRA, if passed, would 
offer new options to RRGs.[Footnote 60] One proposed change would 
expand the type of insurance RRGs may provide to include commercial 
property coverage. RRG representatives with whom we spoke generally 
favored amending LRRA to allow RRGs to provide commercial property 
insurance coverage. For example, one representative said the 
differences in the risk profile between commercial property coverage 
and commercial liability coverage is a potential opportunity to manage 
their risks more strategically. 

In addition, six RRG representatives we interviewed felt that allowing 
coverage of commercial property insurance constituted a removal of 
restrictions on providing insurance products that could be a natural 
extension of their core line of business. For example, an RRG that 
offers professional liability coverage to dentists currently cannot 
underwrite coverage for dental equipment. Similarly, one 
representative of an RRG offering commercial liability insurance 
products to the construction business said that the RRG could not 
offer property insurance related to the same homes constructed under 
their insurance coverage. Another RRG representative said their 
clients would like the option to bundle their property coverage with a 
wide range of specialized insurance products they purchase from the 
RRG for both convenience and cost-effectiveness. Eight RRG 
representatives we interviewed were concerned that some RRGs entering 
the commercial property market might not have adequate capital to 
cover the potentially severe losses that are a part of that line of 
coverage. Four RRG representatives also said that they would expect 
the domiciliary state regulator to review any changes to an RRG's 
business plan to ensure that it had an appropriate capital base for 
its underwriting coverage and risk profile. 

Ten regulators with whom we spoke expressed concerns about RRGs 
entering the commercial property insurance market because of the 
potential risks to owner/insureds and consumers. For example, six 
regulators expressed concern that if an RRG was unable to pay the 
potentially severe losses associated with some lines of property 
insurance, the RRG members could be at financial risk. RRGs cannot 
participate in state guaranty funds that otherwise could help pay 
losses in such cases. In our survey of state insurance regulators, we 
asked whether they thought LRRA should be amended to enable RRGs to 
provide commercial property insurance. Among the responses, 32 
regulators did not think LRRA should be so amended while 5 thought 
LRRA should be amended to allow RRGs to provide property 
insurance.[Footnote 61] Three of the five regulators that favored 
amending LRRA in this way were from the 10 states with the highest RRG 
gross premiums in 2010. 

The proposed legislation also would grant authority to a federal 
entity, such as the recently created Federal Insurance Office in the 
Department of the Treasury, to oversee state compliance with the 
regulatory preemptions in LRRA. For example, the office would resolve 
disagreements about whether LRRA preempts any regulatory actions by a 
state.[Footnote 62] Among the state insurance regulators we surveyed, 
29 said that the federal government should not have a primary role in 
arbitrating disputes between state regulators and RRGs, while 6 said 
that the federal government should have a primary role.[Footnote 63] 
We also asked regulators which department or agency they thought 
should have this authority if the federal government were to arbitrate 
disputes between states and RRGs. Twenty-nine regulators responded 
with no opinion, while 13 regulators indicated their preference for 
the Federal Insurance Office and 6 regulators indicated other agencies 
including the Department of Commerce.[Footnote 64] 

Another proposed change would have the Federal Insurance Office issue 
corporate governance standards for RRGs that would preempt any 
corporate governance standards under state laws.[Footnote 65] Five 
state regulators with whom we spoke also favored developing an 
arbitration mechanism, while five regulators did not think corporate 
governance standards would be burdensome for RRGs to implement. While 
seven RRG representatives we interviewed generally supported 
establishing a federal arbitration mechanism as a more efficient and 
cost-effective way of resolving disputes, four representatives also 
expressed concern about potential encroachment into state regulatory 
activities by a federal entity. 

Conclusions: 

In establishing the Liability Risk Retention Act, Congress allowed 
RRGs to provide commercial liability insurance to RRG members and 
established a lead-state regulatory framework. While constituting a 
small portion of the total liability insurance market, the amount of 
premiums written by RRGs increased from 2004 to 2010 and the financial 
condition of the RRG industry generally has remained profitable during 
this same period. Based on our analysis, RRGs appear to have 
maintained a relatively consistent presence in the market, primarily 
providing coverage in niche markets such as medical professional 
liability insurance and other health care-related insurance lines. 

