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[ RRG UPDATE ]

By Douglas A . Powell, Senior Financial Analyst, Demotech, Inc.

RRGs Report Financially Stable Results at Year-End 2013

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review of the reported financial results of risk retention groups (RRGs) reveals insurers with a great deal of financial stability. Based on year-end 2013 reported financial information, RRGs continue to collectively provide specialized coverage to their insureds. RRGs remain committed to maintaining adequate capital to handle losses. It is important to note that ownership of RRGs is restricted to the policyholders of the RRG. This unique ownership structure required of RRGs may

total liabilities. This also indicates an improvement for RRGs collectively as liquidity was reported at 65.5 percent at year-end 2012. This ratio has improved steadily each of the last five years. Loss and loss adjustment expense (LAE) reserves represent the total reserves for unpaid losses and unpaid LAE. This includes reserves for any incurred but not reported losses as well as supplemental reserves established by the company. The cash and invested assets to loss and LAE reserves ratio measures liquidity in terms of the carried reserves. The cash and invested assets to loss and LAE reserves ratio for year-end 2013 was 249 percent and indicates an Comparing the last five years of results, improvement over 2012, as this ratio was 239.3 cash and invested assets, total admitted percent. These results indicate that RRGs remain assets and policyholders’ surplus have conservative in terms of liquidity. In evaluating individual RRGs, Demotech, Inc. continued to increase at a faster rate prefers companies to report leverage of less than than total liabilities 300 percent. Leverage for all RRGs combined, as measured by total liabilities to policyholders’ surplus, for year-end 2013 was 123.2 percent. This is similar to leverage of 123.7 percent reported at Douglas A. Powell year-end 2012. The loss and LAE reserves to policyholders’ surplus ratio for year-end 2013 was 76.7 percent and indicates an be a driving force in their strengthened capital position. Since RRGs are restricted to liability coverage, they tend to improvement over 2012, as this ratio was 78.9 percent. The higher insure medical providers, product manufacturers, law enforcement the ratio of loss reserves to surplus, the more an insurer’s stability officials and contractors, as well as other professional industries. is dependent on having and maintaining reserve adequacy. RRGs reported direct premium written in eleven lines of business Regarding RRGs collectively, the ratios pertaining to the balin 2013, but nearly 46 percent of this premium was contained in ance sheet appear to be appropriate. the medical professional liability lines.

Premium Written Analysis Balance Sheet Analysis Comparing the last five years of results, cash and invested assets, total admitted assets and policyholders’ surplus have continued to increase at a faster rate than total liabilities (figure 1). The level of policyholders’ surplus becomes increasingly important in times of difficult economic conditions, to allow an insurer to remain solvent when facing uncertain economic conditions. Since 2009, cash and invested assets increased 29.7 percent and total admitted assets increased 22.8 percent. More importantly, over a five year period from 2009 through 2013, RRGs collectively increased policyholders’ surplus 38.4 percent. This increase represents the addition of more than $1 billion to policyholders’ surplus. During this same time period, liabilities increased only 12.5 percent, slightly more than $493.5 million. These reported results indicate that RRGs are 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 2013 was approximately 64.6 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 a dollar of 26 April 28, 2014 / INSURANCE ADVOCATE

RRGs collectively reported $2.6 of billion direct premium written (DPW) at year-end 2013, an increase of 1.7 percent over 2012. RRGs reported $1.3 billion of net premium written (NPW) at year-end 2013, an increase of 6.4 percent over 2012. These increases are favorable and appear reasonable.

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The DPW to policyholders’ surplus ratio for RRGs collectively for year-end 2013 was 72.3 percent and indicates an improvement over 2012, as this ratio was 74.8 percent. The NPW to policyholders’ surplus ratio for RRGs for year-end 2013 was 36.8 percent and is relatively similar to 2012, as this ratio was 36.3 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 RRG to greater scrutiny during the financial review process. Likewise, a NPW to surplus ratio greater than 300 percent would subject an individual RRG to greater scrutiny. 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. In regards to RRGs collectively, the ratios pertaining to premium written appear to be conservative.

The year-end results of RRGs indicate that these specialty insurers continue to exhibit financial stability.

