The carefully crafted balance between state and federal regulatory authority over risk retention groups has recently been tipped heavily in the favor of the states as a result of the recent settlement of the Auto Dealers Risk Retention Group (“AD-RRG”) case in California. This continues a trend of increasing state infringement upon the system of regulation of risk retention groups (“RRGs”) imposed on the states through the Liability Risk Retention Act (“LRRA”). Congressional action is needed.
A Brief History
In 1981, Congress passed the Product Liability Risk Retention Act (“PLRRA”) in response to the absence of affordable product liability insurance. The PLRRA was amended in 1986 in response to the “liability crisis” of that year in which commercial liability insurance was so unavailable or unaffordable that community parks and swimming pools were being closed to avoid the potential liability for which there was no insurance. The 1986 amendments – the LRRA - expanded the authority of RRGs to offer any kind of commercial liability insurance, except workers compensation. The amendments also fleshed out the skeletal regulatory provisions of the 1981 Act and established the concept of “lead state regulation” in which the state of domicile of the RRG is not preempted by federal law, but non-domiciliary states in which the RRG may operate have restricted authority as specified in section 3902 of the Act.
The Congressional intent was abundantly clear and well documented: RRGs, as liability insurance companies chartered in one of the states, could be free to operate on a multi-state basis after providing a “notice filing” in any such non-domiciliary state.
Needless to say, this preemption of regulatory authority by the states was not well received by many of the states. Nonetheless, through the auspices of the National Association of Insurance Commissioners (“NAIC”), a model law was developed and then enacted into state law that empowered the states to exercise those authorities which the states were permitted under federal law. The NAIC also sponsored a working group which ultimately produced the Risk Retention and Purchasing Group Handbook, which, on balance, accurately describes the federal law and the states role in regulation.
As is typical with any federal law that preempts state law, disputes arose regarding the lines of demarcation between state and federal authority. Over the years, litigation has addressed issues such as the definition of a risk retention group, the definition of “liability insurance”, assessment of fees and taxes, “discrimination” against RRGs, and other matters. While the outcome of these disputes has been mixed (from the perspective of RRGs), at least a modest body of legal precedent has been established.
However, the strength of the LRRA (federal preemption of state law) is also its weakness. It’s weak because its enforcement depends upon (1) the scrupulous adherence to the terms of the federal law by state regulators and (2) the ability of an abused RRG to enforce the federal law.
Over time, many states have learned that they can push the regulatory envelope and get away with it. For example, the LRRA allows the assessment of “premium and other taxes” but does not allow the assessment of “fees”. While there are two federal cases that deal directly with this issue (NRRA v. Brown and ALAS v. Fitzgerald), the majority of states charge filing fees. These fees are generally not excessive, and the risk retention group community has, for the most part, decided that it is either (1) reasonable to charge modest filing fees to pay for the cost of administration or (2) not worth the effort to fight.
More significantly, many states require as part of the “notice filing” information in addition to that which is defined in the federal law. While this provision of additional information can become quite burdensome, most RRG filers have again taken the approach that it is not worth a fight.
Even more burdensome is the position taken by a number of states that an RRG filing is not bona fide until it is “approved” or “acknowledged” by the state. Some states, e.g., California and New Jersey, have even enacted these “approval” provisions into state law. This clearly violates the letter and the intent of federal law.
Auto Dealers Risk Retention Group
AD-RRG is a risk retention group chartered in Montana that filed its notice of intent to do business in California. It was authorized by its domiciliary state (Montana) to offer stop loss coverage to members of the RRG who were the plan sponsors for self funded employee health plans. The California Department of Insurance took the position that such coverage was not “liability” coverage as defined in the LRRA. After some discussions between AD-RRG and California, California issued a cease and desist order. AD-RRG then went to the U.S. District Court in Sacramento and obtained a temporary restraining order against California. The issues were then fully briefed by both sides and argued before the U.S. District Court resulting in a preliminary injunction against California. The National Risk Retention Association (“NRRA”) filed an amicus brief in the case.
The opinion of the court was quite favorable to AD-RRG. The Court held that California had exceeded its authority by issuing a cease and desist order and chided California for not seeking an order from federal court. The case was then set for trial on the merits, even though AD-RRG argued that the issue was totally a matter of law and therefore should be decided via summary judgment without any opportunity for discovery. California, however, was able to convince the court it needed some discovery and, as a result, the final hearing on the matter was set for a year later.
AD-RRG, a start up insurer like most RRGs, just could not afford the expense of discovery and a full hearing on the matter. As a result, AD-RRG gave up its fight and entered into a settlement agreement with California. California quite simply used its economic power to grind down AD-RRG, even though a federal court had twice issued favorable rulings.
This abuse of a state’s economic power is only the latest iteration of what has been going on for many years regarding filings and subsequent document requests and other inquiries. In these cases, the state, if it wishes to fight either administratively or in court, has an unlimited budget. As a consequence, the fact that the RRG has the better legal case may not matter.
Legislation has been introduced in the House of Representatives (H.R. 5792), which, if enacted, would impose upon RRGs certain corporate governance requirements along with allowing qualifying RRGs to offer commercial property coverage in addition to commercial liability coverage. The bill would also order the Government Accountability Office (GAO) to investigate abuses of state authority in the regulation of RRGs.
Although this is worthy legislation, it does not go far enough. The expense of litigating against a state government in federal court is just too great for almost any RRG. Those cases that have gone through the federal legal system (briefly mentioned above) have been brought by either the NRRA or those few RRGs that have achieved substantial growth over the years.
A further problem is that, even after a case has been fully litigated, it may only be enforceable in one of the eleven federal circuits. As a result, it may stand as a guideline, but may not be enforceable as precedent.
The answer to this problem is for Congress to acknowledge that its intent has been thwarted by some of the states and that a different dispute resolution process should be adopted. While the normal venue for the resolution of issues regarding federal law is the federal court system, most federal laws are subject to the supervision of a federal agency.
Of course, insurance does not have a federal agency. However, the Treasury, with the cooperation of the NAIC, has served the oversight and rulemaking function for the Terrorism Risk Insurance Act.
Congress should look to that model and establish in the Treasury a binding arbitration or dispute resolution process for LRRA issues. This would finally address both of the most exasperating aspects of the current regime: the unenforceability of federal law in a variety of states and the imbalance of economic power between state governments and RRGs.
Robert “Skip” Myers is co-chairman of the firm’s Insurance and Reinsurance Practice and focuses in the areas of insurance regulation, antitrust, and trade association law. Skip received his bachelor’s degree from Princeton University and his law degree from the University of Virginia.