RRGs have continued to domicile in one of a few states but write most 
of their business in other states, highlighting the importance of 
LRRA's provisions governing the rights and actions available to 
regulators in nondomiciliary states as well as the types of coverage 
allowed under LRRA. However, states have interpreted these provisions 
differently, due in part to LRRA's silence on certain issues such as 
registration requirements, fees, and the types of insurance coverage 
RRGs can write, sometimes resulting in litigation between state 
insurance regulators and RRGs. In addition, some federal courts to 
which these disputes have been brought also have interpreted LRRA 
differently. As a result, RRGs and state insurance regulators have 
continued to operate in an environment with some uncertainty, 
potentially affecting RRGs' operations as well as the ability of state 
regulators to take actions deemed necessary to protect insureds in 
their states. 

To establish a more consistent regulatory environment for the members 
of RRGs and their claimants, our previous report recommended the 
development of broad-based, uniform, baseline standards for the 
regulation of RRGs. NAIC has made progress addressing these concerns, 
including requiring accredited states to implement risk-focused 
examinations and risk-based capital analyses, as well as developing 
corporate governance standards for the RRG industry. Further, NAIC has 
made efforts to more closely align the accreditation standards for 
RRGs with those of traditional insurance companies. Because some of 
these standards only recently were implemented or have not yet been 
implemented, it is too early to evaluate their effect on the RRG 
industry and its regulation. 

Matter for Congressional Consideration: 

To reduce the varying interpretations of LRRA, which have led to 
uncertainty and disagreements among RRGs and state insurance 
regulators, and at the same time continue to facilitate the formation 
and efficient operation of RRGs, Congress should consider clarifying 
certain LRRA provisions. For example, clarifying whether (1) RRG 
registration requirements beyond those currently specified in LRRA are 
permitted in nondomiciliary states and (2) fees in addition to premium 
and other taxes could be charged to RRGs by nondomiciliary states in 
which they operate. Congress also should consider providing a more 
specific definition of the types of insurance coverage permitted under 
LRRA. 

Agency Comments and Our Evaluation: 

We requested comments on a draft of this report from the National 
Association of Insurance Commissioners. NAIC provided written 
comments, which are reproduced in full in appendix II. NAIC also 
provided technical comments, which we incorporated as appropriate. 

NAIC agreed that Congress should consider the merits of clarifying 
certain aspects of LRRA, in particular by providing more specific 
definitions of the type of insurance coverage permitted under the 
LRRA. NAIC further recommended that the definition of "commercial 
liability insurance" be included for consideration since disagreements 
concerning the scope of this definition have led to disputes between 
the states and RRGs that, without further clarification, may continue. 
NAIC also provided several additional comments. 

* NAIC provided clarification regarding the status of their Risk Based 
Capital Models (RBC) and corporate governance standards as it relates 
to NAIC's accreditation standards for RRGs, which we incorporated into 
the draft. 

* NAIC expressed concern with the methodology we used to calculate the 
annual average ratios in figures 3 and 4, and suggested we either use 
an alternate methodology or more clearly describe the one we used. We 
added a more detailed description of our methodology to each of the 
figures. 

* NAIC clarified that when analyzing the ratio of premiums to 
policyholder surplus, whether or not a state allows a letter of credit 
as an admitted asset can change the results of such an analysis. We 
agree and added an explanatory footnote. 

As agreed with your offices, unless you publicly release its contents 
earlier, we plan no further distribution of this report until 30 days 
from its date of issue. At that time, we will send copies of this 
report to the Chairman and Ranking Member of the Senate Committee on 
Banking, Housing and Urban Affairs; the Chairman and Ranking Member of 
the House Financial Services Committee; the Ranking Member of the 
Subcommittee on Oversight and Investigations, House Financial 
Services; and to the Chief Executive Officer of NAIC. In addition, the 
report will be available at no charge on the GAO website at 
[hyperlink, http://www.gao.gov]. 

If you or your staff members have any questions about this report, 
please contact me at (202) 512-7022 or cackleya@gao.gov. Contact 
points for our Offices of Congressional Relations and Public Affairs 
may be found on the last page of this report. GAO staff who made key 
contributions to this report are listed in appendix III. 

Signed by: 

Alicia Puente Cackley: 
Director, Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

Our objectives were to (1) describe changes in the financial condition 
of the risk retention group (RRG) industry from 2004-2010; (2) examine 
the regulatory treatment of RRGs across domiciliary and nondomiciliary 
states; and (3) examine changes to federal and state regulatory 
practices regarding RRGs since 2004. 

