SACRAMENTO, Calif.—A small Montana-domiciled risk retention group providing medical stop-loss coverage to California auto dealers is ending its legal battle with the California Department of Insurance and will stop writing the coverage.

While Auto Dealers Risk Retention Group Inc. had just over a dozen policyholder-owners, its legal tug-of-war with the California Insurance Department drew national attention because of the potential far-reaching consequences for the risk retention group industry.

California insurance regulators tried to stop the group from operating, arguing that neither California law nor the federal Liability Risk Retention Act permits RRGs to write medical stop-loss coverage.

Regulators, who issued a cease-and-desist order, said such coverage was an excess layer of disability/health insurance, which the Risk Retention Act does not allowThe auto dealers' RRG, with support from RRG trade groups, challenged that argument, maintaining that the coverage is allowed under the federal law and that as a nonchartering state, California lacked the authority to block the group from operating without obtaining a court order. RRG advocates said California's action undermined Congress' intent when it enacted the Risk Retention Act: to allow the groups to operate nationwide with minimal interference from out-of-state regulators after meeting the licensing requirements of one state.

In March, a federal judge issued a preliminary injunction blocking the cease-and-desist order, saying that as a nonchartering state, California had no right to regulate the auto dealers' RRG.

But with the prospect of protracted litigation, the auto dealers said they could not afford to continue to fight the California Insurance Department and will cease writing medical stop-loss coverage.

"The board of directors determined that as a newly-formed business enterprise," the RRG "simply cannot incur the cost of protracted litigation with the state of California," the group said in a statement.

California Insurance Commissioner Steve Poizner said in a statement that it is "crucial that companies follow the rules when conducting business in our state."

RRG advocates worry that other states now will attempt to block RRGs from operating within their borders. California's perceived success will embolden other states to try to do the same, said Richard Goff, president of the Self Insurance Institute of America.

In effect, California used its economic power to grind down a small RRG, said Robert "Skip" Myers, Washington counsel for the National Risk Retention Assn. and a partner with Morris, Manning & Martin L.L.P.