Understanding Risk Retention Groups

Most people know and understand what typical insurance is; insurance is the means of guaranteeing against loss or harm. What people don’t understand (and during my 13 years as a dealer I didn’t understand this either) is RRGs.

An RRG is a liability insurance company that is owned by its members. Under the Liability Risk Retention Act (LLRA), RRGs must be domiciled in a state. The LRRA is a federal law passed by Congress in 1986 to help U.S. businesses, professionals and municipalities obtain liability insurance, which had become either unaffordable or unavailable due to the “liability crisis” in the U.S. Because the LLRA is a federal law, it pre-empts state regulation, making it much easier for RRGs to operate nationally.

Once licensed by its state of domicile, an RRG can insure members in all 50 states. As I am not an attorney, let me try to put this into simple language. RRGs are federally chartered and thus not required to undergo the scrutiny of insurance regulators in each of the states where they do business. There is little or no oversight of Risk Retention Groups by any federal agency and relatively little, if any, checks and balances from state regulators to ensure RRGs comply with sound insurance and/or business practices. There is not a guaranty fund or other safety net for dealers or contract holders in the event a RRG becomes insolvent.

I realize this isn’t the most entertaining reading; however, if you can bear with me, it will be worth it. Dealers need to understand the importance of an administration company and/or service contract provider. It is critical to understand this setup as they have customers, money and a reputation on the line. One industry expert, Kelly Price, director of National Automotive Experts based in Ohio, feels the setup of a policy is one of the most important aspects if a dealer is choosing a RRG over a “rated” carrier.

Price posed the questions, “Is the money held in a trust account with the dealer’s name on it? Are the reserves commingled with other dealer reserves? Who has control over the reserves in the event of the demise of the RRG? Under what circumstances can the reserves be withdrawn and who needs to authorize that withdraw?” These are questions that dealers need to be able to answer, especially if they are setting up a re-insurance or off-shore position.

Price continued, “We have had several dealers with success using a RRG for the backing of their products which are ceded into their personal reinsurance companies. Even the National Warranty Insurance Risk Retention Group (NWIG) debacle with their Smart Choice program, one of the largest administrator/provider bankruptcies in history, proved to be a positive thing for many dealers. It was all based on how their money was secured. The dealers who had their reserves in a segregated trust account were the winners. When NWIG went into receivership, the dealers we assisted during this time were able to take control of those funds and pay the claims for their customers. In all of those cases, the dealers came out ahead. They had more reserves than they had claims, therefore their customers were taken care of and they ended up ahead of the game.

If you have been in the auto industry for longer than a year, you have witnessed at least  one of the bigger and better-known administrators/providers bite the dust. Over the years, I have watched as one provider after another crumbles. There are several  reasons for this. Risk retention groups can be established with very little capital ($500,000 or less). Because of their size, many RRGs lack the sophisticated staff necessary to ensure that adequate funds are being placed in reserves to pay for future claims. The lack of experienced staff (with little if any government regulation) combined with a desire to grow the business has resulted in some RRGs allowing their agents to sell extended service contracts at inadequate and unsafe rates.

Basically, low rates/reserves work in the short term, but are dangerous and unhealthy in the long term. Once the administrator or provider runs short on cash and is not able to pay claims, they turn to the insurer. If they are insured through a RRG, chances are there will be no reserves to fall back on and thus we have it—a big crash!

As I mentioned before, I do a lot of analyses of dealerships in the realm of finance. In the course of my work, I have compiled some very simple recommendations for dealerships across the nation:

1. Use a “rated” carrier and ask your agent for proof of this before beginning any service contract program.
2. 2. If you are setting up a reinsurance program through an RRG, whether it be offshore (Controlled Foreign Corporation or CFC) or stateside (Dealer-Owned Warranty Company or DOWC), you should know:
   1. Where the money is being held
   2. Who has ultimate control of the money being held in reserves
3. What happens to the money if something happens to the RRG
4. Always verify that the appropriate safeguards for the reserves are in place!
5. Use a carrier that has withstood the test of time (i.e., one that has been in business longer than 10 years).
6. Use a national administrator/provider in lieu of a local one.

These recommendations, if followed, should help you to sleep better at night and allow your customers to be taken care of. There is plenty of money to make by doing things the right way. I hope this article helps to clarify some of the misconceptions and unknowns about risk retention groups so you can do it right as well. Good luck and good selling!

Vol 5, Issue 9