To determine the extent to which the financial condition of the RRG 
industry has changed since 2004, we examined previous GAO reports, 
various financial indicators from data provided by the National 
Association of Insurance Commissioners (NAIC) and the Risk Retention 
Reporter, a trade journal and data source for the industry. We 
interviewed representatives of two industry associations on their 
members' regulatory experiences operating in domiciliary and 
nondomiciliary states. We reviewed correspondence from state insurance 
regulators to RRG representatives about topics such as registration 
processes and fees charged to RRGs. NAIC officials calculated the 
overall market share of RRGs in the commercial liability insurance 
market for each year during 2004-2010 and the overall market share of 
RRGs in the medical professional liability line for 2007-2010 only. We 
examined the amount of premiums written by RRGs and traditional 
property/casualty insurers for commercial liability insurance in all 
50 states, the District of Columbia, the U.S. territories (American 
Samoa, Guam, Northern Mariana Islands, Puerto Rico, and the Virgin 
Islands), and Canada. To ensure data were comparable, we limited our 
analysis to commercial liability lines of insurance that RRGs are 
allowed write. We examined and analyzed RRG industry data on financial 
indicators of profitability and ability to pay claims, such as 
policyholder surplus, return on equity and combined ratio for 2004-
2010. To determine the number of RRGs domiciled in and operating by 
state, and the percentage of direct written premiums written outside 
the state of domicile, we analyzed information provided by NAIC. 

To assess the reliability of NAIC data we received, we (1) performed 
electronic testing for obvious errors in accuracy and completeness; 
and (2) worked with agency officials to identify any data concerns. 
When we found discrepancies, such as data that were inconsistent, we 
notified agency officials and worked with these officials to correct 
the discrepancies before conducting our analysis. We determined that 
the data were sufficiently reliable for the purposes of our report. 

To compare the concentration of RRGs by business area, we used data 
from 2004 and 2010 from the Risk Retention Reporter. We also obtained 
data from this source for the number of RRGs licensed by business 
area. Data from the Risk Retention Reporter were as of April 2010. We 
did not attempt to verify these data, but did interview officials of 
the Risk Retention Reporter to discuss their data collection methods. 
We determined that the data were sufficiently reliable for the 
purposes of our report. 

Overall, we used interviews, a Web-based survey, and analysis of the 
Liability Risk Retention Act of 1986 (LRRA) with other available 
documentation to determine potential inconsistencies in the regulatory 
treatment and regulatory environment of RRGs in domiciliary and 
nondomiciliary states. We reviewed and analyzed LRRA and its 
legislative history. To determine states' rules and regulations for 
RRGs domiciled or operating in those states, we designed and 
administered a Web-based survey of state insurance regulators in all 
50 states and the District of Columbia. Specifically, the survey asked 
about each state's (1) requirements for RRGs domiciled in state; (2) 
role as a host (nondomiciliary) state regulator for RRGs operating in 
state; (3) applicable fees, taxes, and registration requirements; (4) 
regulatory experiences such as conducting examinations of, taking 
administrative actions against, and filing civil or criminal lawsuits 
against RRGs; and (5) opinions on LRRA. A copy of the questionnaire 
and results are available in the e-supplement to this report, GAO-12-
17SP. The Web-based survey was administered from May 19, 2011, through 
July 25, 2011. Respondents were sent an e-mail invitation to complete 
the survey on a GAO Web server using a unique username and password. 
Throughout the data collection period, nonrespondents received 
reminder e-mails and telephone calls. The final response rate was 49 
out of 51 states including the District of Columbia (96 percent). 
[Footnote 66] 

The practical difficulties of conducting any survey may introduce 
nonsampling errors, such as difficulties interpreting a particular 
question, which can introduce unwanted variability into the survey 
results. We took steps to minimize nonsampling errors by pretesting 
the questionnaire over the telephone in March and April 2011 with four 
state insurance regulators (in both domiciliary and nondomiciliary 
states) and with NAIC officials. We conducted pretests to make sure 
that the questions were clear and unbiased, the data and information 
were readily obtainable, and the questionnaire did not place an undue 
burden on respondents. We made appropriate revisions to the content 
and format of the questionnaire after the pretests. After the data 
were collected, we identified unanswered questions and inconsistencies 
in some responses. We conducted follow-up with the specific states by 
e-mail and telephone to obtain responses to unanswered survey 
questions and confirm the accuracy of responses to several key 
questions, including applicable fees, premium tax rates, waiting 
periods, and regulatory actions. We received a 100 percent response 
rate to our follow-up questions and response confirmations. 

