The Risk Retention Reporter: The Road to a Future Rating Begins

Christopher J. Ridge, JD, MRM, President
Charleston Captive Management Company

RRR: Why would RRG insureds want to secure a Best's rating for the RRG?

Ridge: While an RRG insured is not likely to person-ally care too much about the company's rating, it is the people with whom the insured conducts business that drives the need for the rating. Hospital systems generally require doctors practicing within their facilities to demonstrate proof of liability insurance from an acceptably rated insurer; contractors must show that they are covered by a rated insurer in order to secure certain types of building


Chris Ridge

contracts; automobile dealerships, in the aftermath of the National Warranty RRG fiasco, want to see that a rated insurer is standing behind the warranty products that are being sold to consumers; and so on. The RRG's members may know that their company is financially sound but those members have to do business with people who have no way of knowing how strong the RRG really is.

RRR: What is the economic benefit for an RRG in securing a Best's rating?

Ridge: One of the great advantages of the RRG structure is that it can issue its own paper thus negating the need for a fronting carrier. This, of course, means significant reductions in operating expense for an RRG as compared to a more traditional captive structure. These savings are lost, however, when the RRG members have to show a certificate of insurance from a rated carrier. Despite the ability of the RRG to issue its own certificate of insurance, if a rating is required the company must find and pay for a front solely for the purpose of gaining access to a rating. By securing a rating, the RRG is able to recapture those lost savings.

RRR: If insureds require rated paper, should they still consider forming an RRG?

Ridge: The need for a front can, in fact, have a bearing on the actual corporate structure of the new company. Often, the ability to issue admitted paper is a critical factor in choosing to form as an RRG in the first place. If the company is going to have to be fronted anyway, the founders may consider forming as an association captive rather than as an RRG due to the added complexities and costs associated with operating as an RRG. However, with proper planning, the company can reap the benefits of the RRG structure while minimizing the amount of time that it must operate behind a front.

RRR: When should an RRG begin to contemplate going through the rating process?

Ridge: The need for a rating should be considered in the initial business plan of the RRG. At best, it will take two years to complete the rating process. During that time, the RRG may have to endure the cost of a fronting carrier but it can go ahead and begin positioning itself to achieve an excellent rating as soon as possible.

RRR: Who makes the first contact with the rating agency?

Ridge: The RRG's managers and administrators should contact a rating agency and determine specifically what criteria will be used to rate the group. The company can then be managed with an eye toward critical financial ratios and practices. Understanding the process and the financial indicators that will be used is vitally important in helping management decide how to manage company assets and when to apply for a rating. The only thing worse than not having a rating at all is having a bad rating. Through greater under standing of rating methodology, management can have a good idea of their RRG's potential rating before the application is ever submitted.

RRR: What is the methodology of rating an RRG? What is involved?

Ridge: Rating agencies consider a multitude of factors. Among them are the RRG's business plan and financial projections; lines of business to be insured; corporate structure and history; annual financial statements; actuarial reports; management structure and key personnel; biographical information of principal officers; and capital management strategies. Additionally, the rating agency may consider "anything else that they deem to be relevant". Likewise, management of the RRG can offer additional information that they believe would be pertinent to the rating process. Some of these factors can be analyzed prior to the RRG having very much operating history. Other factors can only be determined after the company has been in business for a while.

RRR: The rating process sounds arduous. Is it worth it?

Ridge: Several issues must be considered in order to answer that question. Actual cost, of course, is the first. Depending upon the size and complexity of the RRG, the cost of securing an initial rating will likely range from $20,000 to $50,000. Maintaining a rating also means annual follow up examinations by the rating agency at a cost of approximately $10,000 to $25,000 each year. When deciding whether the need for a rating justifies the expense, it is important to analyze the market in which the RRG is operating and to determine if the need is long-term or short-term. Will the members always need rated paper? Is the fronting market likely to soften thereby reducing fronting costs? Acquiring a rating can be expensive, indeed, if it is only going to be needed for a relatively short period of time. The front-end expenditures of time and money are substantial.

RRR: Is there a downside in obtaining an RRG rating?

Ridge: Once rated, the RRG will be forever defined by that rating. Can the RRG maintain a solid rating over the long haul? Securing an initial positive rating is great, but if that rating slips over time, the marketplace will be aware of the downturn and the RRG's ability to provide acceptable coverage for its members may be jeopardized. Ultimately, an RRG's management must weigh the expense of securing a rating against the benefits that it will provide. The lack of affordable (or available) fronting arrangements has been a major impetus for RRG formation. Additionally, as more RRG's are rated, those without ratings can be placed at a competitive disadvantage. In the end, some RRG's will benefit from a rating while others will not. Management, however, should be ever mindful of the impact of its actions on a future rating. Even if a rating is not warranted today, tomorrow it could be.

About the author: Chris Ridge serves as President of Charleston Captive Management Company in Charleston, South Carolina. He and his team of insurance professionals design, secure licensing for, and manage alternative risk transfer programs in multiple U.S. and foreign domiciles. Mr. Ridge is a licensed attorney and holds a masters degree in risk management and insurance.

Reprinted from the September 2004 Risk Retention Reporter -Volume 18, Number 9