Traditional insurance companies sell insurance to the public and are subject to the licensing requirements and oversight of each state in which they operate. The licensing process allows states to determine if an insurer domiciled in another state but operating in their state meets the nondomiciliary state’s regulatory requirements before granting the insurer permission to operate in their state. According to NAIC’s uniform application process, which has been adopted by all states, an insurance company must show that it meets the nondomiciliary state’s minimum statutory capital and surplus requirements, identify whether it is affiliated with other companies (that is, part of a holding company system), and submit biographical affidavits for all its officers, directors, and key managerial personnel. After licensing an insurer, regulators in nondomiciliary states can conduct financial examinations, issue an administrative cease-and-desist order to stop an insurance company from operating in their state, and withdraw the company’s license to sell insurance in the state. In addition, most nondomiciliary states have “seasoning requirements” that call for an insurance company to successfully have operated in its state of domicile for anywhere from 1 to 5 years before it can qualify for a license. Although RRGs have some regulatory relief due to the lead state regulatory framework established under LRRA, they still are expected to comply with certain other laws administered by nondomiciliary states. For example, RRGs must pay applicable taxes on premiums and other taxes imposed by nondomiciliary (as well as domiciliary) states. LRRA also imposes other measures that offer protections or safeguards to RRG members including the requirement that each RRG must submit to the domiciliary state insurance regulator a plan of operation or feasibility study that includes the coverages, deductibles, coverage limits, rates, and rating classification system for each line of insurance the RRG intends to offer. The RRG must (1) provide a copy of the plan or study to the insurance regulator in the nondomiciliary states in which the RRG intends to conduct business before it can write any insurance coverage in that state; (2) provide a copy of the group’s annual financial statement (certified by an independent public accountant) to the insurance commissioner of each state in which it is doing business (the financial statement should include a statement of opinion on loss and loss adjustment expense reserves by a qualified loss reserve specialist or actuary); and (3) submit to an examination by a nondomiciliary state regulator to determine the RRG’s financial condition, if the domiciliary state regulator has not begun or refuses to begin an examination. Nondomiciliary, as well as domiciliary, states also may seek an injunction in a “court of competent jurisdiction” against RRGs that they believe are in hazardous financial condition. RRGs are not the only form of self-insurers. “Captive insurance companies” (captives), also chartered and regulated by states, are established by single companies or groups of companies to self-insure their own risks. States chartering captives offer some regulatory relief to these companies based on the presumption that owners of captive companies have sophisticated knowledge about managing their risks and would protect their own interests. States can charter RRGs under regulations intended for traditional insurers or for captives. Non-RRG captives exist largely to cover the risks of their parent, which can be one large company (pure captive) or a group of companies (group captives). Group captives share certain similarities with RRGs because they also comprise several companies, but group captives, unlike RRGs, do not have to insure similar risks. Further, captives may provide property coverage, while RRGs currently may not. Regulatory requirements for captives generally are less restrictive than those for traditional insurers. However, non-RRG captives, like traditional insurance companies, generally cannot conduct insurance transactions in any state except their domiciliary state, unless they become licensed in that other state. State insurance regulators that oversee both traditional insurers and RRGs participate in NAIC’s voluntary accreditation program for the regulation of insurers’ financial solvency. NAIC accreditation is a certification given to a state insurance department once it has demonstrated it has met and continues to meet an assortment of legal, financial, and organizational standards. According to NAIC officials, all 50 state insurance departments and the District of Columbia were accredited as of March 2011. NAIC developed its Financial Regulation Standards and Accreditation Program in 1989 and adopted its formal accreditation program in June 1990. The mission of the program is to establish and maintain standards to promote sound insurance company financial solvency regulation. To execute this mission, NAIC assesses how each state insurance department reviews and monitors the solvency regulation of multistate insurance companies and RRGs to ensure states have (1) adequate solvency laws