Risk Retention Groups' Second-Quarter Results Show Financial Stability

A review of risk retention groups' (RRGs') second-quarter financial results found that despite current political and economic uncertainty, RRGs remain financially stable while providing specialized coverage to their insureds.

The Analysis of Risk Retention Groups Second Quarter 2022 from Demotech, Inc., concluded that the financial ratios calculated based on RRGs' reported results "appear to be reasonable, keeping in mind that it is typical and expected that insurers' financial ratios tend to fluctuate over time."

The report was written by Douglas A Powell, senior financial analyst at Demotech.

"Based on reported financial information, RRGs have a great deal of financial stability and remain committed to maintaining adequate capital to handle losses," Mr. Powell wrote.

The Demotech report found that quarter over quarter, RRGs' cash and invested assets decreased 3.6 percent in the second quarter compared to the same period in 2021, while total admitted assets decreased 0.6 percent.

Demotech found that 122 RRGs reported unrealized capital losses in the second quarter, which contributed to a decrease in aggregate policyholders' surplus. As a group, RRGs reported a 9.0 percent decrease to policyholders' surplus for the second quarter, a drop of $548.4 million.

"The level of policyholders' surplus becomes increasingly important in times of difficult economic conditions by allowing an insurer to remain solvent when facing uncertainty," the report said.

RRGs' liquidity, measured by cash and invested assets to liabilities, stood at 133.5 percent for the second quarter, Demotech reported. "A value more 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 said.

The report said that as it evaluates individual RRGs, Demotech prefers to see companies reporting leverage of less than 300 percent. Second-quarter leverage for the entire group of RRGs was 169.6 percent, the report said.

"Regarding RRGs collectively, the ratios pertaining to the balance sheet appear to remain conservative," the Demotech report said. "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 terms of their underwriting results, the full group of RRGs was profitable through this year's second quarter, Demotech said, with the group reporting an aggregate underwriting gain of $49.4 million. The group of RRGS reported a net loss of $68.6 million, however, which Demotech said was largely the result of net investment losses.

RRGs' collective loss ratio, measured by losses and loss adjustment expenses incurred to net premiums earned, stood at 77.1 percent for the second quarter, Demotech reported, noting that the ratio reflects the underlying profitability of an insurer's book of business.

The group's second-quarter expense ratio, which measures an insurer's operating efficiency and is calculated on the basis of underwriting expenses incurred to net premiums earned, was 20.5 percent.

RRGs' second-quarter combined ratio, which combines the loss ratio and the expense ratio, was 97.7 percent, Demotech said. The combined ratio reflects an insurer's overall underwriting profitability, Demotech noted, with a combined ratio of less than 100 percent typically indicating an underwriting profit and a ratio of more than 100 percent typically indicating an underwriting loss.

"The ratios pertaining to the income statement appear to be appropriate for RRGs collectively," the Demotech report said.

In analyzing the premiums written by RRGs during the second quarter, Demotech noted that because the vehicles are restricted by law to writing liability coverage, they most often insure medical providers, product manufacturers, law enforcement officials, contractors, and other industries with professional liability exposures.

The group of RRGs wrote $2.9 billion in direct premium through this year's second quarter, according to Demotech. That represented an increase of 12.6 percent over last year's second quarter. Net premium written for this year's second quarter was $1.8 billion, Demotech said, a 13.8 percent increase from the same period last year.

The Demotech report also examined the group of RRGs' direct premium written to policyholders' surplus ratio and net premium written to policyholders' surplus ratio. "An insurer relying heavily on reinsurance will have a large disparity in these two ratios," the Demotech report said.

The direct premium written to surplus ratio reflects the insurer's policyholders' surplus leverage on a direct basis, without considering the impact of reinsurance, Demotech said. That figure stood at 106.3 percent for the second quarter.

Meanwhile, the net premium written to surplus ratio reflects policyholders' surplus leverage on a net basis. For the group of RRGs, that ratio stood at 64.8 percent in the second quarter.

"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 Demotech report said. "Likewise, a net premium written to surplus ratio greater than 300 percent would subject an individual RRG to greater scrutiny."

In some cases, however, premium to surplus ratios exceeding those guidelines could be considered appropriate if the RRG could show that relative improvement in rate adequacy contributed to the higher ratio, Demotech said.

"In regard to RRGs collectively, the ratios pertaining to premium written appear to be conservative," the Demotech report said.

The Demotech report emphasized that ownership of an RRG is limited to its policyholders and that RRGs' unique ownership structure might contribute to their strengthened capital position.