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CAS Exam 6U > RBC > Flashcards

RBC Flashcards

1
Q

What is the formula for the RBC ratio

A

RBC ratio = TAC / ACL
where
TAC = Total Adjusted Capital
ACL = Authorized Control Level Capital

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2
Q

what company actions are required for an RBC ratio in the 100-200% range

A
  • must submit action plan within 45 days to meet RBC standards
  • must explain how to do 1 or more of these:
    • increase capital
    • reduce operations
    • reduce risk
  • send to commissioner of domiciliary state
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3
Q

what company actions are required for an RBC ratio in the 0-100% range

A
  • no company action is initially required

- in this range, regulators have authority

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4
Q

what is the regulator action for an RBC ratio in the 70-100% range

A
  • the regulator/commissioner is authorized to take control of the company (not mandatory)
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5
Q

what is the regulator action for an RBC ratio in the 0-70% range

A
  • the regulator/commissioner must rehabilitate or liquidate company (mandatory)
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6
Q

identify regulatory consequences if an insurer’s RBC ratio falls from 85% to 50%

A

action falls from ACL to MCL
(Authorized Control Level to Mandatory Control Level)
- regulator must take control of the insurer
- regulator must rehabilitate or liquidate insurer

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7
Q

what minimum RBC ratio guarantees no required action regardless of anything else

A

300%

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8
Q

what is the ‘trend test’ regarding RBC ratios

A

If
- a company’s RBC ratio is in the 200-300% range
- and COR > 120%
then they are subject to the CAL action from the action table

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9
Q

what is the formula for the ‘Combined Operating Ratio’ or COR

A 
COR = L + E + D
  where
L = company Loss & LAE ratio
E = company expense ratio
D = policyholder dividend ratio
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10
Q

how many components of risk are there in the RBC framework

A

8 (R0 thru R5, Rcat, operational risk)

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11
Q

what are the 3 categories of ‘asset risk’ in the RBC framework

A

Fixed income risk (R1), Equity risk R2, Credit risk R3

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12
Q

what are the 2 categories of ‘U/W risk’ in the RBC framework

A

reserve risk R4, NWP risk R5 (where NWP = Net Written Premium)

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13
Q

what is the formula for the RBC capital required

A

RBC capital required = R0 + [ R1^2 + R2^2 + R3^2 + R4^2 + R5^2 + Rcat^2]½ + (operational risk)

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14
Q

what is the covariance adjustment in the RBC formula

A

it is the part of the RBC formula with the square root

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15
Q

what is the reason for the covariance adjustment

A
  • recognizes that R1 - R5 and Rcat are independent risks
  • it is unlikely they would reach their maximum at the same time
  • this covariance adjustment recognizes this by reducing the total RBC capital required
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16
Q

why is R0 excluded from the covariance adjustment

A
  • R0 is not independent of the other 5 risks (it is correlated with them)
  • investment in an affiliate does not provide a diversification benefit
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17
Q

what is the formula for ‘ACL capital’ in the denominator of the RBC ratio

A

ACL capital = 50% x (RBC Capital Required)

18
Q

describe ‘operational risk’ and specifically how the $-charge can be reduced

A
  • financial loss from operational events not already reflected in other risk charges:
    • inadequacy or failure of internal systems
    • personnel
    • procedures or controls
    • external events
    • legal risk
  • basic operational risk charge = 3% of pre-operational risk RBC charge
  • can be reduced by offset amounts reported by life insurance subsidiaries
19
Q

Formula for TAC, Total Adjusted Capital

A

TAC = PHS - (non-tabular discount) - (tabular discounts on medical reserves)

PHS =Policy Holders Surplus

20
Q

which 2 RBC risk charges are generally the highest

A

R2 (equity risk) and R4 (reserve risk)

21
Q

why is the RBC risk charge R1 (asset - fixed income) the lowest relative risk charge

A
  • fixed income investments are generally considered risk-free
22
Q

briefly describe the RBC risk categories (8)

A

R0: subsidiary risk
- investment in affiliates
- miscellaneous off balance sheet items
R1: asset risk - fixed income
- default risk & risk of change in interest rates
R2: asset risk - equity
- risk of changes in market value of equities (stocks, real estate,..)
R3: asset risk - credit
- default risk for receivables, reinsurance recoverables (and estimation of amounts)
R4: U/W risk - reserves
- risk of adverse development of reserves
R5: U/W risk - NWP
- risk that premiums from future business won’t cover future losses
Rcat: catastrophe risk
- risk of loss due to hurricanes & earthquakes
operational risk: risk of loss from operational events not already included in other categories
- includes inadequacy & failure of internal systems, etc..
- does not include reputational risk from strategic decisions