While many of the questions on the 2004 and 2011 surveys are similar, 
slight differences in wording or question format could result in 
slightly different responses between the two surveys.[Footnote 67] All 
data analysis programs used for this report were independently 
verified for accuracy. Due to the wide variety of responses to some of 
our open-ended questions, preparing statistics and summary 
presentation of findings to these questions was not possible in some 
cases. Therefore, in some cases we provided qualitative explanations 
with examples of responses we received. 

To obtain the information and opinions on the regulatory treatment of 
RRGs across domiciliary and nondomiciliary states, we interviewed 13 
regulators from domiciliary and nondomiciliary states representing a 
nonstatistical sample of states selected for RRG business activity and 
perceived differences in their regulatory treatment of RRGs. The nine 
domiciliary states--Delaware, Florida, Hawaii, Illinois, Montana, 
Nevada, South Carolina, Vermont, and the District of Columbia--
included eight that were among the top 10 states that domiciled the 
highest number of RRGs or had the highest amounts of written premiums 
as of December 31, 2010.[Footnote 68] For states that do not have 
domiciled RRGs, we identified and selected those in which RRGs were 
writing the highest amounts of total premiums as of year-end 2010. 
Those four states were California, Massachusetts, New York and 
Pennsylvania. Views of other domiciliary and nondomiciliary insurance 
regulators were obtained through our Web-based survey. To obtain 
comparable data, the same topics were included in the Web-based survey 
and in interviews with domiciliary and nondomiciliary state insurance 
regulators. 

We also obtained information and opinions on the regulatory treatment 
of RRGs across states from RRG representatives. First, we conducted 
two discussion groups at the 2011 annual conference for a captive 
industry association. We coordinated with the industry association to 
determine which conference participants had specific knowledge of and 
were representatives of the RRG industry. To determine which 
individuals to select to participate in our discussion groups, we 
developed an invitation letter that the industry association e-mailed 
to the identified RRG industry representatives. The letter also 
included a questionnaire to aid in identifying the organization name, 
title, and industry type of the RRG representative. We received 10 
completed questionnaires from conference registrants expressing 
interest in participating in the discussion groups.[Footnote 69] Based 
on the information provided in the questionnaire, we assembled 
discussion group volunteers into two groups: (1) RRG owner/insureds 
and (2) captive/RRG managers. For conference attendees who did not 
respond to the questionnaire by the deadline in the invitation but 
wanted to participate, we provided blank questionnaires at the 
registration table and before the discussion groups. Those who met the 
criteria for either group were allowed to participate in the 
discussion groups. We excluded individuals from industry associations 
whom we previously interviewed and state insurance regulatory 
agencies, as their views were captured in the GAO-administered Web 
survey. Second, we selected a non-statistical sample of 11 RRGs that 
operate on a multistate basis and represent a variety of business 
areas, insurance products, domiciliary states, and a range of direct 
written premiums to obtain their perspectives on the regulatory 
treatment of RRGs across domiciliary and nondomiciliary states. We 
excluded RRGs that we previously interviewed and RRGs that domiciled 
and operated only in their domiciliary state. We are not able to 
generalize results from this sample to the entire RRG industry. To 
obtain comparable data, we covered the same topics in these interviews 
as in the discussion groups noted above. 

To determine the extent to which state and federal regulatory 
practices affecting RRGs have changed since 2004, we reviewed 
regulations, guidance, and legislative and regulatory proposals and 
interviewed stakeholders. More specifically, we reviewed NAIC 
literature and guidance to state insurance departments about RRG 
oversight. We also interviewed NAIC officials about efforts to address 
recommendations from our 2005 report, including revisions to NAIC's 
state accreditation process and progress with developing and 
implementing corporate governance standards for RRGs. We attended NAIC 
working group meetings concerning implementation of accreditation 
standards and approval of updates to the RRG Handbook and corporate 
governance standards for RRGs. We also obtained information about 
RRGs' regulatory environment and views on the potential impact of 
NAIC's changes to the accreditation standards from the 13 select 
domiciliary and nondomiciliary state insurance regulators mentioned 
above. In addition, we obtained information on any changes to state 
regulations affecting RRGs since 2004 through our Web-based survey of 
regulators. We interviewed an actuarial expert about the revisions to 
the accreditation standards. Furthermore, we obtained views from 
representatives of RRGs on their primary challenges and NAIC's efforts 
to establish broad based uniform standards for the oversight of RRGs. 
More specifically, we spoke with the discussion group participants and 
representatives from 11 select RRGs mentioned in the previous 
paragraph. The criteria for selection of these RRGs are described 
above. We excluded those RRGs we already interviewed and RRGs that 
domiciled and operated in only their home state. We are not able to 
generalize results from this sample to the entire RRG industry. We 
also reviewed documentation we received from RRG representatives 
related to their regulatory experiences and the expected impact of the 
revised accreditation standards. Finally, we reviewed key legislation 
concerning RRGs that had been introduced at the federal and state 
level since 2004 to identify recent changes in laws and regulations 
affecting RRGs. 

