VOLUME 123, NUMBER 9 / May 7, 2012 A CINN Group, Inc. Publication

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20 May 7, 2012 / INSURANCE ADVOCATE

[COVER] By Douglas A . Powell, Senior Financial Analyst , Demotech, Inc.

GAO and NRRA at OddsDespite current economic uncertainties

and the dialogue between the GeneralAccountability Office (GAO) and theNational Risk Retention Association(NRRA), Risk Retention Groups (RRGs) intotal improved reported results in a numberof key areas for the year ending December31, 2011. The GAO issued its report per-taining to the overall health of RRGs andcommented on the extent to which non-domiciliary states were exceeding theirauthority under current law.

The NRRA issued a statement inresponse to the latter in February 2012.“We're pleased that the GAO has recom-mended Congressional action but disap-pointed that the agency's report failed totake a strong position in support of RRGswhere certain states have imposed require-ments that clearly are in direct conflict withthe federal law,” said Sanford Elsass, NRRAChairman.

In a statement appearing in a report pub-lished by Demotech, Inc., Robert Myers,General Counsel of NRRA, added, “Althoughthe GAO accurately presented the financialand regulatory health of the RRG industry,its report and analysis of non-domiciliarystate regulatory authority fell short. The GAOreport’s conclusions on the scope of non-domiciliary state regulatory authority beliethe plain language of the Liability RiskRetention Act (LRRA) and federal courts’unambiguous interpretation of the LRRA,especially in reference to non-domiciliaryregistration requirements and fees.”

Although they may disagree on regula-tory issues, an issue in which they are notat odds is the financial health and stabilityof the RRG industry. In its December 2011report, the GAO concluded that the RRGindustry was healthy from a regulatory andfinancial perspective.

Balance Sheet MetricsIn reviewing the financial stability of

risk retention groups for 2011, one shouldget the impression that these are a group ofinsurers with a great deal of financial sta-bility. Assets and policyholders surplus haveincreased for the 12th consecutive year.During this time, policyholders’ surplus hasincreased more than 367 percent, fromapproximately $686 million in 2000 to morethan $3.2 billion in 2011.

The level of policyholders’ surplusbecomes increasingly important in times ofdifficult economic conditions. The logicbeing that an insurer can remain solventwhile facing uncertain economic conditionsand also withstand greater losses.

Liquidity, as measured by liabilities tocash and invested assets, for 2011 wasapproximately 69 percent. A value less than100 percent is considered favorable as itindicates that there was more than $1 ofcash and invested assets for each $1 of totalliabilities. This also indicates an improve-ment for RRGs collectively over 2010 as liq-uidity was reported at over 72 percent.

Demotech prefers companies reportleverage of less than 300 percent. Leverage,as measured by total liabilities to policy-holders’ surplus, for 2011 was approximately136 percent. This also is an improvementfor RRGs collectively, as in 2010 leveragewas reported at more than 146 percent.

In comparison to the $7.7 billion intotal net admitted assets for 2011, policy-holders’ surplus accounted for approximate-ly 43 percent of that reported amount.Losses and loss adjustment expensesaccounted for approximately 39 percent oftotal net admitted assets.

Underwriting Results andOverall Profitability

RRGs have reported net income since1996, with profitable underwriting resultssince 2004 despite the continued difficulteconomic conditions and direct written pre-miums decreasing from 2010 to 2011.Thomas Mason, SNL, reported in hisFebruary 21, 2012 article, Risk retentiongroup space writing less, spawning fewercompanies, that “in aggregate, RRGs record-ed a 2.4 percent decline year over year forthe 12 months ended September 30, 2011.”By the end of 2011, the decrease in year-over-year direct premiums written wasapproximately 1.9 percent.

In looking further, it appears that as rev-enue for RRGs has become stagnant, sohave expenses and losses. The GAO report-ed in December 2011 that the combinedratio, which is calculated by adding the lossratio and the expense ratio, for RRGs hasfluctuated very little during the years 2004through 2010. The GAO reported that intheir analysis of NAIC data, the averagecombined ratio for RRGs ranged from 92.6

percent in 2005 to 88 percent in 2008. Keepin mind that a combined ratio of less than100 percent indicates an underwriting profitor gain. A combined ratio of more than 100percent indicates an underwriting loss.

2012 Outlook of RRG GrowthKarrie Hyatt, Managing Editor of the

Risk Retention Reporter, recently stated,“The prevailing mood among RRG profes-sionals is one of optimism. Coupling thispositive industry sentiment with the moretangible evidence of several RRGs in thepipelines leads to the belief that the RRGmarketplace will be growing steadily byyear’s end.”

Hyatt bases her comment on the factthat, as of April 19, 2012, five new RRGshave been licensed with two more close tofinishing the process. The market for RRGformation leveled off in 2011, reversing thetrend of declining RRGs in the market seenover the last several years. She went on tostate, “In terms of numbers of [RRGs],there will likely be moderate growth in theupcoming year.”

Joseph Petrelli, President of Demotech,adds, “Even in light of the current environ-ment, opportunities remain for RRGs tobring expertise and focused capacity to theProperty and Casualty industry.” In fact, inreviewing the data and in performing analy-sis, it should be easy to conclude that, intotal, these unique insurers will remainfinancially stable and continue to providespecialized coverage to their insureds.[IA]

*See Retention Chart on the next page.Powell is a senior financial analyst with

Demotech, Inc. and possesses extensive expe-rience in monitoring, reviewing and assessingthe financial stability of insurers. He also actsas a liaison on behalf of Demotech and itsclients in correspondence with various gov-ernment agencies, insurance industry associ-ations, insureds and the media. Email ques-tions and comments to dpowell@demotech.com, follow him on Twitter –@powdoug.

Demotech has served P/C insurancecompanies, Title underwriters and specialtyinsurance markets, including RRGs, since1985 and has been assigning FinancialStability Ratings® (FSRs) to these marketssince 1989. Visit www.demotech.com formore information.

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