Demotech Report Finds RRGs Remained Financially Stable in Third Quarter

A review of third-quarter results for risk retention groups (RRGs) shows the insurers continue to provide specialized coverage to their insureds while remaining financially stable, despite political and economic uncertainty, according to a new report from Demotech, Inc.

The report, written by Douglas A Powell, senior financial analyst at Demotech, says that based on financial information reported by RRGs, the vehicles "have a great deal of financial stability and remain committed to maintaining adequate capital to handle losses."

The report, Analysis of Risk Retention Groups—Third Quarter 2020: Risk Retention Groups Report Financially Stable Third Quarter 2020 Results, December 8, 2020, notes that it's important to recognize that RRG ownership is restricted to its policyholders and that their unique ownership structure may be a significant factor in RRGs' strong capital position.

Demotech's analysis found that from the third quarter of 2019 to the third quarter of 2020, RRGs' cash and invested assets increased 4.8 percent while total admitted assets increased 5.4 percent. Meanwhile, RRGs reported a collective 3.2 percent increase in policyholders' surplus, representing a $167.8 million year-over-year increase.

"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 writes.

RRGs' liquidity—measured in terms of cash and invested assets to liabilities—for the third quarter of this year was 147.3 percent, according to the Demotech report. A value greater 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, the report says.

"In evaluating individual RRGs, Demotech, Inc. prefers companies to report leverage of less than 300 percent," the report says. "Leverage for all RRGs combined, as measured by total liabilities to policyholders' surplus, for third quarter 2020 was 144.8 percent."

The ratio of risk retention groups' loss and loss adjustment expense reserves to policyholders' surplus for the third quarter of 2020 was 94.7 percent, the report says, noting that the higher the ratio of loss reserves to surplus, the more an insurer's stability is dependent on having and maintaining reserve adequacy.

"Regarding RRGs collectively, the ratios pertaining to the balance sheet appear to be appropriate and conservative," the report says. "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 assessing the premium written by RRGs, the report notes that since risk retention groups are restricted 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.

RRGs reported writing more than $3.1 billion of direct written premium through the third quarter of 2020, an increase of 5.7 percent over the amount through last year's third quarter, the Demotech report says. Risk retention groups reported approximately $1.8 billion in net premium written through this year's third quarter, an increase of 1.7 percent compared to the third quarter of 2019.

RRGs' collective direct premium written to policyholders' surplus ratio for this year's third quarter was 76.3 percent, the report says, while the net premium written to policyholders' surplus ratio for the period was 42.6 percent. Demotech's report notes that the premium written values for the ratios have been adjusted so they can be compared to year-end ratios.

"An insurer's direct premium written to surplus ratio is indicative of its policyholders' surplus leverage on a direct basis, without consideration for the effect of reinsurance," Mr. Powell writes. "An insurer's net premium written 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 direct premium written to surplus ratio greater than 600 percent would subject an individual RRG to greater scrutiny during financial reviews, according to the Demotech report, as would a net premium written to surplus ratio greater than 300 percent.

"In certain cases, premium to surplus ratios in excess of those listed would be deemed appropriate if the RRG had demonstrated that a contributing factor to the higher ratio is relative improvement in rate adequacy," the report says. "In regards to RRGs collectively, the ratios pertaining to premium written appear to be conservative."

Assessing RRGs' income statements, Demotech found that the collective loss ratio for RRGs—measured by losses and loss adjustment expenses incurred to net premiums earned and providing a measure of an insurer's underlying profitability on its book of business—through the third quarter was 80.1 percent.

RRGs' expense ratio—measured by other underwriting expenses incurred to net premiums earned and reflecting an insurer's operational efficiency in underwriting its book of business—through the third quarter was 25.0 percent.

Risk retention groups' combined ratio—the loss ratio added to the expense ratio—through the third quarter was 105.1 percent, according to Demotech. "This ratio measures an insurer's overall underwriting profitability, the Demotech report says. "A combined ratio of less than 100 percent indicates an underwriting profit and a ratio of more than 100 percent indicates an underwriting loss."

The report notes that in regard to their underwriting results, collectively RRGs were unprofitable through this year's third quarter, reporting a $68.9 million aggregate underwriting loss. RRGs reported a collective net investment gain of $219.0 million, however, and as a result posted a net gain of $137.3 million, the Demotech report says.

"Despite the underwriting losses, the ratios pertaining to the income statement appear to be appropriate for RRGs collectively," the report says.