Risk Retention Groups: Financial Stability is Focus of Demotech Analysis
May 7, 2012
Douglas A Powell, Senior Financial Analyst
GAO and NRRA at Odds
Despite current economic uncertainties and the dialogue between the General Accountability Office (GAO) and the National Risk Retention Association (NRRA), Risk Retention Groups (RRGs) in total improved reported results in a number of key areas for the year ending December 31, 2011. The GAO issued its report pertaining to the overall health of RRGs and commented on the extent to which non-domiciliary states were exceeding their authority under current law.
The NRRA issued a statement in response to the latter in February 2012. “We’re pleased that the GAO has recommended Congressional action but disappointed that the agency’s report failed to take a strong position in support of RRGs where certain states have imposed requirements that clearly are in direct conflict with the federal law,” said Sanford Elsass, NRRA Chairman.
In a statement appearing in a report published by Demotech, Inc., Robert Myers, General Counsel of NRRA, added, “Although the GAO accurately presented the financial and regulatory health of the RRG industry, its report and analysis of non-domiciliary state regulatory authority fell short. The GAO report’s conclusions on the scope of non-domiciliary state regulatory authority belie the plain language of the Liability Risk Retention Act (LRRA) and federal courts’ unambiguous interpretation of the LRRA, especially in reference to non-domiciliary registration requirements and fees.”
Although they may disagree on regulatory issues, an issue in which they are not at odds
is the financial health and stability of the RRG industry. In its December 2011 report, the GAO concluded that the RRG industry was healthy from a regulatory and financial perspective.
Balance Sheet Metrics
In reviewing the financial stability of risk retention groups for 2011, one should get the impression that these are a group of insurers with a great deal of financial stability. Assets and policyholders surplus have increased for the 12th consecutive year. During this time, policyholders’ surplus has increased more than 367 percent, from approximately $686 million in 2000 to more than $3.2 billion in 2011.
The level of policyholders’ surplus becomes increasingly important in times of difficult economic conditions. The logic being that an insurer can remain solvent while facing uncertain economic conditions and also withstand greater losses.
Liquidity, as measured by liabilities to cash and invested assets, for 2011 was approximately 69 percent. A value less than 100 percent is considered favorable as it indicates that there was more than $1 of cash and invested assets for each $1 of total liabilities. This also indicates an improvement for RRGs collectively over 2010 as liquidity was reported at over 72 percent.
Demotech prefers companies report leverage of less than 300 percent. Leverage, as measured by total liabilities to policyholders’ surplus, for 2011 was approximately 136 percent. This also is an improvement for RRGs collectively, as in 2010 leverage was reported at more than 146 percent.
In comparison to the $7.7 billion in total net admitted assets for 2011, policyholders’ surplus accounted for approximately 43 percent of that reported amount. Losses and loss adjustment expenses accounted for approximately 39 percent of total net admitted assets.
Underwriting Results and Overall Profitability
RRGs have reported net income since 1996, with profitable underwriting results since 2004 despite the continued difficult economic conditions and direct written premiums decreasing from 2010 to 2011. Thomas Mason, SNL, reported in his February 21, 2012 article, Risk retention group space writing less, spawning fewer companies, that “in aggregate, RRGs recorded a 2.4 percent decline year over year for the 12 months ended September 30, 2011.” By the end of 2011, the decrease in year-over-year direct premiums written was approximately 1.9 percent.
In looking further, it appears that as revenue for RRGs has become stagnant, so have expenses and losses. The GAO reported in December 2011 that the combined ratio, which is calculated by adding the loss ratio and the expense ratio, for RRGs has fluctuated very little during the years 2004 through 2010. The GAO reported that in their analysis of NAIC data, the average combined ratio for RRGs ranged from 92.6 percent in 2005 to 88 percent in 2008. Keep in mind that a combined ratio of less than 100 percent indicates an underwriting profit or gain. A combined ratio of more than 100 percent indicates an underwriting loss.
2012 Outlook of RRG Growth
Karrie Hyatt, Managing Editor of the Risk Retention Reporter, recently stated, “The prevailing mood among RRG professionals is one of optimism. Coupling this positive industry sentiment with the more tangible evidence of several RRGs in the pipelines leads to the belief that the RRG marketplace will be growing steadily by year’s end.”
Hyatt bases her comment on the fact that, as of April 19, 2012, five new RRGs have been licensed with two more close to finishing the process. The market for RRG formation leveled off in 2011, reversing the trend of declining RRGs in the market seen over the last several years. She went on to state, “In terms of numbers of [RRGs], there will likely be moderate growth in the upcoming year.”
Joseph Petrelli, President of Demotech, adds, “Even in light of the current environment, opportunities remain for RRGs to bring expertise and focused capacity to the Property and Casualty industry.” In fact, in reviewing the data and in performing analysis, it should be easy to conclude that, in total, these unique insurers will remain financially stable and continue to provide specialized coverage to their insureds.