Final Report From Demotech: How Did the RRG Industry Fare Financially in 2020?

UPDATE: Nearly 20% Increase in Policyholders’ Surplus for Q1 2021
Since Demotech issued its year-end 2020 report, the company has released its first-quarter 2021 report, which has good news for the RRG industry. That latest published quarterly report states: “From first quarter 2020 to first quarter 2021, cash and invested assets increased 14.1 percent and total admitted assets increased 13.0 percent. RRGs collectively reported a 19.6 percent increase to policyholders’ surplus. This represents a $974.7 million increase to policyholders’ surplus.”

At the end of April 2021, financial analysis firm Demotech, Inc. released its overall 2020 study results on the risk retention group industry. Demotech specializes in evaluating the financial stability of independent, regional, and specialty insurers. The company reviews more than 400 insurers operating in the U.S.

The report, titled “Risk Retention Groups Report Favorable Results in 2020,” summarized the condition of RRGs as follows:

“A review of the year-end 2020 reported financial results of risk retention groups (RRGs) reveals insurers that continue to collectively provide specialized coverage to their insureds while remaining financially stable. Based on reported financial information, RRGs continue to have a great deal of financial stability and 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 be a driving force in their strong capital position.”

To dig deeper into Demotech’s 2020 findings, we spoke with Douglas A. Powell, Senior Financial Analyst at the company. Powell conducted the research for the report and compiled the findings.

Your 2020 analysis was based on statistics from 219 RRGs. How do you gather all that information?

We access the same figures that RRGs have reported to the National Association of Insurance Commissioners, which pretty much ensures the numbers are accurate. Demotech uses a data provider through S&P Global.

Things got really bad during the pandemic for many sectors of the U.S. economy, but from your report that doesn’t seem to be the case for the RRG industry.

You’re right. The RRG results in 2020 were in line with what we had been seeing in previous years. It appears that most RRGs were not heavily impacted by COVID.

How do you explain that?

Through the first quarter of last year, the financial markets were doing horribly. When we were looking at first-quarter results, everybody’s unrealized capital losses were impacting surplus. Then over the final three quarters, investments rebounded and RRGs finished ahead.

So profitable investments are what turned things around for the RRG industry. Is that a risky thing going forward?

It could be somewhat risky, but since RRGs are like insurance companies, they have to be conservative in their investing. There are certain limitations on what they can invest in. Yes, the stock market has dictated their profitability, but from what we’ve seen, volatility in the market has not impacted them a great deal.

How typical is that for the industry historically?

These companies tend to be somewhat cyclical. Over the last few years, the first quarter has been profitable from an operating perspective. That’s because most of the RRGs have not reported a majority of their losses or expenses. As these expenses get reported later in the year, they have been more than their reported operating revenue.

For example, RRGs in the first quarter of 2020 reported an underwriting gain of $6.7 million and an investment loss of $78.6 million. RRGs’ total net loss for the first quarter 2020 was $65.9 million. However, by the end of 2020 they had a $103.9 million underwriting loss and a $416.5 million investment gain for the year. So for year-end 2020, RRGs reported a net income.

How did the underwriting losses compare to the previous year?

In 2019, RRGs reported underwriting losses of $152 million, as opposed to $103.9 million in 2020. In looking a little deeper at the results, the collective underwriting losses have been dictated by only a few RRGs.

Underwriting losses are one piece of evaluating RRGs. As is stated in our report, RRGs have been able to more than offset these underwriting losses, report overall profitable results, and increase surplus. We believe that collectively, RRGs are financially stable.

Finally, did your collective analysis of RRGs’ loss ratios in 2020 in any way affect your final opinions?

No. Allow me to cite our year-end 2020 results:

The loss ratio for RRGs collectively — as measured by losses and loss-adjustment expenses incurred to net premiums earned — at year-end 2020 was 82.1 percent. This ratio is a measure of the underlying profitability of a book of business.

The expense ratio — as measured by other underwriting expenses incurred to net premiums earned — at year-end 2020 was 23.3 percent, the lowest reported level for the last five year-ends. This ratio measures the operational efficiency in underwriting a book of business.

The combined ratio — loss ratio plus expense ratio — at year-end 2020 was 105.4 percent. This ratio measures overall underwriting profitability. A combined ratio of less than 100 percent indicates an underwriting profit, and a ratio of more than 100 percent indicates an underwriting loss.

RRGs have collectively reported a combined ratio of over 100 percent at the last three year-ends. Despite the underwriting losses, the ratios pertaining to the income statement appear to be appropriate for RRGs collectively.

To view the 2020 end-of-year Demotech report (pdf), click here.

To view the Q1 2021 report from Demotech (pdf), click here.