and regulations to protect consumers, (2) effective financial analysis and examination processes, and (3) appropriate organizational and personnel practices. Based on data reported by RRGs to NAIC since 2004, RRGs in aggregate have shown an increase in premiums written and in their share of the broader commercial liability market. In 2005, we reported that RRGs wrote about $1.8 billion of commercial liability coverage, which constituted about 1.17 percent of the overall market in 2003. According to NAIC data, in 2010 RRGs wrote about $2.5 billion in premiums, which was about 3 percent of the total $92 billion of commercial liability insurance coverage written industrywide. An analysis of direct written premiums by dollar amount indicates that between 2004 and 2010, the largest percentage of RRGs (31 to 37 percent) wrote premiums between $1 million and $5 million (see fig. 1). Of the almost $92 billion of commercial liability insurance written industrywide in 2010, about $10.6 billion was written in the medical professional liability line—also known as medical malpractice. In an analysis of the premiums written for the medical professional liability line, RRGs had a higher share of this specific market compared with their share of the overall commercial liability market. RRGs wrote about 13 percent ($1.4 billion of the total $10.6 billion) of medical professional liability insurance in 2010 (see fig. 2). We further discuss growth in the number of RRGs offering health care-related insurance later in this section. Based on several measures of financial strength or profitability, the RRG industry as a whole generally reported year-to-year gains from 2004 to 2010 (see fig. 3). A key factor in determining an insurer’s overall financial strength is capital and surplus—also known as policyholder surplus— which reflects the amount by which an insurer’s assets exceed its liabilities. Regulators require insurers to maintain adequate surplus so that an insurer can remain solvent even in the face of greater losses than predicted or lower earnings than projected. One of the indicators used to measure the adequacy of policyholder surplus is the ratio of an insurer’s premiums written to its policyholder surplus, which measures an insurer’s ability to pay claims given the volume of premiums written. A lower ratio of premiums written to surplus means an insurer has more net assets available relative to the amount of premiums written. According to the NAIC’s Financial Analysis Handbook–Property/Casualty Edition and other general benchmarking guidelines from NAIC officials, the net written premium-to-surplus ratios for property/casualty insurers in general would receive regulatory scrutiny for excessive leverage risk concerns for ratios greater than 250 to 300 percent, depending on the particular line of insurance. If an insurer’s ratio exceeds this range, a state regulator may conduct additional analyses of the insurer’s financial solvency. According to NAIC officials, there is not an established benchmark for an acceptable premium-to-surplus ratio for the RRG industry. An analysis of NAIC data shows that on average, the industry’s net written premium to policyholder surplus declined from 2004 to 2010, indicating that the financial strength of the industry during this time period has likely either improved or remained stable (see fig. 3). Another indicator of financial strength is return on policyholder surplus, or return on equity (ROE). ROE is generally calculated as the ratio of net income to equity, or in the case of insurers, policyholder surplus. From 2004 to 2010, the average ROE in the RRG industry fluctuated, with a high of 13.4 percent in 2008 and a low of 5.1 percent in 2010 (see fig. 4). While no clear trend was visible over the 7-year period we analyzed, the average ROE for each year generally indicated profitability for the RRG industry. The combined ratio is another measure of an insurer’s financial strength and profitability. This ratio shows the claims and related expenses incurred by an insurer as a percentage of the premiums earned. According to NAIC officials, a combined ratio of less than 100 indicates an underwriting profit (gain)—that is, premiums collected were higher than the claims paid and related expenses—while a combined ratio above 100 can be an indicator of an unprofitable insurer that could be in a hazardous financial condition. An analysis of NAIC data shows that the average combined ratio for RRGs that filed financial statements ranged from a high of 92.6 percent in 2005 to a low of 88 percent in 2008 (see fig. 5). The average combined ratio in 2010 was 90.2. Also based on NAIC data, the percentage of RRGs with a combined ratio above 100 fluctuated from 2006 to 2010 (see fig. 6). For example, 36 percent of the RRGs writing premiums in 2006 had a combined ratio above 100. These percentages increased from 2007 to 2009, with a high of 43 percent in 2009, and decreased to about 37 percent in 2010. Together, these data indicate that while most RRGs appear to have been profitable in any one year, a sizeable but relatively stable percentage in each year could have experienced some financial challenges.