RBC Flashcards
What is the formula for the RBC ratio
RBC ratio = TAC / ACL
where
TAC = Total Adjusted Capital
ACL = Authorized Control Level Capital
what company actions are required for an RBC ratio in the 100-200% range
- 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
what company actions are required for an RBC ratio in the 0-100% range
- no company action is initially required
- in this range, regulators have authority
what is the regulator action for an RBC ratio in the 70-100% range
- the regulator/commissioner is authorized to take control of the company (not mandatory)
what is the regulator action for an RBC ratio in the 0-70% range
- the regulator/commissioner must rehabilitate or liquidate company (mandatory)
identify regulatory consequences if an insurer’s RBC ratio falls from 85% to 50%
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
what minimum RBC ratio guarantees no required action regardless of anything else
300%
what is the ‘trend test’ regarding RBC ratios
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
what is the formula for the ‘Combined Operating Ratio’ or COR
COR = L + E + D where L = company Loss & LAE ratio E = company expense ratio D = policyholder dividend ratio
how many components of risk are there in the RBC framework
8 (R0 thru R5, Rcat, operational risk)
what are the 3 categories of ‘asset risk’ in the RBC framework
Fixed income risk (R1), Equity risk R2, Credit risk R3
what are the 2 categories of ‘U/W risk’ in the RBC framework
reserve risk R4, NWP risk R5 (where NWP = Net Written Premium)
what is the formula for the RBC capital required
RBC capital required = R0 + [ R1^2 + R2^2 + R3^2 + R4^2 + R5^2 + Rcat^2]½ + (operational risk)
what is the covariance adjustment in the RBC formula
it is the part of the RBC formula with the square root
what is the reason for the covariance adjustment
- 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
why is R0 excluded from the covariance adjustment
- R0 is not independent of the other 5 risks (it is correlated with them)
- investment in an affiliate does not provide a diversification benefit
what is the formula for ‘ACL capital’ in the denominator of the RBC ratio
ACL capital = 50% x (RBC Capital Required)
describe ‘operational risk’ and specifically how the $-charge can be reduced
- 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
Formula for TAC, Total Adjusted Capital
TAC = PHS - (non-tabular discount) - (tabular discounts on medical reserves)
PHS =Policy Holders Surplus
which 2 RBC risk charges are generally the highest
R2 (equity risk) and R4 (reserve risk)
why is the RBC risk charge R1 (asset - fixed income) the lowest relative risk charge
- fixed income investments are generally considered risk-free
briefly describe the RBC risk categories (8)
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
identify the items in subsidiaries that R0 considers
- common stocks in the subsidiary
- preferred stocks in the subsidiary
- investments in alien insurance company affiliates
- off-balance sheet or other items
identify risks that the total R1 RBC charge cover (2)
for fixed income investments the total R1 RBC charge covers:
- interest rate risk
- default risk
identify the 4 largest R1 RBC risk charge categories
top 2 (by a wide margin): - unaffiliated bonds - other non-insurance subsidiaries next 2 (rank 3 & 4): - mortgage loans - miscellaneous assets
briefly describe the ‘basic’ R1 RBC charge
- this is the basic RBC charge for the fixed income investments owned by the insurer
briefly describe the BOND SIZE CHARGE
an extra charge reflecting the level of diversification of the bond portfolio
briefly describe the ASSET CONCENTRATION CHARGE (for bonds)
reflects increased risk of large concentrations of bonds
doubles the RBC charge for the 10 largest issuers
reducing R1 - identify 2 ways this can be done without reducing the size of the bond portfolio
- buy better rated bonds (RBC risk factor)
- shift bond issuers out of TOP 10 by purchasing from different issuers (lowers asset concentration charge)
briefly describe the basic R2
- this is the basic RBC charge for the equity owned by the insurer
(multiply asset values by corresponding RBC factors)
describe an exception to the ‘value * factor’ rule for the basic R2 calculation
exception: holding companies
alternate rule:
→ multiply RBC factor by the holding company value in excess of the carrying value for indirectly owned insurance affiliates
in general, what kinds of assets are NOT subject to the ACC (asset concentration factor)
- 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)
is there an exception to the “usual” allocation of RBC for reinsurance recoverable between R3 and R4
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)
what 2 discounts might be applied to the basic R4 RBC charge
[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)
improving RBC - reserving practices (identify reserving practices that may improve the ratio)
- use less conservative reserving methods (results in lower basis for reserves)
- use tabular discounting on reserves to increase surplus
limitations of RBC framework in identifying impairment
- 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)
rapid premium growth - why does it increase the RBC capital requirement (2)
- less insight into new business ==> harder to underwrite and propertly price
- excessive growth has historically led to an increased risk of insolvency
financial health - use of RBC ratios (advantages & disadvantages)
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
describe a similarity & difference between the RBC & IRIS fameworks
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)
describe purpose of RBC from perspective of regulator (2)
- early identification of insurers in financial trouble
- allows or mandates regulator to take corrective action when appropriate
describe arguments for & against using RBC to calculate a ‘universal target capital level’
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
