Magazine article Risk Management

Financial Moves Help Create Risk Retention Groups

Magazine article Risk Management

Financial Moves Help Create Risk Retention Groups

Article excerpt

Financial Moves Help Create Risk Retention Groups

When the Liability Risk Retention Act of 1986 (RRA) was passed, Congress contemplated that only the participants in a risk retention group (RRG) would capitalize the insurer. It also believed that capitalization would be completed prior to or simultaneously with the granting of a license or charter. However, unless an RRG writes business with a small group of large insureds who provide sufficient capital and surplus, the problem of how the group should be formed and licensed arises.

The necessity of a license is apparent under Section 2(4)(C) of the RRA, which defines an RRG as a corporation or "other limited liability association...chartered or licensed as a liability insurance company under the laws of a state and authorized to engage in the business of insurance under the laws of such state." Without a license or charter, a corporation or other limited liability association does not fit the definition and is not entitled to the exemptions from state insurance and federal securities laws provided through the RRA. Because the search for capital and the sale of insurance (or commitment to buy it) typically occur simultaneously, it is important that an RRG-in-formation be licensed.

The National Association of Insurance Commissioners discusses this point in a drafting note to Section 4 of its Model Risk Retention Act. The commissioners observe that the RRA exempts an RRG from "any state law regarding its operation in a state in which it is not domiciled," except as set forth in the RRA. Further, the drafting note states: "If a risk retention group fail to qualify under the definitional requirement of [the RRA], it will not benefit from this exemption from state law. The commissioner, therefore, would be authorized to apply any of the laws that may be pre-empted by [the RRA] because the group will not qualify for the pre-emption."

A license is equally important when offering ownership interests in an emerging RRG. These ownership interests may or may not be considered "securities" for purposes of federal and state securities laws. If they are, the RRA's provisions that exempt such securities from the registration requirements of federal and state securities laws are important because most RRGs will raise initial capital and surplus with funds contributed by insureds when they purchase ownership interests.

Securities Laws Exemptions

Section 5 of the RRA provides:

a) The ownership interests of members in a risk

retention group shall be considered to be exempted

securities for purposes of Section 5 of the

Securities Act of 1933 [15 U.S.C. 77e] and for purposes of

Section 12 of the Securities Exchange Act of 1934

[15 U.S.C. 781]; and considered to be securities for

purposes of the provisions of Section 17 of the

Securities Act of 1933 [15 U.S.C. 77q] and the

provisions of Section 10 of the Securities Exchange

Act of 1934 [15 U.S.C. 78j].

b) A risk retention group shall not be considered to

be an investment company for purposes of the

Investment Company Act of 1940 (15 U.S.C. 80a-1

et seq.).

c) The ownership interests of members in a risk

retention group shall not be considered securities

for purposes of any state blue sky law.

Section 5(a)(1) of the RRA permits offering and sale of ownership interests in an RRG without compliance with the registration requirements of Section 5 of the Securities Act of 1933 and Section 12 of the Securities Exchange Act of 1934. Section 5(a)(2) of the RRA, however, makes it clear that the antifraud provisions of the federal securities laws (Section 7 of the 1933 act and Section 10 of the 1934 act) apply to offerings and sales of ownership interests in RRGs. Thus, in virtually all cases, it is advisable to provide some form of disclosure documents to prospective purchasers of ownership interests in RRGs. …

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