23
Q

identify the items in subsidiaries that R0 considers

A
  • common stocks in the subsidiary
  • preferred stocks in the subsidiary
  • investments in alien insurance company affiliates
  • off-balance sheet or other items
24
Q

identify risks that the total R1 RBC charge cover (2)

A

for fixed income investments the total R1 RBC charge covers:

  • interest rate risk
  • default risk
25
Q

identify the 4 largest R1 RBC risk charge categories

A 
top 2 (by a wide margin):
  - unaffiliated bonds
  - other non-insurance subsidiaries
next 2 (rank 3 & 4):
  - mortgage loans
  - miscellaneous assets
26
Q

briefly describe the ‘basic’ R1 RBC charge

A
  • this is the basic RBC charge for the fixed income investments owned by the insurer
27
Q

briefly describe the BOND SIZE CHARGE

A

an extra charge reflecting the level of diversification of the bond portfolio

28
Q

briefly describe the ASSET CONCENTRATION CHARGE (for bonds)

A

reflects increased risk of large concentrations of bonds

doubles the RBC charge for the 10 largest issuers

29
Q

reducing R1 - identify 2 ways this can be done without reducing the size of the bond portfolio

A
  • buy better rated bonds (RBC risk factor)

- shift bond issuers out of TOP 10 by purchasing from different issuers (lowers asset concentration charge)

30
Q

briefly describe the basic R2

A
  • this is the basic RBC charge for the equity owned by the insurer
    (multiply asset values by corresponding RBC factors)
31
Q

describe an exception to the ‘value * factor’ rule for the basic R2 calculation

A

exception: holding companies
alternate rule:
→ multiply RBC factor by the holding company value in excess of the carrying value for indirectly owned insurance affiliates

32
Q

in general, what kinds of assets are NOT subject to the ACC (asset concentration factor)

A 
- assets deemed to be of low risk
  (like class 01 unaffiliated bonds or preferred stock)
- assets that have already received the maximum charge of 0.3000
  (like class 06 unaffiliated bonds)
33
Q

is there an exception to the “usual” allocation of RBC for reinsurance recoverable between R3 and R4

A 
Yes, IF
  R4 ≤ (RBC charge for non-invested assets) + ½(RBC charge for reinsurance recoverables)
THEN
  100% is allocated to R3
(this wil almost never happen)
34
Q

what 2 discounts might be applied to the basic R4 RBC charge

A

[1] LSD or Loss-Sensitive Discount
(it is subtracted from the the basic charge)
[2] LCF or Loss Concentration Factor
(it is multiplied by the ‘after-LSD’ RBC charge)

35
Q

improving RBC - reserving practices (identify reserving practices that may improve the ratio)

A
  • use less conservative reserving methods (results in lower basis for reserves)
  • use tabular discounting on reserves to increase surplus
36
Q

limitations of RBC framework in identifying impairment

A
  • doesn’t measure all relevant risks (ignores interest rate risk) -
  • method is formula-based and uses industry average (may not be appropriate for a particular company)
37
Q

rapid premium growth - why does it increase the RBC capital requirement (2)

A
  • less insight into new business ==> harder to underwrite and propertly price
  • excessive growth has historically led to an increased risk of insolvency
38
Q

financial health - use of RBC ratios (advantages & disadvantages)

A

ADVANTAGE(s):
- RBC ratio is a formula based on financial statements
- hard to manipulate, facilitates cross-company comparisons
DISADVANTAGE(s):
- ignores important risks (business strategy, reputational risk)
- isn’t customized to a company’s unique characteristics

39
Q

describe a similarity & difference between the RBC & IRIS fameworks

A

SIMILARITIES:
- Quantitaive measures of financial health
- Excessive growth penalties
- use Financial statement data
- Numeric thresholds
DIFFERENCES:
- RBC (calculates minimum capital required)
- IRIS (doesn’t)
- RBC(has regulatory authority to intervene if ratio too low)
- IRIS (doesn’t, not solely on IRIS ratios)
- RBC (doesn’t consider adequacy of reserves)
- IRIS (does)

40
Q

describe purpose of RBC from perspective of regulator (2)

A
  • early identification of insurers in financial trouble

- allows or mandates regulator to take corrective action when appropriate

41
Q

describe arguments for & against using RBC to calculate a ‘universal target capital level’

A

FOR:
- hard to manipulate (based on audited financial statements)
- facilitates cross-company comparison
AGAINST:
- ignores important risks (business strategy, reputational risk)
- isn’t customized to a company’s unique characteristics
- a ‘good’ ratio may give an insurer a false sense of security

CAS Exam 6U (5 decks)

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