RBC

Question 1

Risk based capital system

Answer 1

tool to help provide early warning of potential impending insurer insolvency

Question 2

RBC formula

Answer 2

calc min level of capital that insurer should hold based on risks to which it is exposed; output feeds

RBC ratio = actual capital/required capital

Question 3

RBC model act for insurers

Answer 3

provides state regulator authority to take action if RBC ratio falls below threshold level

-RBC formula applies specific factors to certain risks to which insurer is exposed and P&C consists or asset risk, UW risk, and covariance adj

Question 4

Asset Risk

Answer 4

-Risk that assets lose value

R0 Subsidiary insurers: default risk from investments in these companies

-off-balance sheet risk

R1 Fixed income: impact of changing interest rates on valuation and default risk

R2 Equity: change in valuation

R3 Credit

-risk that counterparties such as reinsurers will not pay as expected

Question 5

UW Risk

Answer 5

-risk that prem will be insufficient to cover loss and expense and that reserves may develop adversely

R4 Reserve risk: risk that reserves will develop adversely assuming current values are adequate

R5 Net WP risk: risk that following year’s business will be unprofitable

-predominant portion of RBC charge

Question 6

Excluded risks

Answer 6

business plan & strategy, management, internal controls, systems, reserve adequacy, ability to access capital bc too difficult to quantify

Question 7

r0 Common stock investment

Answer 7

charge depends on accting method used to record investment in subsidiary

-market value approach = based on market value adj for ownership %

RBC=min(aff RBC, statutory surplus)*ownership%

-equity method = investment based on statutory equity adj for unamortized goodwill and adj for ownership -> carrying value is initially the cost and then adj based on income

RBC=min(aff RBC ownership%, book/adj carrying value of stock)

Question 8

r0 Off-balance sheet & other

Answer 8

: not included in financials but still are assets/potential liab so expose insurer to risk

• Non-controlled assets, contingent liab, guarantees for benefit of affiliates
• 1% charge factor applied to these items
• 0.2% for securities lending programs that conform to certain rules that lower risk

Question 9

r0 Investments in alien insurance affiliates

Answer 9

not subject to RBC requirements

• for directly owned: RBC= book/adj carrying value*0.5
• for indirectly owned: RBC= carrying value*0.5

Question 10

bond size factor

Answer 10

: reflects amount of diversification; measured based on # of issuers of bonds

Factor = weighted issuers/issuers -1

• 1^st 50 issuers = 250%, next 50 130%, next 300 100%, rest 90%
• if over 1300 issuers, adj = 0

Question 11

r1: mortgage loans and misc assets

Answer 11

Mortgage loans: RBC = 0.05*book/adj carrying value of loans

Misc Assets: RBC = factor*book/adj carrying value of assets (excess of amounts considered elsewhere in RBC fomula)

-0.003 for cash & short term and 0.05 for admitted collateral loans

Question 12

r1 general formula

Answer 12

R1 = bond charge + bond size charge + asset concentration charge

Question 13

Unaffiliated common stock

Answer 13

RBC=0.15*book/adj carrying value of stock

-non-gov money market funds are incl but use 0.003

Question 14

r3 Non-invested assets

Answer 14

RBC = 0.05*net admitted value

-investment income and accrued uses 0.01 bc mostly comes from bonds so gets factor of unaffiliated class 2 bonds

Question 15

Reinsurance recoverables 10% has been criticized

Answer 15

bc it does not differentiate by reinsurer strength or whether recoverables have been collateralized but charge remains due to need to be conservative when reins is involved (uncollectible balances have historically been responsible for several ins failures and reins has been used to overstate surplus/hide results)

Question 16

Reserve RBC

Answer 16

designed to measure susceptibility to adverse devel

• applying factor (company RBC %) to net loss & LAE reserves gross of non-tabular discount and generated separately for each line from Sched P
• gross of non-tabular discount bc different companies have different methods to determine discount so to ensure consistent treatment
• base RBC is first calc then 2 adjustments made to reflect loss sensitive contracts and loss concentration

Question 17

r4 Adj for investment income

Answer 17

provided by NAIC and is based on 5% interest rate and payment patterns using IRS discount method

-discount factor for WC is adj to reflect portion of reserves that already received tabular discount

Question 18

Adj for loss concentration

Answer 18

reflects level of diversification across lines and is applied to aggregate RBC reserve charge

LCF = 0.3*net reserves in line with highest reserves/total net reserves + 0.7

Final net reserve RBC = total reserve RBC after discount for all lines * 1000 * LCF

-LCF reflects adverse devel is not only caused by random fluctuations so devel across lines may not be totally independent

Question 19

Excessive Prem Growth

Answer 19

reserves are subject to lot more uncertainty if insurer is growing rapidly – won’t have as much insight into NB relative to current book, estimate of unpaid claims is more difficult for growing co relative to one in SS bc avg writings are going to be skewed towards end of policy yr

-insurer with excessive growth = 3yr avg growth rate in GWP exceeding 10%

Avg growth rate factor = min (max[avg growth, 0.1],0.4)-0.1

Excessive prem growth charge = avg growth rate factor * 0.45 * net reserves

Question 20

WP RBC

Answer 20

risk that future business may be unprofitable and will require resources from surplus to cover these future losses, based on current year prem with 2 adj to reflect loss sensitive contracts and prem concentration

RBC = curr yr NWP*(comp RBC LR*adj for investment income + comp UW expense ratio-1)

Comp RBC LR = average(industry LR ratio provided by NAIC, industry RBC LC adj for company experience)

Adj for company experience = company avg LR/industry avg LR

-avg is based on 10 AYs and ratios are capped at 300% for each yr

Question 21

-adj for investment income r5

Answer 21

calc using same assumptions as reserve RBC factor with exception that yrs included at diff bc WP that is being discounted; provided by NAIC

Question 22

Excessive Prem Growth: r5

Answer 22

similar to reserve risk but applied to NWP instead of reserves and factor is 0.225 and 0.45; factor is based on LR of companies with excessive growth relative to industry adj for discount factor of 90%

Question 23

Total adjusted capital

Answer 23

surplus – nontabular discount – tabular discount on medical reserves

Question 24

RBC Model Act

Answer 24

RBC helpful bc reflects info specific to insurer in its min capital requirements; RBC requirement is not target-level surplus but a min level so can be used to help id insurers in financial trouble

• 150-200% company action level, 100-150% regulatory, 70-100% authorized, <70% mandatory
• company & regulatory action=company submits action plan to commissioner explaining how it will obtain needed capital or reduce risk
• authorized & mandatory= none initially by company
• company = no action required by DOI
• regulatory=right to take corrective action by DOI
• authorized=commissioner authorized to take control
• mandatory=commissioner must rehabilitate or liquidate insurer

Question 25

Trend Test

Answer 25

looks for companies that satisfy RBC btw 200% & 300% and combined ratio > 120%

• CR=LR + dividend ratio + expense ratio
• designed to be early warning of companies that may incur RBC ratios <200%