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rrGs report Financially stable results at year-end 2012 by Douglas A Powell, Senior Financial Analyst, Demotech. Inc. This article originally appeared in “Analysis of Risk Retention Groups – Year-End 2012”

I

n reviewing the reported financial results of risk retention groups (rrgs), one gets the impression that this is a group of insurers

with a great deal of financial stability. Based on year-end 2012 reported financial information, RRGs continue to collectively provide specialized coverage to their insureds. Over the past five years, RRGs have remained

Since rrgs are restricted to liability coverage, they tend to insure medical providers, product manufacturers, law enforcement officials and contractors, as well as other professional industries. While rrgs reported direct premium written in eleven lines of business in 2012, more than 50 percent of this premium was contained in the medical professional liability lines.

committed to maintaining adequate capital to handle losses. It is important

Balance sheet analysis

to note that ownership of an rrg is

Comparing the last five years of results, cash and invested assets, total admitted assets and policyholders’ surplus have all continued to increase at a faster rate than total liabilities (figure 1). The level of policyholders’ surplus

restricted to the policyholders of the rrg. This unique ownership structure required of rrgs may be a driving force in the strengthened capital position exhibited by rrgs.

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becomes increasingly important in times of difficult economic conditions, as properly capitalized insurers can remain solvent while facing uncertain economic conditions. Since 2008, cash and invested assets increased 40.5 percent and total admitted assets increased 33.9 percent. More importantly, over a five year period from 2008 through 2012, rrgs collectively increased policyholders’ surplus 71.5 percent. This increase represents the addition of more than $1.4 billion to policyholders’ surplus. During this same time period, liabilities increased only 13.7 percent, slightly more than $500 million. These reported results indicate that rrgs

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collectively are adequately capitalized 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 2012 was approximately 65.4 percent. A value less than 100 percent is considered favorable as it indicates that there was more than $1 of net liquid assets for each $1 of total liabilities. This also indicates an improvement for rrgs collectively as liquidity was reported at 69.5 percent at year-end 2011. Moreover, 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 2012 was 236.9 percent and indicates an improvement over 2011, as this ratio was 214 percent. These results indicate that rrgs remain conservative in terms of liquidity. In evaluating individual rrgs, Demotech, Inc. prefers companies to report leverage of less than 300 percent. leverage for all rrgs, as measured by total liabilities to policyholders’ surplus, for year-end 2012 was 123.3 percent. This indicates an improvement for rrgs collectively as leverage was reported at 138.4 percent at year-end 2011. The loss and lAe reserves to policyholders’ surplus ratio for year-end 2012 was 79.7 percent and indicates an improvement over 2011, as this ratio was 93 percent. The higher the ratio of loss reserves to surplus, the more an

insurer’s stability is dependent on having and maintaining reserve adequacy. In regards to rrgs collectively, the ratios pertaining to the balance sheet appear to be appropriate.

Sheet Metrics (In Billions) Figure 11Ð –RRG RRGBalance Balance Sheet Metrics (In Billions)

Premium Written analysis rrgs collectively reported $2.6 of billion direct premium written (DPW) at year-end 2012, an increase of nearly 5 percent over 2011. rrgs reported $1.3 billion of net premium written (NPW) at year-end 2012, an increase of 3.7 percent over 2011. These increases are favorable and reasonable. The DPW to policyholders’ surplus ratio for rrgs collectively for year-end 2012 was 74.3 percent and indicates an improvement over 2011, as this ratio was 78.1 percent. The NPW to policyholders’ surplus ratio for rrgs for year-end 2012 Figure 2 Ð RRG Income (In Millions) was 36.6 percent and indicates an improvement over 2011, as this ratio was 38.9 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.

Income statement analysis The profitability of RRG operations remains positive (figure 2). RRGs reported an aggregate underwriting gain for 2012 of nearly $181 million, an increase of 19.7

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Figure 2 – RRG Income (In Millions)

percent over the prior year, and a net investment gain of nearly $221 million, an increase of 6.7 percent over the prior year. rrgs collectively reported net income of over $324 million, an increase of 8.6 percent over the prior year. looking further back, rrgs have collectively reported an 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 2012 was approximately 55.7 percent and indicates an improvement over 2011, as the loss ratio was 59.6 percent.This ratio is a measure an insurer’s underlying profi tability on its book of business.

Figure 3 Ð RRG Ratios - Total

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The expense ratio, as measured by other underwriting expenses incurred to net premiums written, for yearend 2012 was 28.8 percent and was comparable to 2011, as the expense ratio was reported at 28 percent. This ratio measurers an insurer’s operational effi ciency in underwriting its book of business. The combined ratio, loss ratio plus expense ratio, for year-end 2012 was 84.5 percent and indicates an improvement over 2011, as the combined ratio was reported at 87.6 percent. This ratio measures an insurer’s overall underwriting profi tability. A combined ratio of less than 100 percent indicates an underwriting profi t. regarding rrgs collectively, the ratios pertaining to income statement analysis appear to be appropriate. Moreover, these ratios have remained fairly stable each of the last fi ve years and well within a profi table range (fi gure 3).

Loss and Loss adjustment expense reserve analysis A key indicator of management’s commitment to fi nancial stability,

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3 –Ratios RRG -Ratios Total – Total FigureFigure 3 Ð RRG

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.

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rrgs collectively have reported adequate loss reserves at year-end 2012 as exhibited by the one-year and two-year loss development results. The loss 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 development to prior year’s policyholders’ surplus for 2012 was -7.2 percent and indicates an improvement over 2011, as this ratio was reported at -6 percent. The two-year loss development to second prior year-end policyholders’ surplus for 2012 was -12.2 percent and indicates a diminishment over 2011, as this ratio was reported at -14.1 percent. In regards to rrgs collectively, the ratios pertaining to loss reserve analysis appear to be favorable.

Figure 5 Ð Direct Premium Written by Lines of Business (000Õ s omitted) © Self-Insurers’ Publishing Corp. All rights reserved.

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analysis by Primary Lines of Business 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 a reasonable 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.

Figure Ð Direct Premium Lines (000’s of Business Figure 5 –5Direct Premium WrittenWritten by Lines ofby Business omitted) (000Õ

s omitted)

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.

Conclusions Based on 2012 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 for 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. n 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.

Figure 6 Ð Direct Premium Written by State (000Õ s omitted)

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© Self-Insurers’ Publishing Corp. All rights reserved.

RRGs Report Financially Stable Results at Year-End 2012  

This article originally appeared in the June 2013 issue of The Self Insurer (page 28).

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