Michael Meehan
Milliman

The soft commercial market has slowed growth in risk retention groups, but they remain poised to operate more efficiently and take advantage of a hardening—if and when it happens. Michael Meehan of Milliman explains

How did RRGs perform in 2016?

From what I have been seeing, risk retention groups (RRGs) experienced modest premium growth of approximately 2 percent during 2016. This was certainly lower than the near 7 percent growth in 2015 and more than 10 percent growth in 2014. The growth the industry experienced in the middle part of this decade has clearly slowed. I think this is largely influenced by the soft commercial market, particularly as it relates to the liability coverages that would often be good candidates to be insured through RRGs.

The rate increases in these lines of business have been modest at best over the past several years, which may be part of the reason that few new RRGs have formed over that time period. However, I would say the industry remains strong as the number of RRGs in operation has remained pretty stable. To me, this suggests that RRGs that have already formed are not being influenced by changes in the commercial market and may view the RRG as their long term risk financing solution as opposed to a stop gap or bridge solution during a harder commercial market.

Has this picture changed in 2017?

It is still relatively early in the year, which makes it challenging to draw any sort of definitive conclusions with regards to performance in current year. However based on the limited Q1 information that I have seen, the results are very similar to what the RRG industry experienced during 2016, with loss and loss expense ratios of approximately 80 percent.

Do RRGs remain adequately capitalised?

RRGs, while considered a type of captive insurance company, are really sort of a hybrid between a captive and a more traditional mutual insurance company. As such, they are required to complete an annual statutory filing, often referred to as ‘the yellow book’, which provides the regulator with a substantial amount of financial information about the RRG. For example, as part of the required statutory filing, RRGs are required to calculate their risk-based capital, which is a financial metric developed and used by regulators to evaluate the minimum capital that is needed by a company to support its overall operations and risk.

In addition, RRGs are also required to calculate a series of financial metrics known as Insurance Regulatory Information System (IRIS) Ratios that regulators, as well as actuaries and auditors, will also review when evaluating the financial strength of RRGs. Therefore, in general, I would say that RRGs are typically capitalised pretty well as regulators have the means to identify pretty quickly those that are not. The regulator can then work with the RRG to develop an action plan to get them back to a stronger financial position.

In reviewing some RRG industry information, specifically aggregated premium, loss reserve, and surplus data, I would say that over the past five years or so, there has been a bit of reduction in the overall level of surplus for RRGs relative to their net written premiums, and reserve amounts. While the numbers do vary quite a bit by RRG, the combined numbers are still indicate that the industry as a whole is financially strong.

What can RRGs do in terms of risk management to bring down their costs?

RRGs could consider using predictive analytics to help them control their costs. As an industry, we have become much better with gathering and maintaining claims information.

This, coupled with the increased computing power available to us, presents companies with significant opportunities for potentially reducing their costs. For example, using predictive analytics, companies are mining their claims information to help identify triggers or common traits that can often be indicative of a potentially costly claim. This enables the company to dedicate its best resources to the more complex claims sooner, which can lead to lower claims costs. Advances in technology are providing companies with significant cost saving opportunities and that trend is likely to continue.

What are some of your predictions for the financial performance of RRGs for the rest of 2017?

I hesitate to make too many predictions because there are a number of factors that could have a significant impact on the industry. For example, a precedent setting legal decision could have a material impact on the cost of claims and thus, on the financial performance of RRGs. However, as I stated earlier, rate level changes in the commercial market have been modest over the past few years.

Through the first few months of 2017, we have been seeing these rate level changes starting to rise, albeit slightly, in the liability lines. If this trend continues, and the commercial market begins to harden, the potential is there for there to be some modest growth in the risk retention market, either through existing groups adding new members, or possibly through the creation of new RRGs.

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