Risk Based Capital (RBC)

Question 1

RBC Ratio

Answer 1

RBC = TAC / ACL
- Total Adjusted Capital / Authorized Control Level Capital
- TAC = Policyholder Surplus – Non-tabular discount – Tab discounts on medical reserves
- ACL = 50% * RBC Capital Required
- RBC Capital Required = R0 + sqrt(R12 + R22 + R32 + R42 + R52 + Rcat2) + R(operational)
- R(operational) = 3% of pre-operational RBC capital required - offsets

Question 2

RBC Ratio Action Levels

With ranges

Answer 2

CRAM
- Company Action Level (150-200%) / Trend Test
- Regulatory Action Level (100-150%)
- Authorized Control Level (70-100%)
- Mandatory Control level (<70%)

Question 3

Company Action Level (150%-200%)

Actions by insurance and/or company

Answer 3

• Insurance dept: None
• Company: Submit Action plan within 45 days to meet RBC standards

Question 4

Regulatory Action Level (100%-150%)

Actions by insurance and/or company

Answer 4

• The regulator has the authority to take corrective actions such as restricting new business
• Company: Submit Action plan within 45 days to meet RBC standards

Question 5

Authorized Control Level (70%-100%)

Actions by insurance and/or company

Answer 5

• Regulator is authorized to take control of the insurer

Question 6

Mandatory Control level (<70%)

Actions by insurance and/or company

Answer 6

• Regulator must take over the company and prepare to rehabilitate or liquidate

Question 7

Trend Test (Company Action Level)

Formula

Answer 7

• Company’s RBC ratio 200-300% and also Combined Operating Ratio (COR) > 120% THEN they are subject to CAL
• COR = Loss & LAE R + ExpenseR + DividendR > 120%
  
  • Loss & LAE = CY net incurred loss & LAE / NEP
  • (other U/W expenses + aggregate write-ins for U/W deductions) / NWP
  • Policy holder dividends / NEP

Question 8

Company’s Action Plan for Meeting RBC Standards

Answer 8

Explain how to:
- raise needed capital
- reduce operation to save money
- reduce risks to lower RBC charges

Question 9

RBC Risk Components and Descriptions

Answer 9

Asset risks:
- Fixed income risk (R1)
- considers changes in interest rates and potential default of fixed income investments.
- Equity Risk (R2)
- considers changes in asset valuations for non-fixed income investments (stocks, real estate)
- Credit Risk (R3)
- credit risk associated with receivables on the balance sheet as well as risk associated with reinsurance recoverables.

U/W risks:
- Reserve Risk (R4)
- risk that the company’s recorded loss and LAE reserves will develop adversely
- NWP Risk (R5)
- (risk that the company’s future business will be unprofitable) or (risk that the premiums will not be able to cover losses)

Other risks:
- Subsidiary Insurance Companies and Misc Other Amounts (R0)
- considers default risk associated with investments in affiliated insurance companies.
- Catastrophe Risk (Rcat)
- Operational Risk (L-PIPE)
- Personnel
- Inadequacy or failure of internal systems
- Procedures or controls
- External events

Question 10

Reason for Covariance Adjustment

Answer 10

• R1 – R5 are assumed to be independent
• Adjustment reduces the required capital to reflect assumption of independence
• R0 excluded from adjustment because it is correlated with other risk

Question 11

Total Adjusted Capital (TAC)

Formula

Answer 11

= Policyholder Surplus – Non-tabular discount – Tab discounts on medical reserves
- No tabular no medical

Question 12

Bright Line Indicator Test

If, then

Answer 12

• If: (The appointed actuary does not address MAD) AND (10% * net L+LAE reserves > TAC – CAL = TAC – 2 * ACL
• Then: the financial analyst should pursue comments from the appointed actuary

Question 13

Fixed Income Risk (R1), Equity Risk (R2)

General formula

Answer 13

R1 = basic charge + bond size charge (BSC) + asset concentration charge (ACC)
R2 = basic charge + asset concentration charge (ACC)