We conducted this performance audit from October 2010 to December 2011 
in accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: Comments from the National Association of Insurance 
Commissioners: 

NAIC: 
National Association of Insurance Commissioners: 
and: 
The Center for Insurance Policy and Research: 

Executive Office: 
444 North Capitol Street NW, Suite 701: 
Washington, DC 20001-1509: 
p: 202-471-3990; f: 816-460-7493: 

Central Office: 
2301 McGee Street, Suite 800: 
Kansas City, MO 64108-2662: 
p: 816-842-3600; f: 816-783-8175: 

Capital Markets & Investment Analysis Office: 
48 Wall Street, 6th Floor: 
New York, NY 10005-29016: 
p: 212-398-9000; f: 212-382-4207: 

[Hyperlink, http://www.naic.org] 
 
November 30. 2011: 

Ms. Alicia Puente Cackley: 
Director, Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G. Street, NW: 
Washington, DC 20548:  

Dear Ms. Puente Cackley,  

Thank you for providing the National Association of Insurance 
Commissioners (NAIC) with an opportunity to submit comments on the 
GAO's draft report, Risk Retention Groups: Clarifications Could 
Facilitate Slates' Implementation of the Liability Risk Retention Act 
(GAO-12-16).  

As a general comment, we agree Congress should consider the merits of 
clarifying certain aspects of the LRRA. The GAO draft report mentions 
Congress should consider providing more specific definitions of the 
type of insurance coverage permitted under the LRRA. The NAIC would 
further recommend Congress consider clarifying the definition of 
"commercial liability insurance." Some RRGs and their domiciliary 
states have taken a broader view of what constitutes commercial 
liability insurance than may have been originally intended by 
Congress. This in turn is causing confusion and leading to disputes 
between the states. Without legislation or further guidance these 
disputes most likely will continue.  

We would also like to provide additional clarification regarding the 
NAIC's accreditation standards for Risk Based Capital Models (RBC) and 
corporate governance standards. Although the NAIC Risk Retention Group 
(E) Task Force has recommended RBC should become an accreditation 
requirement, the Financial Regulation Standards and Accreditation (F) 
Committee has not yet adopted this recommendation. However, since this 
does not appear to be a contentious issue it is anticipated the 
Financial Regulation Standards and Accreditation (F) Committee will 
adopt the Task Force's recommendation and make RBC an accreditation 
standard for RRGs. 

Corporate governance standards will be incorporated into the NAIC's 
Model Risk Retention Act, having been adopted by the NAIC Property and 
Casualty Insurance Committee (C) on November 5, 2011. The NAIC 
membership is expected to adopt the corporate governance standards for 
RRGs by this year end. After the final adoption of the corporate 
governance standards, the Financial Regulation Standards and 
Accreditation (F) Committee will begin considering whether the 
standards will become an accreditation requirement. These 
discussions arc expected to begin in March 2012.  

Additionally, the NAIC has concerns with the methodology used to 
calculate Figure 3 and Figure 4 in the Report, as it appears the GAO 
added together the legal entity ratios and then divided by an average 
number of entities for a given year to arrive at another ratio. It is 
our understanding the GAO's rationale for using this methodology stems 
from the desire to capture the experience of a large number of small 
RRGs. The NAIC recommends the GAO use one of the following approaches: 
(1) sum the numerators and denominators of each entity and then divide 
the total numerator and total denominator to arrive at a ratio; or (2) 
create two or three RRG groupings based on direct premium size and 
then repeat #1 for each. If the GAO insists on using the current 
methodology, the NAIC requests a more detailed description of the 
methodology to better inform readers of the report. 

Finally, we would like to make a clarification regarding the financial 
position of RRGs. The comparison of the ratio of net written premium 
to policyholder surplus ignores one important fact. RRGs are allowed, 
in some states, to recognize a letter of credit as an admitted asset. 
However, both Statutory Accounting Principles (SAP) and Generally 
Accepted Accounting Principles (GAAP) do not allow a letter of credit 
to be treated as an admitted asset. If the analysis were repeated 
without counting the letters of credit, the financial position of RRGs 
would look very different than presented. 