Loss and Loss Adjustment Expense 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 loss adjustment expense 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. RRGs collectively reported adequate loss reserves at year-end 2013 as exhibited by the one-year and two-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 one-year loss reserve development to prior year’s policyholders’ surplus for 2013 was -3.4 percent and is not as favorable as 2012, when this ratio was reported at -7.5 percent. The twoyear loss reserve development to second prior year-end policyholders’ surplus for 2013 was -11.3 percent is slight less favorable than 2012, when this ratio was reported at -13.1 percent. In regards to RRGs collectively, the ratios pertaining to loss reserve development are favorable. 28 April 28, 2014 / INSURANCE ADVOCATE

Income Statement Analysis

The profitability of RRG operations remains positive (figure 2). RRGs reported an aggregate underwriting gain for 2013 of $97.3 million, a decrease of 47.1 percent over the prior year, and a net investment gain of nearly $216.4 million, a decrease of less than one percent over the prior year. RRGs collectively reported net income of over $252.8 million, a decrease of 22 percent over the prior year. Looking further back, RRGs have collectively reported an annual underwriting gain since 2004 and positive net income at each year-end since 1996. The loss ratio for RRGs collectively, as measured by losses and loss adjustment expenses incurred to net premiums earned, for year-end 2013 was approximately 63.5 percent, an increase over 2012, as the loss ratio was 54.7 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, for year-end 2013 was 27.8 percent and indicates an improvement over 2012, as the expense ratio was reported at 29.1 percent. This ratio measurers an insurer’s operational efficiency in underwriting its book of business. The combined ratio, loss ratio plus expense ratio, for year-end 2013 was 91.3 percent and indicates a diminishment over 2012, as the combined ratio was reported at 83.8 percent. This ratio measures an insurer’s overall underwriting profitability. A combined


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ratio of less than 100 percent indicates an underwriting profit. Regarding RRGs collectively, the ratios pertaining to income statement analysis appear to be appropriate. Moreover, these ratios have remained fairly stable for each of the last five years and well within a profitable range (figure 3).

Analysis by Primary Lines of Business

…these ratios have remained fairly stable for each of the last five years and well within a profitable range.

The financial ratios calculated based on the year-end results of the various primary lines of business appear to be reasonable (figure 4). Also, the RRGs have continued to report changes in DPW within an acceptable threshold (figure 5). It is typical for insurers’ financial ratios to fluctuate year over year. Moreover, none of the reported results are indicative of a continuing negative trend.

by jurisdictions for year-end 2013 is available in figure 7 - see page 33.)

Conclusions Based on 2013 Results

Despite political and economic uncertainty, RRGs remain financially stable and continue to provide specialized coverage to their insureds. The financial ratios calculated based on year-end results of RRGs appear to be reasonable, keeping in mind that it is typical and expected that insurers’ financial ratios to fluctuate over time. The year-end results of RRGs indicate that these specialty insurers continue to exhibit financial stability. It is important to note again that while RRGs have reported net underwriting gains and net profits, they have also continued to maintain adequate loss reserves while increasing premium written year over year. RRGs continue to exhibit a great deal of financial stability. [IA]

Jurisdictional Analysis Much like insurers, it is typical for jurisdictions to compete for new business. Some of the factors that may impact an insurer’s decision to do business in a certain jurisdiction include minimum policyholders’ surplus requirements and the premium tax rate. RRGs have continued to report changes in DPW, on a jurisdictional basis, within a reasonable threshold (figure 6 - see page 32). (Note: a more extensive breakout of DPW by line of business

Mr. Powell has nearly ten years of progressively responsible experience involving financial analysis and business consulting. Email your questions or comments to Mr. Powell at dpowell@demotech.com. For more information about Demotech, Inc. visit www.demotech.com.

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[ ON THE LEVEL ] continued from page 10

at PIA or any other trade association in our business who doesn’t say they get more out of their work than they put into it. But, the truth of the matter is: Without the volunteers, no organization can survive. As I write this article after being in Albany, it’s refreshing to know we have so many dedicated volunteers and like every organization, we could use creative, new thinkers to keep us going. To all the fellow agents who have said they are glad we are working on their behalf, I ask you: “What are you doing?” Regardless of what association you participate in, the important thing is that you participate. [IA]

N. Stephen Ruchman, CPIA, is a retired partner of B&B Coverage LLC. A past president of the Professional Insurance Agents of New York State Inc., he is an active supporter of PIANY, and has sat on, or chaired, nearly every committee including the Executive Committee and the Long Island Advisory Council and PIANY’s Political Action Committee. A graduate of Michigan State University, with a major in insurance, Ruchman is past president of the Peninsula Counseling Center and a member and past president of the Rockville Centre Chamber of Commerce board of directors. He is division chair for the Insurance Division of the United Jewish Appeal and has served on the business advisory board

of The First National Bank of Long Island. He can be reached via email at nsruchman@gmail.com.

Serving New York, New Jersey, Pennsylvania and Connecticut Since 1889 www.insurance-advocate.com INSURANCE ADVOCATE / April 28, 2014 31


RRGs Report Financially Stable Results at Year-End 2013