By Andrew P. Morriss
Professor, Bush School of Government & Public Service and School of Law
Texas A&M University
In creating risk retention groups and purchasing groups, Congress created what has become a vibrant “law market” for insurance regulation, providing a model for successful harnessing of competition to improve the legal system. In a forthcoming article in the Journal of Special Jurisdictions, I take an in-depth look at how both the Liability Risk Retention Act and the Non-Admitted and Reinsurance Reform Act (which deals with surplus lines coverage) improved insurance regulation by expanding the law market, in effect creating what we can call “non-territorial special economic zones” for the types of insurance they cover. Thinking about these laws as measures to expand the law market is not just fun for academics like me; it can be useful in crafting strategies to overcome resistance to the expansion of RRGs and PGs.
What’s a law market?
In their 2009 book, The Law Market, Profs. Erin O’Hara and Larry Ribstein examined how jurisdictions compete for business entities and transactions by creating favorable legal rules. The most well-known such competition is for corporate charters, with Delaware the market leader for large corporations (having stolen the crown from New Jersey in the early twentieth century). There are many U.S. examples of such markets: New York law is the market leader for corporate debt, South Dakota is a leading jurisdiction for trusts, Nevada once held the top position in divorce law, and Wyoming is making a bid to be the cryptocurrency banking center. In insurance, the success of Vermont, the District of Columbia, South Carolina, and others in captive insurance is another illustration of a vibrant law market. Internationally, Bermuda, Guernsey, and Cayman are examples of strong insurance law market competitors. Gibraltar is a leading jurisdiction for online gaming.
Beyond jurisdictions that turn their entire space into a competitor, special economic zones (SEZs) are a means by which they compete in law markets, by offering special regulatory regimes for businesses and individuals operating within the zones’ territories. For example, in the United States, there are several hundred Foreign Trade Zones, with special tax and regulatory regimes. Globally, there are thousands of SEZs, located everywhere from India to Honduras.
Jurisdictions and SEZs benefit from success in the law market because those using their laws often pay fees (e.g., to register a company), hire local professionals, and visit the jurisdiction for meetings, etc. Unsurprisingly, smaller jurisdictions have dominated these niches since the gains from attracting such businesses are more significant in a smaller economy. (By various estimates, a quarter to a half of Delaware’s budget derives directly or indirectly from its success in attracting corporate charter business, revenue that wouldn’t be nearly as significant for California or New York.)
Those who don’t like such competition often complain that it leads to a “race to the bottom” in regulatory standards. However, the academic work on such competition has not produced much evidence of such a race—largely because those making use of law markets aren’t usually interested in the absence of regulation but in appropriate regulation. For example, when Harvard was shopping for a home for its medical malpractice captive, part of what it sought was a jurisdiction willing to develop the regulatory infrastructure needed to keep out potential bad actors who might have harmed Harvard’s reputation. Cayman won Harvard’s business in part because it was willing to invest in regulatory infrastructure. Harvard also has a risk retention group domiciled in Vermont that covers the liability risk of its medical institutions.
What most people unfamiliar with how law markets work forget is that when jurisdictional competition occurs, the result is not that there is no regulator involved but that there is a different regulator overseeing transactions. Because that regulator is subject to competitive pressures in the law market, it behaves differently from regulators that are insulated from competition. The economist J.R. Hicks famously commented in 1935 that “the best of all monopoly profits is the quiet life,” an observation that applies to regulators as well as to businesses. Injecting competition into the law market is important to increase both innovation by regulators and their acceptance of innovation by regulated entities.
How does this help insureds?
One reason RRGs and PGs have been successful is that they have expanded access in market segments where traditional state-based insurance regulation is most likely to fail to provide a net benefit. Much state insurance regulation is extremely costly—not only does it cost insurers time and money to file for approval of policy language or rates, but regulation deters innovation by insurers that can actually help reduce risks. These costs may be worth it in areas such as consumer purchases of homeowners’ insurance, where relatively unsophisticated buyers come up against complex policy language and are unable to evaluate insurers’ solvency. In those cases, state regulators are more likely to provide useful protection for consumers. For RRGs and PGs, however, where the insureds’ needs for liability insurance are driven by the particulars of their industry and where the RRG/PG members are highly motivated to insist the RRG/PG police their fellow members’ loss records, these regulatory measures are unlikely to yield net benefits.
Moreover, as regular readers of the Risk Retention Reporter will know from the dozens of case studies published here, RRGs in particular are innovative in finding ways to reduce risks. Indeed, a key benefit of alternative risk management measures more generally is that they generate data that enables insureds to reduce their exposure to risks, not just shift them to an insurer.
Successful RRG domiciles have invested in developing the means to strike a regulatory balance that reduces burdens and encourages innovation, while protecting the domicile’s reputation by screening out excessively risky or bad actors. These domiciles invest in developing staff who can assess proposals for an RRG or changes to business plans both quickly and effectively. These regulators frequently partner with regulated entities to find solutions, rather than taking the path of least resistance and simply rejecting innovations.
Expanding the scope of the LRRA
When considered as a measure to expand the law market, the LRRA has been an amazing success because it has created what is in effect an SEZ for liability insurance, one which is not limited in territorial scope. Through RRGs and PGs, not only have many insureds gained access to insurance at lower prices, but innovations spurred by the data and analyses done by the RRGs and insurers selling to RRG and PG members have helped reduce risks.
What is needed is a further expansion of the law market so that these benefits can reach even more firms and individuals. Unfortunately, some state regulators—largely from jurisdictions which have not been successful in competing and, one suspects, whose “quiet life” has been disturbed by the appearance of RRGs and PGs in their states—have lobbied against expansion of the LRRA. Anti-competitive regulators have taken steps—often with blatant disregard for the plain language of the statute—to discourage RRGs and PGs from operating in their jurisdictions. They’ve managed to get away with this because litigation costs often make a legal challenge not economically viable for the burdened RRGs and PGs. As a result, convincing Congress to expand the LRRA’s scope remains an uphill battle. Fortunately, the National Risk Retention Association has been a strong voice in spreading the good news about RRGs and PGs and the more than three decades of coverage of the industry by the Risk Retention Reporter provides a thorough record of the industry’s operations.
Expanding the scope of the LRRA to allow RRGs and PGs into additional lines of insurance would allow building on the LRRA’s success. The genius of the LRRA is that it creates a law market where none existed, by removing a barrier to competition. Now that we have the lessons of over forty years’ experience with the PLRRA and the LRRA to demonstrate that the more protectionist state regulators who opposed the statutes were wrong in their predictions of a race to the bottom, it is time to expand the LRRA to allow additional areas of coverage.
Andrew Morriss is a professor at the Bush School of Government and Public Service and the School of Law at Texas A&M University. He received his A.B. from Princeton, his J.D. and M.Pub.Aff. from the University of Texas at Austin, his Ph.D. (economics) from M.I.T., and his M.Ed.Pysch. from Texas A&M University.
Readers who want the full version of the article can email Professor Morriss at [email protected] for a draft. The article will also be available online at http://ojs.instituteforcompgov.org/index.php/jsj after publication.
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