Sincerely, 

Signed by: 

Andrew J. Beal: 
Chief Operating Officer and Chief Legal Officer: 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Alicia Puente Cackley, (202) 512-7022 or cackleya@gao.gov: 

Staff Acknowledgments: 

In addition to the individual named above, Patrick A. Ward, Assistant 
Director; Susan Baker; William Chatlos; Shamiah Kerney; Jill Lacey; 
May Lee; Marc Molino; Patricia Moye; Daniel Newman; Jasminee Persaud; 
and Barbara Roesmann also made major contributions to this report. 

[End of section] 

Footnotes: 

[1] Pub. L. No. 97-45, 95 Stat. 949 (1981) (codified, as amended, at 
15 U.S.C. §§ 3901-06). 

[2] Pub. L. No. 99-563, 100 Stat. 3170 (1986). As amended, LRRA 
permits RRGs to offer commercial liability insurance, excluding 
worker's compensation. 

[3] See 15 U.S.C. §§ 3901-02. A domiciliary state is the state in 
which the RRG is chartered and primarily regulated, whereas a 
nondomiciliary state is any state in which the RRG is not chartered or 
regulated, but conducts business. 

[4] 15 U.S.C. § 3902(d)(2)-(3). See 15 U.S.C. § 3902(a)(1)(B), which 
allows any state (domiciliary or nondomiciliary) to require payment of 
premium and other taxes, but does not mention fees. 

[5] 15 U.S.C. § 3902(a)(1). 

[6] H.R. Rep. No. 99-865, at 12 (1986), reprinted in 1986 U.S.C.C.A.N. 
5303, 5309; S. Rep. No. 99-294, at 13-14 (1986). 

[7] Insurance insolvency guaranty funds typically are maintained by 
contributions of insurance companies operating in a particular state 
and are made available to settle the claims of insureds in the event 
of insolvency of traditional insurance companies. 

[8] NAIC is a voluntary association of the heads of insurance 
departments from each state, the District of Columbia, and five U.S. 
territories that provides a national forum for addressing and 
resolving major insurance issues (including those concerning RRGs) and 
for promoting the development of consistent policies among the states. 

[9] GAO, Risk Retention Groups: Common Regulatory Standards and 
Greater Member Protections Are Needed, [hyperlink, 
http://www.gao.gov/products/GAO-05-536] (Washington, D.C.: Aug. 15, 
2005). 

[10] In 2003, 127 RRGs were licensed to write business. 

[11] SAP is a set of accounting principles dominant in the traditional 
insurance industry that is geared towards assessing solvency, and 
produces some variations from another set of accounting principles--
GAAP--which are more widely used outside the insurance industry to 
assess the general performance of a business. 

[12] See, e.g., Ophthalmic Mut. Ins. Co. v. Musser, 143 F.3d 1062 (7th 
Cir. 1998); National Warranty Ins. Co. RRG v. Greenfield, 214 F.3d 
1073 (9th Cir. 2000). 

[13] See, e.g., H.R. 2126, 112th Cong. (2011). 

[14] The survey and corresponding results can be viewed at GAO-12-17SP. 

[15] 15 U.S.C. § 3902(a)(1). 

[16] Id. § 3902(a)(1)(B). 

[17] Id. § 3902(d)(1). 

[18] Id. § 3902(d)(2). 

[19] Id. § 3902(d)(3). Loss reserve is the estimated liability, as it 
would appear in an insurer's financial statement, for unpaid insurance 
claims or losses that have occurred as of a given evaluation date. 
Loss reserves usually include losses incurred but not reported, losses 
due but not yet paid, and amounts not yet due. For individual claims, 
the loss reserve is the estimate of what ultimately will be paid out 
on that claim. 

[20] 15 U.S.C. § 3902(a)(1)(E). 

[21] Id. § 3902(a)(1)(H), (e), (f). 

[22] In general, accreditation is a process by which a program has 
been certified as fulfilling certain standards by a national 
professional association. 

[23] Premiums written are the total amount of premium charges in a 
particular period for all policies the insurer "writes." 

[24] [hyperlink, http://www.gao.gov/products/GAO-05-536]. 

