In the 1980's, the United States Congress created a new type of insurance carrier which has a significant strategic advantage over all other insurance carriers: it may write insurance in all 50 states without having to comply with many of the insurance laws/regulations of the states in which it operates. Specifically, the day-to-day regulation of this new type of insurance carrier, called a "risk retention group," is controlled by the state in which the risk retention group chooses to be initially chartered ("Chartering State"). [1981 U.S. Code Cong. & Ad. News 1432, 1439; and 15 U.S.C. ' 3902.] Most of the insurance laws/regulations of other states in which the risk retention group is operating ("Non-chartering States") are preempted by the Liability Risk Retention Act of 1986. [15 U.S.C. ' 3902 & 3905.]
This article examines the impact of the preemption provisions contained in the Liability Risk Retention Act on the ability of states to regulate risk retention groups. First, however, a brief history and description of risk retention groups will be presented to provide a background for discussion.
History of Legislation
The initial impetus for the Liability Risk Retention Act was a contraction in the property-casualty insurance market which took place in the 1970s. The contraction adversely affected the affordability and availability of product liability insurance for a broad spectrum of businesses. In 1976, a Federal Interagency Task Force on Product Liability was established in the U.S. Department of Insurance to analyze the causes of the contraction. The Task Force noted three principle reasons for it:
- insurance premiums were not set based on objective actuarial data, but on subjective underwriter opinion;
- manufacturers' practices were in fact unsafe; and
- uncertainty in judicial and statutory treatment of product liability claims due to variations in tort law from state to state and the lack of foreseeability regarding potential product exposure. [Home Warranty Corp. v. Caldwell, 777 F.2d 1455, 1463 (11th Cir. 1985).]
In 1981, Congress passed the Product Liability Risk Retention Act to address the first cause of the product liability insurance contraction (i.e., subjective rate setting) by creating risk retention groups. Congress anticipated the availability of risk retention groups in the market place would provide companies an opportunity to reduce their insurance costs where their favorable claims experience was not currently reflected in their rates. This in turn would encourage development of specialized loss information services, better loss prevention techniques, and establishment of rates by commercial insurance more closely related to actual risk.
During the 99th Congress, the country was again shaken by a crisis in the availability and affordability of property-casualty insurance; specifically, commercial liability insurance. Congress viewed this crisis as a more severe repetition of the previous crisis in the product liability insurance area. As a partial remedy of this new crisis, Congress elected, in 1986, to amend the Product Liability Risk Retention Act and re-name it the Liability Risk Retention Act (the "Act"). By this amendment, the insurance which could be written by a risk retention group was broadened to include commercial liability insurance for "any business" and "any state or local government." [15 U.S.C. ' 3901(a)(2).]
Definitions
Generally speaking, risk retention groups resemble a multi-owner captive insurance company or a group self-insurance program, which provides commercial liability insurance for its members. Risk retention groups must possess the following characteristics:
- Its primary activity must consist of assuming, and spreading all, or any portion, of the liability exposure of its members;
- It must be organized for the primary purpose of supplying liability insurance;
- It must be owned, directly or indirectly, by members who are engaged in businesses or activities similar or related with respect to the liability to which such members are exposed by virtue of any related, similar, or common business, trade, product, services, premises, or operations; and
- It must not exclude any person from membership solely to provide for members of the group a competitive advantage over such person. [15 U.S.C. ' 3901.]
In summary, risk retention groups allow similar businesses, or state or local governments to form groups to provide self-insurance.
The liability insurance which may be provided by risk retention groups is broadly defined. It means any insurance arrangement to cover 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:
- Any business (whether profit or nonprofit), trade, product, services (including professional services), premises, or operations; or
- Any activity of any state or local government, or any agency or political subdivision thereof. [15 U.S.C. ' 3901(a)(1) & (2).]
However, risk retention groups cannot provide insurance for employer's liability with respect to its employees other than legal liability under the Federal Employer's Liability Act (45 U.S.C. 51 et seq.). They also cannot include liability for damages because of injury to any person, damage to property, or other loss or damage resulting from any personal, familial, or household responsibilities or activities.
The foregoing definition of liability insurance is critically important because it establishes the scope of preemption.[15 U.S.C. ' 3905(b); Home Warranty Corp. v. Caldwell, 777 F.2d 1455, 1475 (11th Cir. 1985) and Nat'l Home Ins. Co. v. State Corp. Comm'n of the Commonwealth of Va ., 838 F. Supp. 1104, 1110 (E.D. Va. 1993).] To the extent a risk retention group writes lines of insurance other than liability insurance as defined by the Act, the risk retention group will not have the benefit of the preemption provisions contained in the Act.
