By Barbara McHatton
Are you a builder who is frustrated with the high cost of liability insurance? Can you even get liability insurance from a local insurance company?
According to Ric Glover, senior vice president at risk and insurance services firm Marsh Inc.'s Construction Industry Practice, risk retention groups (RRGs) could be one possible solution. Some groups have even profited from their endeavors.
How RRGs work
An RRG is a group of businesses that pool their money and essentially form their own liability-insurance company. They may allow members to obtain membership from out-of-state entities in order to spread the risk. It may sound complicated, but there are several benefits.
"One positive aspect of RRGs," says Glover, "is one can actually invest the money he or she is putting toward insurance coverage." He says that when one pays traditional insurance companies, that money goes toward insurance and cannot be recovered and normally one does not receive dividends from it. RRGs, though, require that the money be placed in low-risk investments, where it can potentially earn dividends. Also, if the RRG is ever dissolved, as when its members retire, any surplus (once all liabilities are satisfied) would be returned to the RRG's members.
For builders, Glover says it would behoove them to gain membership from states other than their own. "There would be a benefit for Florida builders to pool their resources with builders in Iowa, Arizona and Ohio, for example, in order to spread the risk potential around. Spreading risk helps avoid a single event resulting in claims against all members.
For example, Florida is subject to hurricanes, and building codes reflect this exposure. If a code is not accurately applied, all the members may be exposed to this single loss. Conversely, Iowa, Arizona and Ohio are not affected by this specific catastrophe but have their own unique exposures. The likelihood of a single exposure affecting buildings in all four states is less than if members were in a single state. The benefit to Iowa and Ohio is that year-round building in Florida and Arizona requires fewer logistical challenges in dealing with the severe weather of the colder climates.
Although regulations vary from state to state, the minimum capitalization rate is about $100,000, says Glover. Actual capitalization requirements would be determined by the profile of the RRG. Additionally, capital contributions would be required during the course of the RRG. And, he says, there are very specific rules to establishing an RRG. Generally, they follow the same guidelines as commercial insurance. To ensure its success, the RRG should retain a staff that includes such support as an investment manager and accounting and actuarial services.
Interested builders may also join already-established RRGs. "Depending on how the RRG was set up to begin with," he says, "some RRGs may require a contribution to capital [or an investment]; others may not allow any new member to participate in the ownership or underwriting profits." The RRG can declare dividend to the individual insured members, and all members of the RRG can still have a separate corporate distribution of the underwriting profits to the owners, he says.
Glover claims that one of the biggest reasons for an RRG's failure is understating a risk for loss and underfunding it. "It's helpful to seek help from an insurance consulting group, because the process is complex," he says. "It's better to over-fund the RRG to ensure its success in the long term."
For more information on RRGs, go to:
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