Contractual Liability for Warranty
Business – More than Meets the Eye
Regulatory Perspective
Leslie M. Jones
Executive Assistant/Consulting Actuary
South Carolina Department of Insurance
Overview
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Evolution of the use of Risk Retention Groups (“RRGs”)
to provide Coverage for Warranty Business (“Warranty
Coverage”)
Typical Structure of an RRG used to Provide Warranty
Coverage
Typical Coverage Provided by “Warranty RRG’s”
Regulatory Concerns
National Warranty RRG
Regulatory Response
NAIC – CATF – Warranty Subgroup
Regulatory Guidance Document
Evolution of the Use of RRGs to
Provide “Warranty Coverage”
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Federal Liability Risk Retention Act of 1986
– Permitted the formation of insurance companies (called
“RRGs”) by
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“persons” engaged in businesses or activities similar or related with
respect to the liability of which such “persons” are exposed by
virtue of any related, similar, or common business, trade, product,
services, premises, or operations; and
which has as its owners only persons who comprise the
membership of the risk retention group and who are provided
insurance by such group (or a similar sole owner)
– The RRG may only offer liability coverage to owner/insureds.
– The RRG must be licensed in one state and then may, in general,
engage in business in any other state by “registering” in that
state.
Evolution of the Use of RRGs to
Provide “Warranty Coverage”
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Regulation of Service Contract Providers (SCPs)
– Most states do not require SCPs to be licensed as
insurance companies and therefore states do not
generally regulate the reserves or investments of the
SCP.
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NAIC Model Act
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Differentiates between “warranties” and “service contracts”
Requires evidence of “financial responsibility” for SCP
Evolution of the Use of RRGs to
Provide “Warranty Coverage”
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SCPs faced with availability/affordability
issues turned to the “alternative markets”
and formed RRGs to provide “liability”
coverage for the risks under the service
contracts they offered.
Typical Structure of an RRG used to
Provide “Warranty Coverage”
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Owners of the RRG are the SCPs (also known as
Administrator Obligors (AOs))
The SCPs are also the insureds
The RRG provides “liability” coverage to the
SCPs with respect to the service contracts which
they offer (typically vehicle service contracts
(VSCs) but also may include service contracts on
appliances or “brown and white products”)
The SCPs covered by a single RRG are often
related entities
Typical “Liability” Coverage
Provided by the RRG
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First Dollar (aka “Ground Up”)
– RRG is responsible for reimbursing the SCP for the entire
amount of any claim incurred under the covered service
contracts.
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Excess of Loss
– RRG is responsible for reimbursing the SCP for claims incurred
in excess of the SCPs loss reserve fund (generally based upon an
agreed upon loss ratio) for covered service contracts.
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Contractual Liability
– RRG is responsible for all claims made under covered service
contracts in the event that the SCP fails to fulfill its obligation.
These policies are generally issued on a “one-year claims made
basis.”
Regulatory Concerns
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Concerns primarily relate to Contractual
Liability Coverage
Example: RRG provides one-year claims made
contractual liability coverage for underlying
service contracts written by SCP.
– Projected Future Liability for underlying service
contracts written by SCP = $41M
– Assets available to SCP to pay claims on underlying
service contracts - $30.5M
– i.e., the “underlying deficit” is $10.5M
– Capital and Surplus of RRG is $7M
Regulatory Concerns
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For the example, what responsibility does the opining actuary for
RRG have in forming his/her opinion to:
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assess the underlying reserve liability?
examine the underlying assets to ensure that the assets of the SCP that are
presumably “available to pay claims” are actually set aside for the purpose
of paying claims, provide sufficient liquidity to pay claims, are invested in a
reasonable manner re: quality/diversification, etc?
Assess the financial condition of the SCPs?
What reserves, if any, should RRG establish?
What, if anything, should the actuary disclose in his/her opinion for
RRG regarding the underlying deficit and/or the ability of the SCP to
continue to meet its obligations under the covered service contracts?
Should the underlying deficit be considered a “single risk” for
purposes of the “10 to 1” rule (i.e., the maximum retained loss on
any one risk should not exceed 10% of surplus)?