Preemption Overview
The objective of the Act's preemptive provisions is to facilitate the formation of a specialized insurance carrier that can operate on a multi-state basis. Congress perceived that the primary hurdle to such a specialized insurance carrier was the difficulty in complying with the various laws and regulations of each state. For an insurer seeking to provide specialized coverage to a limited number of risks, these laws and regulations create an almost insurmountable burden.
In order to resolve this problem, the Act contains two types of preemption provisions. The first prohibits laws or regulations of all states which restrict the ability of risk retention groups to operate in more than one state. The second set of preemption provisions preempts state laws of a non-chartering state which attempt to regulate, directly or indirectly, the formation and operation of risk retention groups. However, the Act reserves for non-chartering states the right to regulate risk retention group operation in several discrete areas, the most important of which are:
- unfair claims settlement practices;
- corrective actions in the event of financial impairment; and
- deceptive, false, or fraudulent acts or practices.
Preemption Provisions Applicable to All States
Preemption provisions which are applicable to all states fall in three categories. The first prevents states from letting risk retention groups participate in insurance insolvency guaranty funds. The second category preempts state laws which limit the use of nonresident agents or brokers by risk retention groups. The final category preempts states from otherwise discriminating against a risk retention group or any of its members.
Insurance Insolvency Guaranty Funds
Congress provided two reasons for preventing risk retention groups from participating in insurance insolvency guaranty funds. First, risk retention groups are not full-fledged, multi-line insurance companies, but limited operations providing coverage only to member companies, and only for a narrow group of coverages. Apparently, Congress believed that because of the limited nature of risk retention groups, states do not have as great a need to protect their citizens from an insolvency of such an insurer. The second reason is that the prohibition will create a strong incentive for risk retention groups to set adequate premiums and establish adequate reserves because each member knows there is no other source of funds from which to pay claims.
In actual practice, risk retention groups may still receive state aid if they become insolvent by initially chartering in a state with a more liberal regulatory philosophy. Because of the preemption provision, such state aid cannot come from a state guaranty fund. [Garcia v. Pa. Financial Responsibility Assigned Claims Plan, 688 A.2d 209, 211 (Pa. Super. Ct. 1997).] However, the regulatory philosophy of some states is to take steps to rehabilitate financially troubled insurance companies, rather than requiring such companies to discontinue operations. [Nat'l Home Ins. Co. v. State Corp. Comm'n of the Commonwealth of Va., 838 F. Supp. 1104, 1107-1108 (E.D. Va. 1993).] To this end, the state of Colorado provided a capital infusion of $2.5 million to one risk retention group with a deficiency in unearned premium reserves. Consequently, persons desiring to form a risk retention group can ensure that they will have some protection in the event of insolvency by initially chartering the group in a state with a "rehabilitation regulatory philosophy."
On a different topic, the Act contains one provision which may have a negative impact on the marketing of risk retention group memberships. Specifically, states may require risk retention groups to put the following in notice on their insurance policies:
"NOTICE"
This policy is issued by your risk retention group. Your risk retention group may not be subject to all of the insurance laws and regulations of your State. State insurance insolvency guaranty funds are not available for your risk retention group." [15 U.S.C. ' 3902(a)(1)(I).]
To date, at least 36 states have enacted laws requiring that such a notice be placed on a risk retention group application or policy.
Agents/Brokers
One indirect obstacle to the creation of a nationwide or multi-state risk retention group is the regulation of insurance agents and brokers. Many states require every insurance policy issued in that state to be countersigned by an agent who is a resident of that state. Such states, quite often, also require that the countersigning agent receive a certain percentage of the commission. In addition, many states restrict or prohibit solicitation by a nonresident agent.
These types of regulations can significantly increase the cost of forming a multi-state risk retention group. Each type requires the risk retention group to utilize an agent who is a resident of the state in which the policy is issued. Risk retention groups, by definition, are geared to provide insurance to persons in the same type of business or the same industry, not to the general public. Therefore, such groups do not have much of a need for salesmen or marketing personnel in each state to sell the insurance product. Consequently, a state's regulations, which require the use of a resident agent to sell insurance in that state, cause a risk retention group to incur additional, unnecessary costs (i.e., agents' commissions) to sell insurance in many states.
Congress recognized that this additional, unnecessary cost could limit the ability of risk retention groups to operate on a multi-state basis. Therefore, it added a preemption provision to the Act prohibits a state from requiring "any insurance policy issued to a risk retention group or any member of the group to be countersigned by an insurance agent or broker residing in that state." [15 U.S.C. ' 3902(a)(3).] The Act also contains two other provisions which probably preempt state laws prohibiting solicitation by nonresident agents.
