D.1 Risk Based Capital

Question 1

Goal of RBC and the RBC Model Act

Answer 1

goal: minimize the risk of insolvency and the cost of insolvency when it does occur

RBC = method of measuring the min amount of capital appropriate for an insurance company to support its overall business operations, based on its size and risk profile

Question 2

Ways for a company to restore surplus above target surplus

Answer 2

Target surplus = approx 3-4x the min RBC amount

Restoring surplus:

• emphasize products with low RBC requirements
• redesign products to lower RBC requirements
• increase profitability by lowering expenses, exiting unprofitable LOBs, changing prices
• buy assets with low RBC requirements and sell assets with high RBC requirements
• reduce liability risk with reins, or sell LOBs
• reorg the legal structure of the company. ex: move subsidiaries to a holding company
• Raise capital by issuing surplus notes or equity securities

Question 3

RBC risk Categories C0 - C4

Answer 3

C0 - affiliated assets risk
C1 - unaffiliated asset risk
C2 - insurance risk
C3 - Interest rate risk
C4 - Business Risk

C0
-if the affiliate company is an insurance company then C0 = affiliate RBC

C1

• assets are divided into different classes based on quality
• Bonds - lowest RBC requirement
• Mortgages - RBC requirements are based ont he mortgage risk
• Preferred and common stocks - RBC requirements are based on the Beta of the company portfolio and how heavily invested the company is
• Real estate - foreclosed RE requires more RBC
• SA assets

C2

• factors are applied to the NAR
• NAR = Life insurance inforce - Reserves

C3

• risk driven by having to reinvest future CFs in a falling IR environment
• or risk driven by having to sell assets at below-statement values in a rising IR environment (disintermediation)
• also includes health risk and market risk on variable products with Gtds
• factors are applied to reserves, not NAR

Question 4

RBC action levels

Answer 4

Trend test Corridor [200%, 300%)
-Company performs trend test

Company Action [150%, 200%)
-Company prepares and submits an RBC plan to the commissioner

Regulatory Action [10%, 150%)
-Company Submits RBC plan, commissioner will issue order specifying actions

Authorized Control [70%, 100%) Commissioner authorized to take any actionsnecessary

Mandatory Control <70%
Company is placed under regulatory control

Question 5

RBC C3 phase 1

Answer 5

• require scenario testing to determine C3 for IR sensitive products
• products = single premium life and fixed deferred annuities

steps:

1. start with the same models used for the year end CFT
2. NAIC supplies IR scenario test sets
   - can run either a set of 50 or 12, the 12 is more adverse
3. capture the STAT surplus at the year end of each scenario year
4. • for each scenario the C3 = most negative PV stat surplus of any year in that scenario
     - the discount rate = 1.05 * 1yr treasury rates for that scenario
5. order the scenarios
6. calculate the average of a subset of the ranked C3 measures:
   - 50 scenarios: use weighted #5-17
   - 12 Scenarios: simple avg of 2 and 3

exemption criteria for C3 phase 1:

1. C3 Significance test = C3 / sum C0 -> C4 must be less than 40%
2. C3 stress test
   - using the covariance adjusted RBC formula, multiply the C3a component by 7.5%
   - if the resulting RC ratio > 100%, the company passes

Question 6

RBC C3 phase 2

Answer 6

• extends C3 CFT to products with equity risk such as VAs
• principles based approach
• determine the total asset requirement

principle 1. objective of TAR is to quantify the stat capital needed to meet contractual obligations in light of risk exposure

principle 2. TAR is based on results from a stochastic analysis of asset and liability CFs

Principle 3. The implementation of a model involves decisions about the experience assumptions and the modeling techniques to be used

Principle 4. the stochastic CF model will naturally still have limitations

Principle 5. cannot completely quantify an insurers exposure to risk

Steps to calculating phase 2:

1. perform a stochastic simulation with prudent best estimates
2. for each scenario; RC = max PV (accumulated deficiencies)
3. sort each scenario RC
4. Additional assets requirement = CTE 90 of the required capital assets scenario
5. TAR = AAR + beginning assets
6. Final C3 requirement = TAR - Stat reserves