[25] Commercial liability comprises various insurance lines, which 
include the liability portion of commercial multiple peril; other 
liability; products liability; commercial automobile (personal injury 
protection); other commercial automobile liability; warranty; and 
medical professional liability. The medical professional and other 
liability data consolidate occurrences (an event resulting in an 
insured loss during the policy period) and claims made (claims filed 
during the policy's term or applicable reporting period). Workers' 
compensation premiums for traditional insurance companies are excluded 
as RRGs cannot write this type of coverage. See 15 U.S.C. § 
3901(a)(1). The difference in the total premiums written by RRGs and 
the total premiums written industrywide equals the coverage written by 
traditional insurance companies. 

[26] Net written premiums are written premium less deductions for 
commissions and ceded reinsurance. 

[27] In some states, RRGs are allowed to use letters of credit as 
assets, which in some cases can result in a varied interpretation of 
the financial condition of an RRG based on the accounting principle 
used for financial reporting. Information on select differences 
between accounting principles as they relate to financial reporting 
for RRGs are available in appendix III of [hyperlink, 
http://www.gao.gov/products/GAO-05-536]. 

[28] ROE is expressed as a percent of the mean of prior and current 
year-end policyholder surplus. This ratio measures a company's overall 
after-tax profitability from underwriting and investment activity. 

[29] Two ratios, the loss ratio and the expense ratio, constitute the 
combined ratio. The loss ratio is calculated by dividing incurred 
losses plus loss adjustment expense by earned premiums. The expense 
ratio is calculated by dividing all other expenses by either written 
or earned premiums. 

[30] For an RRG, a letter of credit is a document issued by a 
financial institution on behalf of a beneficiary (for example, the 
insurance commissioner) stating the amount of credit the customer has 
available, and that the institution will honor drafts up to the amount 
written by the customer. An irrevocable letter of credit could not be 
canceled or amended without the beneficiary's approval. 

[31] Gross premiums are the premiums paid by the original insureds. 

[32] GAO, Medical Malpractice Insurance: Multiple Factors Have 
Contributed to Increased Premium Rates, [hyperlink, 
http://www.gao.gov/products/GAO-03-702] (Washington, D.C.: Jun. 27, 
2003). 

[33] According to NAIC, "active" includes RRGs writing insurance 
premiums, formed but not yet writing insurance premiums, under 
receivership, or in liquidation. "Inactive" RRGs were excluded. 

[34] According to the Risk Retention Reporter, the laws of three 
states are silent about whether RRGs can form under captive 
legislation. 

[35] According to these domiciliary state regulators, regardless of 
the statutory minimum required, regulators may require an increased 
minimum capital amount based on factors such as an assessment of the 
RRG's proposed business plan--including the volume of premiums written 
and the types of coverage offered. 

[36] In 2010, 19 of the 249 active RRGs did not write any premiums. 

[37] One state did not respond to this survey as state employees were 
furloughed for a part of the period in which this survey was open. 
Another state insurance regulator did not completely respond to all 
survey questions, therefore this regulator's responses were omitted 
from our analyses. 

[38] "Special Report: Impact on Risk Retention Groups of State 
Encroachment of Liability Risk Retention Act Preemptions," Risk 
Retention Reporter (January 2009). The response rate for this survey 
was 45 percent, representing 118 RRGs. 

[39] NAIC's model laws are designed to create a national standard by 
providing guidance to states on implementing laws that affect the 
insurance industry. The Model Risk Retention Act, developed in 2002, 
aims to present a model for state regulation of the formation and 
operation of RRGs and purchasing groups (any group of persons with 
similar or related liability risks who form an organization for the 
purpose of purchasing commercial liability insurance). 

[40] 927 F. Supp. 195 (M.D. La. 1996), aff'd, 114 F.3d 1183 (5th Cir. 
1997). 

[41] 174 F. Supp. 2d 619 (W.D. Mich. 2001). 

[42] According to LRRA, "liability - (A) means legal liability for 
damages (including costs of defense, legal costs and fees, and other 
claims expenses) because of injuries to other persons, damage to their 
property, or other damage or loss to such other persons resulting from 
or arising out of - (i) any business (whether profit or nonprofit), 
trade, product, services (including professional services), premises, 
or operations, or (ii) any activity of any state or local government, 
or any agency or political subdivision thereof; and (B) does not 
include personal risk liability and an employer's liability with 
respect to its employees other than legal liability under the Federal 
Employers' Liability Act." 15 U.S.C. § 3901(a)(2). 

