RBC Flashcards by Syed Haider Ali

What is the formula for the RBC ratio

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

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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

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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

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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)

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

the regulator/commissioner must rehabilitate or liquidate company (mandatory)

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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

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

300%

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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

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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

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how many components of risk are there in the RBC framework

8 (R0 thru R5, Rcat, operational risk)

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

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

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

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

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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)

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what is the covariance adjustment in the RBC formula

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

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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

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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

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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