The implementation of governance standards in Vermont

Risk retention groups (RRGs) are subject to and operate under the Federal Liability Risk Retention Act of 1986, 15 USC 3901-3906 (1981, as amended 1986), hereinafter referred to as the LRRA. Under the LRRA a RRG is chartered, or licensed and domiciled as a liability insurance company under the laws of one state and authorised to engage in the business of insurance under the laws of such state, and which has as its owners only persons who comprise the membership of the RRG and who are provided insurance by the RRG.

While a RRG is owned by its policyholders, other parties can play a significant role in managing its affairs, therefore proper governance should be an important focus. The shift came at a time when auditing standards and the National Association of Insurance Commissioners (NAIC) moved to a risk-based approach.

The need for RRG governance standards was highlighted in 2005 when the General Accounting Office (GAO) issued a report to the US Congress indicating that the LRRA lacks governance standards to protect RRGs from potential abuses by service providers. The GAO concluded that some common regulatory standards and greater policyholder protections were needed, so the development of governance standards was taken up by the NAIC’s Risk Retention (C) Working Group. Vermont was a participating member of the working group in cooperation with other states.

A set of adopted standards was incorporated into the NAIC’s Risk Retention Model Act (Section 3.D. of model #705). To enforce the standards, state regulators working with the NAIC’s Financial Regulation Standards and Accreditation (F) Committee added the governance standards contained in Section 3.D. of Model #705 as an accreditation standard for all states that charter RRGs. Effective January 1, 2017 all states that license and regulate RRGs must have laws that contain these governance standards and existing RRGs have one year from the chartering state’s effective date of the law to achieve compliance.

On May 7, 2015 Vermont enacted the NAIC’s governance standards for RRGs in Title 8 of the Vermont Statutes, Chapter 142, Section 6052(g).

Vermont adopted the standards earlier than the NAIC’s accreditation implementation deadline primarily to work with its more than 90 RRGs on implementation, and to establish a reasonable set of standards substantially similar to those prescribed by the NAIC accreditation programme.

Vermont issued two guidance memos in 2016 to address specific interpretations of Vermont law with respect to director independence, material service provider contracts, audit committee and partner rotation requirements, board policies and guidance for newly formed RRGs.

Implementation clarifications
Prior to the effective date of implementation, many Vermont-domiciled RRGs had board policies and procedures that were similar to those prescribed by the new requirements. Although much of the law has been easy for RRGs to follow and understand, there were areas that called for further discussion and necessitated Vermont’s involvement to help its RRGs with interpretation.

The most common sections of the law requiring Vermont’s guidance are discussed below. Full descriptions of the standards, including definitions and all requirements, can be found on Vermont's website.

Majority independent directors
One of the most important things to remember is that as a general rule, the members/policyholders of a RRG are considered independent. By virtue of the fact that the member owners of a RRG are its policyholders, whose interests are at stake, it is appropriate to have those members govern the RRG.

Subsection (1)(C)(i) of the materiality calculation applies to compensation received by any business with which a director is affiliated. Therefore, any director who is affiliated with another entity receiving compensation from the RRG must aggregate fees for determination of independence, even if the affiliation is with a separate legal entity and separate contracts are executed (for example, management and brokerage services).

Every captive insurance company domiciled in Vermont is required to have a Vermont-resident director to ensure the board includes at least one member with knowledge of the captive insurance industry and Vermont requirements. Subsection (1)(C)(i) could have the effect of disqualifying certain Vermont-resident directors who are employed by service providers of the RRG from being considered independent, which is not in keeping with the intent of the resident director requirement. Consequently, Vermont may allow a resident director to qualify as independent, on a case-by-case basis, upon petition by such director describing steps that will be taken to ensure that the director’s other relationships do not have an undue influence on the board’s decisions.

Subsection (2) requires the board to determine independence each year and keep records of such determination. The Vermont Department of Financial Regulation (DFR) does not require annual submission of the independence determinations; however, we will review such records during a full scope examination.

Material service provider contracts
Since fees for defence counsel are rarely known or fixed in advance, Vermont law stipulates that defence counsel will be considered material only if such fees are breached in three of last five years. Additionally, in order to avoid the need to continuously track aggregate fees for other service providers that are paid on time and expense or per claim basis, the Vermont DFR will not consider such service providers to be material until the calendar year following the one in which their actual compensation exceeds the threshold.
As such, a RRG can continue working with that service provider through the initial calendar year but must then obtain the required approvals from the RRGs board and Vermont if the engagement will continue.

Subsection (3) specifies a five-year maximum term for any material service provider contract. Vermont does not prohibit evergreen clauses, provided the contract, or its renewal, is approved by the board and Vermont every five years and has the appropriate termination clause. No contract with an evergreen clause may automatically renew for a period exceeding five years.

Audit committee
Subsection (6) requires a RRG to have an audit committee composed of at least three independent board members, but allows the Commissioner to waive the requirement of an audit committee if the RRG demonstrates that having such committee is impracticable and the board is able to perform sufficiently the committee’s responsibilities. If a RRG requests a waiver from the Vermont DFR, such request must be made in writing and only needs to be made one time, not annually. If a waiver is granted, the board must fulfil the responsibilities of the audit committee as outlined in Subsection (6).

Newly formed RRGs
Since new RRGs do not have the premium and surplus history needed to calculate materiality thresholds as required by subsections (1)(C)(i) and (1)(D), Vermont will allow RRGs to use the financial projections submitted with the application for purposes of calculating materiality in the RRG’s first two years of operations. Additionally, during the application process, Vermont will review draft governance documents and director independence.

Best practices
Over the last couple of years since the governance standards were enacted, Vermont has seen some excellent examples being utilised by its RRGs, Vermont managers, and local attorneys. While not required, we offer the following best practices:

• Maintain a spreadsheet showing calculation of annual materiality threshold, names and affiliations of each director, and determination of independence.
• Add an attestation of independence to the Conflicts of Interest statement which must be signed by all directors and officers annually.
• Maintain a governance calendar for board meetings that outlines dates of meetings and actions to be taken.
• Maintain a governance checklist which includes the requirements pursuant to Subsection (5) (and Subsection [6] if audit committee waiver is granted) to help the board see compliance responsibilities and track accomplishments annually.
• Keep detailed board and committee meeting minutes to evidence discussions and actions taken by the board, including review and approval of material service provider contracts, oversight of key service providers, review of independent directors, etc.
• Review written policies regularly and update as needed.
• Ensure written governance standards are available to be provided to RRG members upon request.
• Document succession planning, for both board members and management.
• Remember that the various written policies and procedures can be commensurate with a RRG’s operations—taking into consideration its size and structure and the sophistication of its membership.

Applying governance standards consistently to all RRGs has been a more than 10-year effort. Input was received from both regulators and industry throughout the process. The standards allow for consistency in board oversight and strengthen the domiciliary state’s ability to regulate RRGs. The governance standards should be viewed as a tool to help board members meet their fiduciary responsibilities and promote uniformity in regulation. They encourage accountability and transparency to all stakeholders.

Sandy Bigglestone is the director of captive insurance at the Vermont Department of Financial Regulation. She can be contaced at:  Sandy.Bigglestone@vermont.gov

Christine Brown is the assistant director of captive insurance at the Vermont Department of Financial Regulation. She can be contacted at:  Christine.Brown@vermont.gov

For more information visit  www.dfr.vermont.gov/captives/captive-insurance-division