By Karl T. Muth, Ph.D.
From Early Cooperatives to Modern RRGs
Several concepts first developed at the margins of the risk market are increasingly relevant in the support of defense and national-security-aligned initiatives. Prior to WWII, whether a farm cooperative or a dangerous kind of manufacturing (e.g., ammunition, refined fuels, or poisonous chemicals), groups of businesspeople banded together to form at-first-loss cooperatives, then formal mutuals, then, post-1986, modern risk retention groups (RRGs).
In 1986, Congress created RRGs as part of the Liability Risk Retention Act of 1986 (LRRA). While RRGs embrace many of the characteristics of prewar mutuals, including being controlled by policyholders, the biggest difference between the two is conventional mutuals are creatures of contract among the members and, as a result, are governed principally by state law (as all contract law is state law). Think of an RRG as a more national mutual.
One enormous advantage of RRGs over traditional mutuals is they can be domiciled in one state and simply register to do business in other states (while mutuals must hold a Certificate of Authority in each operating state. Also, RRGs are expressly forbidden from joining state guaranty funds (which protect against insurer insolvency) and, as a result, RRG policyholders are not protected from the RRG’s insolvency. Because defense procurement and defense-relevant research is nationwide, a state-specific mutual structure is inappropriate.
The Limits of Traditional Insurance
Today, many companies are operating in spaces that are fundamentally uninsurable not only in the admitted commercial lines insurance market, but even in non-admitted risk markets (e.g., the excess and surplus market). Small modular nuclear reactors are understandably exciting, but the magnitude of an incident is potentially enormous. Likewise, commercial space launches capture the imagination, but a rocket falling in Times Square would be a disaster.
One of the core advantages of RRGs is the shared expertise of the members combined with pooled risk incentive dynamics. Commercial space launch providers sharing risk will not allow a poorly-vetted, unsafe launch operation to join the RRG. Gene-editing research startups won’t let unsafe research into the risk pool. Hypersonic weapons and armed drone startups are incentivized to not let firms engaged in unsafe testing into the risk pool.
I was recently made aware of two “stealth mode” efforts to start RRGs for AI research. This is a good use of the structure, since the potential liability from AI malfunctions is very large in national security use cases where AI models might make shoot/no-shoot decisions, process and interpret large volumes of intercepted communication, or accuse someone of being a terrorist. This is another good use case for RRGs to further research (and reassure investors).
The bottom line, and I say this as a person with investments in many defense-related areas, is that the technologies we need to keep our nation safe are sometimes dangerous to develop.
Hypersonic weapons and space vehicles sometimes fail in flight, and, admittedly, some of those failures are catastrophic. Absolute American dominance in AI is not a “nice to have” but a critical analytical and defensive (and offensive) asset, and it will be fueled by small-reactor nuclear-powered datacenters. Quantum computing and high-energy-density battery arrays both require exotic local infrastructure that can be complex and potentially dangerous to construct.
LRRA Reform Could Help Maximize National Security Innovation
The traditional commercial lines insurance market simply will not be willing to underwrite these risks and absorb the associated losses. Yet, we need a way to protect firms and investors from the high-magnitude, low-frequency risks among these industries. Further, we need a way to foster innovation and compete against our global rivals who will fund and indemnify their national champions in ways not practicable within our legal system.
To achieve these goals, I suggest an amendment to the 1986 LRRA allowing “defense tech” companies to form RRGs even if their underlying business operations would normally be incompatible under that law’s strictest interpretations (e.g., one makes hypermaneuverable munitions and one makes infantry robots). This would allow risk pooling of the scale appropriate for insuring what could potentially be (in areas like AI, nuclear, and hypersonic/laser weaponry) multi-billion-dollar claims.
While substantive Congressional revisions to the LRRA have been rare, never before have there been so many activities vital to the collective defense and the safety of our Pacific and Article 5 allies that are fundamentally uninsurable activities. Because of the sensitivity of these technologies, this work should not be done overseas. As this must be on-shore, secure-facility, known-investor activity and that means creating an on-shore risk pool to protect those investments. This imperative extends beyond traditional defense technologies. Investments that follow the principles of Global Competition and Innovation (GCI)—those leveraging private capital to accelerate technologies critical to national security and global stability—should also be eligible for participation in such risk-sharing mechanisms.
This is an innovative adaptation that is not incongruous with the original purposes of policyholder-controlled risk entities. See generally Karl T. Muth and Andrew Leventhal, Mutuals: An Area of Legal Climate Change, 9 Wm. & Mary Bus. L. Rev. 597 (2018), available at: https://scholarship.law.wm.edu/wmblr/vol9/iss3/3. In fact, it’s analogous to the purposes for which industry-specific risk pooling began; the only change in my proposal is that “defense tech” (rather than “aerospace” or “energy” or “software”) is the macro industry. If I were to propose one further change, it would be to allow the RRG for defense tech to offer excess coverages (all LRRA RRGs are general-liability-only).
The Uninsurable Risk Landscape and the Need to Act
Today, the technologies most critical to national security are often those with development risks so profound they are considered “fundamentally uninsurable” by admitted markets, like crop failures in the 1930s or fear of oilfield exploration risk in the 1960s. The potential for catastrophic failure—a small modular reactor incident, a hypersonic test vehicle failing over a populated area, an AI-driven autonomous system making a lethal error, or the uncontrolled release of an engineered gene—presents a liability tail that traditional underwriters cannot price or absorb.
The kinds of firms I envision allying within, and benefiting from, a defense-tech-focused but multi-industry RRG structure focused on defense tech would include small modular nuclear reactor firms (e.g., Oklo), in-orbit factory operators (e.g., Varda), multimission space vehicles (e.g., Stoke), hypersonic armsmakers (e.g., Castelion), battlespace-relevant AI (e.g., Anduril and Shield), national cyberdefense (e.g., Abnormal), gene editing (e.g., Scribe), Quantum (e.g., PsiQuantum), and high-density energy research (e.g., QuantumScape).
Without some kind of structured capital backstop—whether in the form of a recourse credit facility, a sovereign-backed loss aggregation facility, or a risk retention group (RRG)— American progress will be retarded or even jeopardized by fears of an unlikely but devastating research-interrupting event. Congress should act—ideally in concert with DoD, DOE, FAA, NASA, etc. but if necessary independent of administrative agencies—to make our most important ventures and projects able to share investors in a way that guards against bad events, protects investors, and allows defense tech progress to continue.
Like the merchant classes of England and the Netherlands in the 1600s or the American farmers of the 1920s and 1930s, forward progress has always depended on the courage to share risks too great for any one actor. But unlike those earlier markets, today’s risks are not local or cyclical: they are global, generational, and strategically decisive. If Congress declines to adapt, American will not only merely be tolerating inefficiency, it will be choosing to handicap its own innovators while our rivals race ahead.
Risk is no longer just an accounting matter; it is a national asset. The question is whether we will structure it in a way that fuels American leadership, or leave it as the gap our adversaries exploit.
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Author’s Disclosure:
Karl T. Muth has a variety of defense-related investments, including direct venture investments, investments as an LP in multiple venture funds, and investments in publicly traded firms. For over seven years, he advised the most senior executives of a Fortune 250 mutual and has worked on the restructurings of a variety of mutual and mutual-like entities and resulting venture-backed spinouts. He leads underwriting-related strategy at a PE-backed excess and surplus lines insurance entity and has worked in the most exotic high-magnitude, low-frequency parts of risk products development for over fifteen years.
