SAN FRANCISCO -- Oregon laws that require automobile dealers and distributors selling vehicle service contracts to purchase reimbursement policies from "authorized" insurers and not from risk retention groups are pre-empted by the Risk Retention Act, a federal appellate court ruled last week.

A three-judge panel of the 9th U.S. Circuit Court of Appeals in San Francisco unanimously ruled that Oregon's categorical exclusion of RRGs as a market option violates the federal law that limits state regulation of RRGs. In passing the Risk Retention Act, "Congress decided that RRGs, as a group, were sufficiently trustworthy providers of insurance that they should be allowed to provide insurance free of state regulation, subject only to specifically granted and fairly narrow exceptions," the court said last week, affirming a 1999 ruling by a U.S. magistrate (BI, Sept. 20, 1999).

While the Risk Retention Act grants Oregon the authority to, for example, prevent a financially unsound RRG from writing coverage, "it may not categorically exclude coverage from all RRGs," the court concluded.

Oregon regulators said they were disappointed with the ruling and will decide soon whether they will ask either the full appellate court or the U.S. Supreme Court to review the decision, said a spokesman for the Oregon Department of Justice, which is representing the state insurance department in the matter.

RRG advocates, however, said the decision should send a clear message to state insurance regulators to abandon their efforts to seek and enforce rules and laws that discriminate against RRGs.

"This is a very well-reasoned decision. Simply put, a state cannot set criteria that risk retention groups, as a class, cannot satisfy," said Jon Harkavy, a member of the National Risk Retention Assn's. government affairs committee and vp and general counsel in the Arlington, Va., office of Risk Services L.L.C., a captive and RRG manager.

"State laws cannot be applied in a discriminatory fashion," said Phil Olsson, NRRA's general counsel and a principal with Olsson, Frank & Weeda P.C. in Washington.

The appellate court decision comes in the wake of a series of conflicts over the last year or so between state insurance regulators and RRGs, as well as RRGs' distant cousins -- risk purchasing groups.

Last year, for example, Hawaii attempted to impose a $406 fee on each RRG licensed in another state and each purchasing group with policyholders in the state. But Hawaii later dropped its efforts to impose the fee, after RRGs and purchasing groups protested that the fees were illegal under the Risk Retention Act.

Also last year, the Indiana Insurance Department demanded that purchasing groups each pay a $650 fee for participating in a Y2K readiness survey. Lately, though, purchasing groups' administrators say, the department has ceased its demands that the groups pay the fee.

But squabbles over fees pale in comparison to the controversy in Oregon, which, had the state insurance department prevailed, would have knocked out risk retention groups as a market alternative for employers in certain industries.

"This is an important case for all risk retention groups, not just National Warranty," said M. Hannah Leavitt, an attorney with Buchanan Ingersoll P.C. in Harrisburg, Pa., which represented National Warranty Insurance Co. RRG, a Risk Retention Group. NWIC filed a suit challenging the oregon law.

"The states have been working hard to narrow the exemption from state regulation that Congress gave risk retention groups," and the 9th Circuit has "held the line" on that effort, Ms. Leavitt said.

At issue in the Oregon litigation is the relationship between sections of the Risk Retention Act that pre-empt state laws that discriminate against RRGs and other sections that protect from pre-emption state laws and rules that require employers in certain industries to demonstrate financial responsibility.

Under Oregon law, insurers must be authorized by the Department of Consumer and Business Services to do business in the state. In order to be authorized, an insurer must be a member of the Oregon Insurance Guaranty Assn., which pays claims for policyholders of insurers that become insolvent. Under the Risk Retention Act, RRGs cannot be members of state guaranty associations. Consequently, they cannot become authorized insurers in Oregon.

Under another Oregon statute, automobile dealers must be registered with the state in order to sell vehicle service contracts. To register, a dealer must meet mandated "financial stability" requirements. The dealer can meet the requirement either by showing that it has a net worth of at least $100 million or by purchasing a reimbursement policy from an authorized insurer.

In 1996, the Oregon Department of Justice said RRGs could not offer reimbursement policies to dealers selling service contracts because RRGs were not authorized insurers.

NWIC sued Mike Greenfield, director of the Oregon Department of Consumer and Business Affairs, saying that the Oregon requirements violated the Risk Retention Act, which allows an RRG to operate nationwide after being licensed in one state. NWIC was licensed in 1984 in the Cayman Islands, under a sunset provision in the original 1981 Risk Retention Act. Under the act, an RRG could be set up in the Cayman Islands or in Bermuda if it also met the capital and surplus requirements of at least one state. NWIC meets Pennsylvania's requirements. That provision has since expired, and an RRG now must be licensed in a state, but those RRGs that took advantage of the earlier provision can continue to operate.

Oregon regulators said the "financial responsibility" provision of the Risk Retention Act saved from federal pre-emption the state's statute requiring auto dealers to buy policies from authorized insurers. Under that provision, states are not pre-empted from specifying acceptable means of demonstrating financial responsibility.

In its ruling, the appeals court said that a state financial responsibility law could -- without violating the Risk Retention Act -- require insurance providers to meet minimum financial criteria. That could result in some RRGs, as well as some authorized insurers, being barred from writing coverage.

While the "most reasonable reading" of the Risk Retention Act is that states can exclude a particular RRG from doing business if it is financially unstable, laws such as Oregon's that categorically exclude all RRGs from writing coverage in certain lines of business are pre-empted, the court said.

NRRA's Mr. Olsson said the appeals court made a very "straightforward" interpretation of the federal law. While states have the right -- under the Risk Retention Act -- to specify the means of demonstrating financial responsibility, such requirements cannot discriminate against RRGs, he said.

"States can set financial responsibility requirements, such as capital and surplus. But those requirements have to be applied in a non-discriminatory fashion. RRGs cannot be excluded as a category," Mr. Olsson said.

National Warranty Insurance Co. RRG, a Risk Retention Group, vs. Mike Greenfield, Director of Consumer and Business Affairs of the State of Oregon, 9th U.S. Circuit Court of Appeals, No. 98-36054