Title: RiskBased Capital for Insurers: The U' S' System
1Risk-Based Capital for Insurers The U. S. System
2National Association of Insurance Commissioners
(NAIC)
- Association of chief regulators in 50 states,
District of Columbia, American Samoa, Guam,
Puerto Rico and U.S. Virgin Islands - Established in 1875 to enhance coordination
between states - Maintains common database
- Has no authority in and of itself regulatory
powers reside with members
3Historical Development
- RBC Formulas Developed During 1990s
- Life Formula Introduced In 1993
- PC Formula Introduced in 1994
- Health Organizations Formula Introduced in 1998
- Same Time Frame Saw a Variety of Initiatives
Including FAST, Accreditation, Accounting Changes - Significant Input From Industry On Design Of
Formula And Formula Components - American Academy of Actuaries
- Interested Parties
- Regulators
- NAIC Staff
- RBC Is Only One Component In Regulatory Toolbox
4THE NAIC RBC System
- Risk-Based Capital Formulas
- Life Insurer Version
- Property/Casualty Version
- Health Organizations Version
- Fraternal Version
- Risk-Based Capital for Insurers Model Act Serves
As A Guide for State Laws - Risk-Based Capital Law In Each State Makes System
Operational - NAIC Produces Common Formula By Agreement But
Regulatory Powers Reside With States - RBC Is Meant To Streamline Regulatory Process,
Not To Introduce New Regulatory Powers
5Purpose of Regulatory Capital
- To ensure that the insurer does not use excessive
financial leverage - To reasonably guaranty that the insurers
promises are met - To allow timely intervention in case of financial
distress - To conserve the remaining assets in the wake of
financial distress to an insurer - To avoid unreasonable interference with the
financial decisions and management of the insurer
6 Other Capital Standards
- Significant Developments in Tandem with NAIC RBC
- Regulatory Purpose is to Establish Minimum
Standards while Rating Agency Purpose is to
Establish Qualitative Standards - Regulatory Capital Standards Can And Do Differ
Significantly From An Insurers Own Internal
Capital Standards And From Standards Set By
Private Rating Agencies
7Minimum Capital Standards
- Vary From State to State
- Generally Range From 1 Million to 2 Million
- Multi-line Requirements Are Usually Less Than
Aggregate Monoline Requirements - Can Include "Experience" Factor for Longevity
- In Some States, a Variable Minimum Standard Is
Applied With Some Recognition of Risk - Minimum Is Material to Most Companies Because of
Size But Immaterial to Large Companies That Make
Up Bulk of Industry Volume - RBC System Is a Complement to State Minimums
8Regulatory Minimum RBC
- Regulatory minimum RBC standards are set at
minimum levels so as to impose a floor level of
safety on the operations of an insurance company - System allows companies freedom to operate as
long as capital exceeds the regulatory minimum - Minimizes market disruptions by non-managers
while still maintaining minimum safety levels - Regulatory minimum standard makes comparisons
between companies inappropriate - Regulatory minimum is NOT best capital amount
9Problems With Common Standards
- "One Size Fits All" Approach Must Be Applied
Uniformly To All Companies - Reliance On Accounting Values
- Not All Risks Accounted For
- Simplicity Tradeoffs
- Measurement Errors
- Political Considerations
- Each Component is Material to Someone
- Regulatory Approaches Differ
- Concerns About State Sovereignty
10Basic NAIC Formula Computation
- Apply risk factors against annual statement
values (factor approach) or use proprietary data
(internal review approach) - Sum risk amounts and adjust for statistical
independence - Calculate Authorized Control Level Risk-Based
Capital (ACL RBC) amount, which is the amount of
capital necessary to avoid automatic regulatory
intervention - Compare ACL RBC to Total Adjusted Capital (TAC)
11Major Categories of Risk in the Life Formula
C0 Affiliates Risk C1cs -- Asset Risk
Unaffiliated Common Stock C1o Asset Risk
Other Assets C2 Insurance Risk C3a Interest
Rate Risk C3b Health Credit Risk C4a General
Business Risk C4b Administrative Expense Risk
12Life Industry Aggregate RBC By Size
Source NAIC Research Quarterly April 1997, page
37
13The RBC Ratio Determines the Action Level
According To State Statute
- NAIC RBC standard is a minimum standard that is
GRADUATED so that regulators have freedom and
discretion to deal with troubled insurers. - Definition of financial impairment is now
codified - Total Adjusted Capital (Actual Capital) is
divided by Authorized Control Level RBC
(Hypothetical Minimum Capital) to get the RBC
Ratio - No Action (98 of companies) -- TAC/RBC over 200
- Company Action Level -- TAC/RBC is 150 to 200
- Authorized Control Level -- TAC/RBC is 70 to
100 - Mandatory Control Level -- TAC/RBC is less than
70
14Company Action Level
- Insurer submits a comprehensive financial plan
that - Identifies conditions that led to financial
problems - Contains proposals to correct financial problems
- Provides projections future financial conditions
- Lists key assumptions underlying the projections
- Identifies problems areas and quality areas of
insurer's business - Insurer is expected to comply automatically with
these provisions, or drop to the Regulatory
Action Level
15Regulatory Action Level
Insurer is required to file an action plan as
required under the Company Action Level. In
addition, the state insurance commissioner is
required to perform any examinations or analyses
of the insurers business and operations deemed
necessary. The state insurance commissioner
issues appropriate corrective orders to address
the companys financial problems.
16Authorized Control Level
- This is the first point at which the state
insurance commissioner is authorized by law to
take control of the insurer the first point at
which the insurer is technically insolvent. - This authorization is in addition to the remedies
available at the higher action levels. - The insurance company should still be have more
assets than liabilities (capital greater than
zero) - Commissioner is authorized to take control, but
not required to take control - Maximizes Commissioner's discretion.
17Mandatory Control Level
- State insurance regulator is required to take
steps to place the insurer under regulatory
control - Requirement protects all policyholders by
imposing an absolute limit on regulatory
discretion - Insurer may still be solvent, with assets greater
than liabilities, but in many cases insurer is
fully bankrupt - All regulatory remedies under other action levels
apply here as well - Appeals process is included in Model Law to
ensure due process
18Capital-to-Assets and RBC-to-Assets By Size Groups
Life Companies
Life Companies
Source NAIC Research Quarterly April 1995
19(No Transcript)
20Variations in Capital By Size
Smaller insurers have much greater variation in
capital than larger insurers, which is why they
already hold more capital. The degree to which
capital can move is also a function of size. RBC
is meant to establish a floor level of capital,
not an average or optimal.
21(No Transcript)
22Omissions From Regulatory RBC
- Not All Risks Are Accounted For In The Formula
(e.g., Liquidity Risk) - Measures Of Risk Are Continually Refined (e.g.,
Interest Rate Risk) - Some Risk Measures Are Inappropriate For A
Public, REGULATORY MINIMUM Formula Approach
(e.g., Management Quality) - Awareness Of Risks Included AND Excluded Is
Primary Benefit Of On-Going Formula Development
23Conclusions Regarding NAICs Regulatory Minimum
RBC Formula
- It is better than what existed before
- It is part of A comprehensive toolbox
- Most criticism of the NAIC RBC formula is based
on its inability to predict insolvency, but that
is not how it is designed and is not the
underlying purpose - Complexity does not mean accuracy, but does
enhance awareness - Simplicity tradeoffs often produce an equal, if
not better, measurement of risk in a regulatory
formula - Primary benefit has been increased awareness of
risk by all parties as well as greater
information sharing between industry players