National Warranty RRG
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Major insolvency of an RRG covering
SCPs writing vehicle service contracts
Domiciled Offshore but entered through
the state of Nebraska
Left many consumers without coverage for
their vehicle service contracts
Consumers were not covered by state
guaranty funds
Regulatory Response
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GAO Report (published August 2005)
Recommended
– Consistent regulatory standards for RRGs
among states
– With partial preemption granted only to states
that adopt those standards
– Strengthening Corporate Governance
Standards
Regulatory Response
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NAIC Activities
– RRG (E) Task Force
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Reviewing accreditation standards to determine applicability to RRGs
The standards will likely include a requirement for RRGs to report on the
NAIC P&C statement blank and to provide the related Statement of
Actuarial Opinion (SAO)
The Task Force is considering the applicability of the “10 to 1” rule to
RRGs
– RRG (C) Task Force
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Reviewing recommendations of GAO report
Requested assistance from the Casualty Actuarial Task Force (CATF) with
respect to “warranty reserves”
Will consider whether contractual liability coverage is truly “liability”
coverage as provided for in the Federal Risk Retention Act
NAIC CATF – Warranty
Subgroup
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Letter from Director Wagner
– Requested CATF to “give consideration to supporting
a modification in the standards that apply to the
actuarial certification of reserves held by insurers that
underwrite service contracts.”
– The request was based on the ‘absence of any
indication of financial stress in the certified financial
statements or the actuarial opinions of several
insurers that engaged in this business and failed.”
NAIC CATF – Warranty
Subgroup
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Letter from Director Wagner –cont.
– Director Wagner states that he has concluded that to protect the
public from the failure of service contract insurers
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The reserves must be “ground up” and must be reviewed and
opined on by a qualified independent actuary.
The “reserves” must be subject to a regulated investment code.
– However, he concedes that this is politically difficult to achieve
and that the only way to create a national solution is by
strengthening the standards upon which an actuary opines on the
reserves held by a service contract insurer and the financial
reporting and oversight process.
– He concludes by stating that “This is an issue that should be
addressed by the actuarial community as part of its responsibility
rather than through a statute or regulation.”
NAIC CATF – Warranty
Subgroup
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CATF Response Letter indicates that it intends to pursue
the following:
– Include an alert in the annual Regulatory Guidance Document
requesting that the actuary disclose in the SAO what the actuary
believes to be the financial condition of the obligor for the
service contracts and/or the adequacy of any reserve funds the
obligor holds for payment of claims under the service contracts
covered by the insurer
– Provide educational sessions at the CLRS and the opinion
writers’ workshop
– Ask the CAS Research Committee to prepare an educational
“primer” to address issues related to pricing and reserves for
warranty and service contract reimbursement insurance
exposures. Roger Hayne, Milliman, is preparing the primer. A
draft will be available at www.naic.org/committees_c_catf.htm
NAIC CATF – Warranty
Subgroup
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CATF response letter further indicates
– That there are other initiatives that could be pursued by other
NAIC groups (e.g., SC requires a semi-annual review of the loss
reserves and an annual submission of financial statements for the
underlying SCPs).
– The Blanks committee is considering making warranty business
a stand-alone statutory line of business. As part of this review
Blanks could consider requiring insurers to report this on the
“Financial Guarantee” line rather than “Other Liability”. This
would raise the mandatory surplus requirements and reduce the
distortion of Schedule P that results from reporting this as “Other
Liability.”
Regulatory Guidance Document
(draft available at www.naic.org/
committees_c_catf.htm)
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Paragraph 4: Scope
Coverage for Service Contracts. Regulators in several states have
recently encountered threats to solvency involving companies that
provide coverage for service contracts (automobiles, appliances,
etc). Due to wide variation in state laws, this type of product may or
may not be insurance. Insurance may only come into play as excess
coverage for contractual liability. The insurer and the Appointed
Actuary often have no underlying data on loss experience absorbed
by the policyholder. When losses break through the retention, they
can be catastrophic for the insurer, particularly a specialty writer or a
risk retention group with concentration in this exposure. ASOP #36,
Section 3.5, the CAS Statement of Principles on Loss and Loss
Adjustment Expense Reserves, and other actuarial literature address
the relevance of exposure to the reserve actuary’s work. The CATF
expects the actuary to understand the exposure associated with the
Opinion to be issued.
Questions?
Thank You!