Unquestionably, the first of these preemption provisions will eliminate resident agent countersigning laws and the related commission sharing laws. Thus, the only remaining obstacle would be state laws restricting or prohibiting solicitation by nonresident agents. In response to the Act, four of the ten states with "solicitation" laws enacted exceptions to such laws for risk retention groups, therefore, only six states have laws . . . prohibiting solicitation by nonresidents: Mississippi, South Dakota, Texas, Wyoming, Florida, Georgia, Hawaii, Kentucky, North Carolina and Ohio.
Even the "solicitation" laws of these remaining six states are probably preempted by other provisions. The Act preempts any non-chartering state law which would prohibit or regulate the operation of risk retention groups. The purpose of this preemption provision is to facilitate the efficient operation of risk retention groups by eliminating the need for compliance with numerous non-chartering state statutes that, in the aggregate, would thwart the interstate operation of risk retention groups.
Since the "solicitation" statutes contained in the remaining six states inhibit the ability of risk retention groups to operate on an interstate basis, it is likely that this broad preemption provision would preempt such statutes. A second preemption provision which may eliminate the "solicitation" statutes is as follows: "[a] State may require that a person acting . . . as an agent or broker for a risk retention group obtain a license from the State, except that a State may not impose any qualification or requirement which discriminates against a nonresident agent or broker." This anti-discrimination provision appears to only apply to the licensing of agents or brokers rather than the conduct of agents or brokers after becoming licenses. Thus, it may prohibit discrimination only in connection with obtaining a license.
On the other hand, this provision may be broadly interpreted to prohibit discriminatory qualifications or requirements on nonresident agents or brokers, in which case it would preempt the "solicitation" laws in the remaining six states. To date, there has been no case law interpreting the provision, therefore, it is impossible to know the effect it will have. Nevertheless, one of the two preemption provisions above will probably preempt the "solicitation" statutes enacted in Florida, Georgia, Hawaii, Kentucky, North Carolina and Ohio.
In summary, the Act clearly preempts any state law which would require the utilization of a resident agent in each state in which a risk retention group issues insurance policies except for the statutes of six states which disallow soliciting of insurance in those states by nonresident agents, and even the "solicitation" statutes in those six states are probably preempted by the provisions found at 15 U.S.C. ' 3902(a)(1) & (c).
Other Discrimination
The preemptive effect of the Act's anti-discrimination provision is limited because of the difficulty in proving that a state law is discriminatory. The anti-discrimination provision preempts state laws which "discriminate against a risk retention group or any of its members," but does not preempt laws generally applicable to persons or corporations. In order to prove a state law is discriminatory, a risk retention group must do more than merely show that the law disadvantages risk retention groups. [Preferred Physicians Mutual Risk Retention v. Pataki, 85 F.3rd 913, 918 (2nd Cir.1996).]
The risk retention group must also show that the intent in enacting the law was to injure risk retention groups. Alternatively, the risk retention group may be able to meet its burden of proof by showing that the law's injurious effect disparately impacts risk retention groups regardless of whether the law was intended to do so. [City Cab Co. v. Edwards, 745 F.Supp 757, 762 (D. Maine 1990).] However, there is case law implying that this easier "disparate impact" test cannot be used to prove discrimination under the Act. [Pataki at 918, n. 10 and Mears Trans. Group v. State, 34 F.3rd 1013, 1018-1019 (11th Cir. 1994).]
States have managed to make laws which disadvantage risk retention groups without discriminating against them. For example, Florida enacted a statute requiring the owners and operators of for-hire passenger transportation vehicles to prove financial responsibility by maintaining insurance purchased from "an insurance carrier which is a member of the Florida Insurance Guaranty Association."
Since risk retention groups cannot participate in insurance insolvency guaranty associations, this statute effectively excluded risk retention groups from providing insurance to meet the Florida financial responsibility standards. The Court noted that the purpose of the statute was to provide the protection of state insurance guaranty funds for members of the public injured in for-hire passenger transportation vehicles. Also, the statute does not single out only risk retention groups for preclusion, but also surplus line companies, captive insurers, accessible mutual companies, reciprocals and commercial self-insurance trust funds. As a result, even though the statute disadvantages risk retention groups, it does not discriminate against them.
Although the anti-discrimination provision is difficult to prove it still will provide a restraint on the types of laws enacted by states. Specifically, states cannot enact a law solely intended to disadvantage risk retention groups. In addition, states may not be able to make laws which unintentionally have a greater injurious effect on risk retention groups than other types of insurance entities.