[43] Contractual liability insurance covers liability of the insured 
that is assumed in a contract under specified conditions. Stop-loss 
refers to any provision in a policy designed to end an insurer's 
losses at a given point. 

[44] No. Civ. 07-2660 FCD KJM (E.D. Cal., Mar. 7, 2008). 

[45] 174 F. Supp.2d 619. 

[46] 15 U.S.C. §§ 3902(a)(4), 3905(d). 

[47] 214 F.3d 1073 (9th Cir. 2000). 

[48] 796 F. Supp. 154, 159 (M.D. Pa. 1992). 

[49] Id. at 159 n.6. The court did not decide this case on the merits, 
but denied the defendant's motion to dismiss on the grounds that the 
case did not involve a federal question, by holding that the case 
involved interpretation of a federal law, LRRA, which was a federal 
question. 

[50] 143 F.3d 1062, 1070 (7th Cir. 1998). 

[51] 34 F.3d 1013 (11th Cir. 1994). 

[52] Id. at 1016. 

[53] NAIC's accreditation standards are minimum standards that state 
regulators must meet to remain accredited with NAIC. NAIC's full 
accreditation review of a state's solvency regulation of multistate 
insurance companies occurs once every 5 years and includes the 
examination of (1) the state's relevant laws and regulations, (2) the 
financial analyses and examinations conducted by the insurance 
department, and (3) the department's organizational and personnel 
practices. 

[54] Statutory accounting principles were established and promulgated 
by NAIC for the insurance industry. 

[55] A total of 49 states responded to the survey. 

[56] The differences in the two sets of accounting principles reflect 
the different purposes for which each was developed and each produces 
a different, and not necessarily comparable, financial picture of a 
business. SAP generally meets the needs of insurance regulators, the 
primary users of insurance financial statements, and stresses the 
measurement of an insurer's ability to pay claims and remain solvent 
in order to protect owner/insureds. However, GAAP provides guidance 
that businesses follow in preparing their general purpose financial 
statements that provide users, such as investors and creditors, with 
useful information that allows them to assess a business's ongoing 
financial performance. 

[57] GAO, Insurance Regulation: The NAIC Accreditation Program Can Be 
Improved, [hyperlink, http://www.gao.gov/products/GAO-01-948] 
(Washington, D.C.: Aug. 31, 2001). 

[58] The Risk Retention Group (E) Task Force formed the RRGs and Risk-
Focused Examinations Subgroup in 2010 to consider possible exemptions 
to the risk-focused examination process for RRGs. 

[59] A completed RBC calculation of a company is considered 
confidential and not available to the public. 

[60] For example, the Risk Retention Modernization Act of 2011 (H.R. 
2126, 112th Cong. (2011)) was introduced in the U.S. House of 
Representatives in June 2011, and a similar bill, The Risk Retention 
Modernization Act of 2010 (H.R.4802, 111th Cong. (2010)), was 
introduced in the 111TH Congress in the prior year. 

[61] Twelve respondents had "no opinion." 

[62] If passed, the Risk Retention Modernization Act of 2011 (H.R. 
2126, 112th Cong. (2011)) would designate the Federal Insurance Office 
as a federal arbitrator. 

[63] Fourteen respondents stated "no opinion." 

[64] One respondent did not provide a response to the question. 

[65] If passed, the Risk Retention Modernization Act of 2011 (H.R. 
2126, 112th Cong. (2011)) also would establish such a requirement for 
the Federal Insurance Office to set corporate governance standards for 
RRGs. 

[66] According to officials from the state of Minnesota, the state did 
not respond to this survey because state employees were furloughed for 
a part of the period in which this survey was open. Maryland did not 
completely respond to all survey questions, therefore this regulator's 
responses were omitted from our analyses. 

[67] Information on the methodology and results of the 2004 
questionnaire is available in appendixes I and II of the previous 
report, [hyperlink, http://www.gao.gov/products/GAO-05-536]. 

[68] The eight states that placed among the top 10 domiciliary states 
with the highest amounts of RRGs or direct written premiums as of year-
end 2010 were: Delaware, Hawaii, Illinois, Montana, Nevada, South 
Carolina, Vermont, and the District of Columbia. 

[69] One respondent was a domiciliary state regulator, and therefore 
was excluded from the focus groups. A separate interview was scheduled 
to obtain the views of this regulator. In addition, one representative 
of a captive management company that provides service to RRGs could 
not attend the discussion group and was interviewed by telephone at a 
later date. 

[End of section] 

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