The latest financial reports and recent legal developments have risk retention groups (RRGs) well positioned for the future. Year-end results for 2012 present continued positive financial performance for RRGs and a recent decision from the US Court of Appeals for the Ninth Circuit should promote a more competitive and well-defined marketplace going forward for RRGs.
The latest financial reports and recent legal developments have risk retention groups (RRGs) well positioned for the future. Year-end results for 2012 present continued positive financial performance for RRGs and a recent decision from the US Court of Appeals for the Ninth Circuit should promote a more competitive and well-defined marketplace going forward for RRGs.
Legal analysis
One of the most significant legal issues facing RRGs is their regulatory treatment by non-domiciliary states. The Liability Risk Retention Act of 1986 (LRRA) exempts RRGs from much state regulation and prohibits states from discriminating against RRGs. Still, some states have ignored these provisions and imposed overreaching regulations on RRGs.
The Ninth Circuit recently issued an important decision for RRGs, upholding the protections afforded to them by the LRRA. The court found that a state cannot deny an RRG’s right to provide insurance in the state.
In Alliance of Nonprofits for Insurance, Risk Retention Group v Kipper, the court determined that an order from the Nevada’s insurance commissioner preventing an RRG chartered in Vermont from providing first dollar auto liability coverage for its members in Nevada was a discriminatory act in violation of the LRRA. Nevada argued that its state law requires minimum auto liability insurance to be provided by an insurer with a certificate of authority from the state. Nevada also argued that because the foreign RRG lacked a certificate of authority, it was unauthorised to provide such coverage.
Applying the plain language of the LRRA and an earlier Ninth Circuit decision, the court upheld a district court ruling that the LRRA preempts Nevada law and held that a state action discriminates against an RRG if it “differentiates between insurance providers without an acceptable justification”. In this case, Nevada’s commissioner offered no acceptable justification for denying the RRG’s right to conduct business in the state.
The court also dismissed the commissioner’s suggestion that the RRG could have complied with Nevada law by entering into a fronting arrangement with an authorised insurer. The court stated that “one of the main purposes of the LRRA’s enactment was the elimination of state-law hurdles to interstate operation”.
The decision is not surprising, given the plain language of the LRRA and the court’s previous ruling on the issue. Nevertheless, the holding is important for RRGs, affirming that the LRRA preempts state law and that states cannot deny an RRG’s right to do business in the state. The LRRA provides important protections for RRGs where non-domiciliary states overreach with discriminatory regulations. RRGs should be encouraged by the Ninth Circuit’s application of the law.
Balance sheet analysis
RRGs collectively reported financially stable results as measured both by liquidity and leverage.
Liquidity, as measured by liabilities to cash and invested assets, at year-end 2012 was approximately 65.3 percent. A value less than 100 percent is considered favourable. This indicates an improvement for RRGs collectively, as liquidity was reported at 69.4 percent at year-end 2011. Moreover, this ratio has improved steadily each of the last five years.
Leverage, 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 138.3 percent at year-end 2011.
Over the five-year period from 2008 through 2012, RRGs as a whole have increased policyholders’ surplus by 69 percent. This increase represents the addition of more than $1.4 billion to policyholders’ surplus. During this same time period, liabilities have increased only 11.7 percent, a little more than $440 million.
Income statement analysis
RRGs reported an aggregate underwriting gain for 2012 of nearly $188 million, an increase of 19.4 over the prior year. Further exhibiting these favourable underwriting results is the combined ratio reported by RRGs collectively. The combined ratio, loss plus expense, for year-end 2012 was 83.5 percent. This indicates an improvement, as the combined ratio was reported at 88.5 percent at year-end 2011.
RRGs collectively reported net income of over $322 million, an increase of 5.7 percent over the prior year. For a historical perspective, RRGs have reported an underwriting gain since 2004 and positive net income at year-end since 1996.
The financial ratios calculated based on year-end results of RRGs appear to be reasonable and positive. It is important to note that while RRGs have reported net underwriting gains and net profits, they have also continued to maintain adequate levels of policyholders’ surplus while increasing DPW period over period. These reported results indicate that RRGs collectively are adequately capitalised and able to remain solvent if faced with adverse economic conditions or increased losses.
