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Demotech Second Quarter 2020 Analysis Finds RRGs Remain Financially Stable

The Word Stability with Letters Reflected Underneath and Magnifying Glass over the S
November 02, 2020

Assets and surplus of risk retention groups (RRGs) increased in the second quarter of this year relative to the same period last year, as the alternative risk transfer vehicles continue to provide specialized coverage to their insureds while remaining financially stable, according to a new analysis from Demotech, Inc.

"Based on reported financial information, RRGs have a great deal of financial stability and remain committed to maintaining adequate capital to handle losses," Douglas A Powell, senior financial analyst at Demotech, writes in "Risk Retention Groups Report Increases in Surplus and Premiums," Analysis of Risk Retention Groups—Second Quarter 2020, October 29, 2020.

The report notes that RRG ownership is restricted to its policyholders, with the report suggesting that the nature of that ownership structure may be a factor in RRGs' strengthened capital position.

According to the report, RRG cash and invested assets increased 4.5 percent in the second quarter of 2020 from the same period last year. Meanwhile, total admitted assets increased 5.3 percent and RRGs' collective policyholder surplus increased 3.1 percent year-over-year in the second quarter, a $163.1 million increase in policyholders' surplus.

"The level of policyholders' surplus becomes progressively important in times of difficult economic conditions by allowing an insurer to remain solvent when facing uncertainty," Mr. Powell noted.

Risk retention groups' liquidity—measured by case and invested assets to liabilities—for the second quarter of this year was 145.1 percent, according to the Demotech report. The report notes that values of more than 100 percent are considered favorable as they indicate the availability of more than a dollar's worth of net liquid assets for each dollar of total liabilities.

"In evaluating individual RRGs, Demotech, Inc., prefers companies to report leverage of less than 300 percent," the report said. "Leverage for all RRGs combined, as measured by total liabilities to policyholders' surplus, for second quarter 2020 was 146.7 percent."

RRGs' loss and loss adjustment expenses reserves—loss reserves—to policyholders' surplus ratio for the second quarter of this year was 95.5 percent, Demotech reported. "The higher the ratio of loss reserves to surplus, the more an insurer's stability is dependent on having and maintaining reserve adequacy," Mr. Powell wrote.

"Regarding RRGs collectively, the ratios pertaining to the balance sheet appear to be appropriate and conservative," according to Mr. Powell. "These reported results indicate that collectively RRGs remain adequately capitalized and able to remain solvent if faced with adverse economic conditions or increased losses."

In its analysis of RRGs' income statements, the Demotech report notes that the collective loss ratio for RRGs through this year's second quarter—measured by losses and loss adjustment expenses incurred to net premiums earned—was 79.6 percent. The report indicates that the loss ratio serves as a measure of the underlying profitability of an insurer's book of business.

RRGs' second quarter expense ratio—measured by other underwriting expenses incurred to net premiums earned —was 24.7 percent through this year's second quarter, Demotech reported, noting that the ratio measures the operational efficiency in an insurer's underwriting.

RRGs' combined ratio—the loss ratio added to the expense ratio—was 104.3 percent through the second quarter, according to Demotech. A combined ratio of less than 100 percent indicates an underwriting profit, while a ratio of more than 100 percent indicates an underwriting loss, Mr. Powell explained in the report.

Collectively, RRGs' underwriting was unprofitable in the second quarter, as they reported an aggregate underwriting loss of $39.8 million, Demotech reported. "However, RRGs collectively reported a net investment gain of $115.6 million and, as a result, a net gain of $70.5 million," Mr. Powell wrote. "Despite the underwriting losses, the ratios pertaining to the income statement appear to be appropriate for RRGs collectively."

Analyzing RRGs' second quarter premium, the report notes that since the risk transfer vehicles are restricted by law to writing liability coverage, they tend to insure medical providers, product manufacturers, law enforcement officials, and contractors, as well as other industries with professional liability.

During this year's second quarter, RRGs collectively reported $2.3 billion of direct written premium, according to Demotech, an 8.8 percent increase over the same period last year. RRGs' net written premium in the second quarter was $1.3 billion, also an 8.8 percent increase over 2019's second quarter.

RRGs' collective second quarter direct premium written to policyholders' surplus ratio was 84.1 percent, according to Demotech, while the net premium written to policyholders' surplus ratio for the period was 49.9 percent. The report said that the premium written values for the ratios were adjusted so they can be compared relatively to year-end ratios.

The report notes that an insurer's direct premium written to surplus ratio speaks to its policyholders' surplus leverage on a direct basis, without consideration of the effects of reinsurance. The net premium written to surplus ratio, meanwhile, offers a measure of policyholders' surplus leverage net of reinsurance. "An insurer relying heavily on reinsurance will have a large disparity in these two ratios," Mr. Powell wrote.

"A direct premium written to surplus ratio in excess of 600 percent would subject an individual RRG to greater scrutiny during the financial review process," the report said. "Likewise, a net premium written to surplus ratio greater than 300 percent would subject an individual RRG to greater scrutiny."

The report does note that in some cases premium to surplus ratios exceeding those amounts could be considered appropriate if the RRG demonstrates that relative improvement in rate adequacy contributed to the higher ratio.

"In regards to RRGs collectively, the ratios pertaining to premium written appear to be conservative," Mr. Powell wrote.

Offering final conclusions from Demotech's second quarter RRG analysis, Mr. Powell wrote, "Despite political and economic uncertainty, RRGs remain financially stable while providing specialized coverage to their insureds. The financial ratios calculated based on the reported results of RRGs appear to be reasonable, keeping in mind that it is typical and expected that insurers' financial ratios tend to fluctuate over time. The results of RRGs indicate that these specialty insurers continue to exhibit financial stability."

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