Risk Retention Groups Remain Financially Stable Despite Mixed Reported Results

A review of the reported financial results of risk retention groups, as reported in Demotech's Analysis of Risk Retention Groups Year-End 2016, reveals insurers that continue to collectively provide specialized coverage to their insureds while remaining financially stable. Based on reported financial information, risk retention groups have a great deal of financial stability and remain committed to maintaining adequate capital to handle losses. It is important to note that ownership of risk retention groups is restricted to the policyholders of the risk retention group. This unique ownership structure required of risk retention groups may be a driving force in their strengthened capital position.

Balance Sheet Analysis

Since year-end 2015, cash and invested assets increased 3 percent, and total admitted assets increased 3 percent. More importantly, over the last year, risk retention groups collectively increased policyholders' surplus 4.8 percent. The level of policyholders' surplus becomes increasingly important in times of difficult economic conditions by allowing an insurer to remain solvent when facing uncertain economic conditions. This increase represents the addition of over $216.6 million to policyholders' surplus. During this same time period, liabilities have only increased 1.8 percent. These reported results indicate that risk retention groups remain adequately capitalized in aggregate and able to remain solvent if faced with adverse economic conditions or increased losses.

Liquidity, as measured by liabilities to cash and invested assets, for year-end 2016 was 65.7 percent. A value less than 100 percent is considered favorable as it indicates that there was more than a dollar of net liquid assets for each dollar of total liabilities. This also indicates a decrease for risk retention groups collectively as liquidity was reported at 66.5 percent at year-end 2015.

In evaluating individual risk retention groups, Demotech, Inc., prefers companies to report leverage of less than 300 percent. Leverage for all risk retention groups combined, as measured by total liabilities to policyholders' surplus, for year-end 2016 was 144.4 percent and indicates a decrease compared to year-end 2015, as this ratio was 148.7 percent.

The loss and loss adjustment expense (LAE) reserves to policyholders' surplus ratio for year-end 2016 was 105 percent and indicates a decrease compared to year-end 2015, as this ratio was 105.9 percent. The higher the ratio of loss reserves to surplus, the more an insurer's stability is dependent on having and maintaining reserve adequacy.

Regarding risk retention groups collectively, the ratios pertaining to the balance sheet appear to be appropriate and conservative.

Premium Written Analysis

Since risk retention groups are restricted to liability coverage, they tend to insure medical providers, product manufacturers, law enforcement officials, and contractors as well as other professional industries. Risk retention groups collectively reported nearly $3.1 billion of direct premium written (DPW) through year-end 2016, an increase of 4.7 percent over 2015. Risk retention groups reported nearly $1.8 billion of net premium written (NPW) through year-end 2016, an increase of 4 percent over 2015.

The DPW to policyholders' surplus ratio for risk retention groups collectively through year-end 2016 was 65 percent, down from 65.1 percent in 2015. The NPW to policyholders' surplus ratio for risk retention groups through year-end 2016 was 38.3 percent and indicates a decrease over 2015, as this ratio was 38.6 percent.

An insurer's DPW to surplus ratio is indicative of its policyholders' surplus leverage on a direct basis, without consideration for the effect of reinsurance. An insurer's NPW to surplus ratio is indicative of its policyholders' surplus leverage on a net basis. An insurer relying heavily on reinsurance will have a large disparity in these two ratios.

A DPW to surplus ratio in excess of 600 percent would subject an individual risk retention group to greater scrutiny during the financial review process. Likewise, an NPW to surplus ratio greater than 300 percent would subject an individual risk retention group to greater scrutiny. In certain cases, premium to surplus ratios in excess of those listed would be deemed appropriate if the risk retention group had demonstrated that a contributing factor to the higher ratio is a relative improvement in rate adequacy.

In regard to risk retention groups collectively, the ratios pertaining to premium written appear to be conservative.

Loss and LAE Reserve Analysis

A key indicator of management's commitment to financial stability, solvency, and capital adequacy is their desire and ability to record adequate loss and LAE reserves (loss reserves) on a consistent basis. Adequate loss reserves meet a higher standard than reasonable loss reserves. Demotech views adverse loss reserve development as an impediment to the acceptance of the reported value of current, and future, surplus and that any amount of adverse loss reserve development on a consistent basis is unacceptable.

Consistent adverse loss development may be indicative of management's inability or unwillingness to properly estimate ultimate incurred losses.

Risk retention groups collectively reported adequate loss reserves at year-end 2016 as exhibited by the 1-year and 2-year loss development results. The loss reserve development to policyholders' surplus ratio measures reserve deficiency or redundancy in relation to policyholder surplus and the degree to which surplus was either overstated, exhibited by a percentage greater than zero, or understated, exhibited by a percentage less than zero.

The 1-year loss reserve development to prior year's policyholders' surplus for 2016 was -2.3 percent and was less favorable than 2015 when this ratio was reported at -4.6 percent. The 2-year loss reserve development to second prior year-end policyholders' surplus for 2016 was -8.4 percent and was more favorable than 2015 when this ratio was reported at 20.3.7 percent. In regard to risk retention groups collectively, both of these loss reserve developments to prior year's policyholders' surplus ratios would be viewed as favorable.

Income Statement Analysis

In regard to underwriting gains and losses, risk retention groups collectively were not profitable again in 2016. Risk retention groups reported an aggregate underwriting loss for 2016 of $44.8 million, albeit an increase over 2015, and a net investment gain of $273.7 million, a decrease over 2015. Risk retention groups collectively reported net income of $181.7 million, a decrease of 22.2 percent over 2015. Looking further back, risk retention groups have collectively reported an annual net income at each year-end since 1996.

The loss ratio for risk retention groups collectively, as measured by losses and LAEs incurred to net premiums earned, through year-end 2016 was 78.9 percent, a decrease over 2015, as the loss ratio was 79.3 percent. This ratio is a measure of an insurer's underlying profitability on its book of business.

The expense ratio, as measured by other underwriting expenses incurred to net premiums written, through year-end 2016 was 23.8 percent and indicates an increase compared to 2015, as the expense ratio was reported at 23.3 percent. This ratio measures an insurer's operational efficiency in underwriting its book of business.

The combined ratio, loss ratio plus expense ratio, through year-end 2016 was 102.7 percent and indicates an increase compared to 2015, as the combined ratio was reported at 102.6 percent. This ratio measures an insurer's overall underwriting profitability. A combined ratio of less than 100 percent indicates an underwriting profit.

Regarding risk retention groups collectively, the ratios pertaining to income statement analysis appear to be appropriate. Moreover, these ratios have remained within a profitable range.

Conclusions Based on 2016 Results

Despite political and economic uncertainty, risk retention groups remain financially stable and continue to provide specialized coverage to their insureds. The financial ratios calculated based on the reported results of risk retention groups 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 risk retention groups indicate that these specialty insurers continue to exhibit financial stability. It is important to note again that while risk retention groups have reported net income, they have also continued to maintain adequate loss reserves while increasing premium written year over year. Risk retention groups continue to exhibit a great deal of financial stability.