Question 14

R1/R2 Basic Charge

Formula, assets

Answer 14

R1 basic charge = sum(asset values subject to basic charge * RBC factor)
- fixed income assets:
- bonds
- cash/cash equals
- mortgage/collateral loan
- off balance collateral

R2 basic charge = sum(asset values subject to basic charge * RBC factor)
- non-fixed income assets:
- affiliated investments
- unaffiliated stocks
- real estate
- schedule BA assets

Question 15

R1 Bond Size Charge (BSC) / Bond Size Factor (BSF)

Formula, assets, chart

Answer 15

BSC = BSF * sum(assets subject to BSF * RBC factor)
BSF = weighted # of bond issuers / total # of bond issuers
(# of bond issuers) * (weight) = weighted # of bond issuers
- (first 50) * (2.5)
- (second 50) * (1.3)
- (next 300) * (1)
- (remaining) * (0.9)

Assets subject to bond size factor:
- Class 01-06 unaffiliated bonds
- NOT US government bonds

Question 16

R1/R2 Asset Concentration Charge (ACC)

Formula and assets

Answer 16

sum(asset values subject to TOP 10 issuers * RBC factor)
- bonds (class 02-05)
- collateral loans
- mortgage loans
- working capital finance investments – NAIC 02
- low income housing tax credits

sum(asset values subject to TOP 10 issuers * RBC factor)
- unaffiliated preferred (class 02-05) and common stock
- real estate
- schedule BA
- receivable for securities
- aggregate write-ins for invested assets
- derivatives

Question 17

Credit Risk (R3)

General Formula

Answer 17

R3 = basic charge - ½ * (RBC charge for reinsurance recoverables)

Second part subject to criteria

Question 18

R3 Basic Charge

Formula, assets

Answer 18

sum(asset values subject to basic charge * RBC factor)
AIRFARe
- Amount receivable (uninsured plans)
- Investment income (due/accured) (RBC factor = 0.01)
- Recoverable (parent/subsidiary/affiliates)
- guaranty Funds receivable (on deposit)
- Aggregate write-ins for NON-invested assets
- Reinsurance recoverables (RBC factor = 0.1)
- E for Exam 6!

Question 19

R3/R4 Split

criteria

Answer 19

R4 (unpaid loss & LAE) > (RBC charge for non-invested assets) + ½ * (RBC charge for reinsurance recoverables)

Question 20

Reserve Risk (R4), NWP Risk (R5)

General formula

Answer 20

R4 = (Base RBC - LSD) * LCF + (excessive growth charge) + ½ * (RBC charge for reinsurance recoverables)

R5 = (Base RBC - LSD) * PCF + (excessive growth charge)

LSD = Loss sensitive discount, L/PCF = Loss/premium concentration factor

Question 21

R4/R5 Base RBC

General formula

Answer 21

R4 Base RBC = (Reserves) * [(company L+LAE RBC%) * (adjustment for investment income) + (adjustment for investment income) - 1]

R5 Base RBC = (NWP) * [(company L+LAE RBC%) * (adjustment for investment income) + (U/W expense ratio) - 1]

R4 Base RBC = [[(C+1) * A] - 1 ] * (reserves)

Question 22

R4/R5 Company L+LAE RBC%

Formula

Answer 22

Average of:
- industry L+LAE ratio
- industry L+LAE ratio * (company average L+LAE ratio) / (industry average L+LAE ratio)
- (company average L+LAE ratio) = straight average over last 10 years capped at 300% each year

Question 23

R4/R5 Loss Sensitive Discount (LSD)

Formula

Answer 23

LSD = Base RBC * (0.3 * % direct loss sensitive + 0.15 * % assumed loss sensitive)

Question 24

R4/R5 Loss/Premium Concentration Factor (LCF, PCF)

Formula

Answer 24

R4 LCF = 0.7 + 0.3 * (max reserve by line) / (total reserve)
R5 PCF = 0.7 + 0.3 * (max NWP by line) / (total NWP)

Question 25

R4/R5 Excessive Growth Charge

Formula, bounds

Answer 25

R4 = 0.45 * (excess growth) * (reserves)
R5 = 0.225 * (excess growth) * (NWP)

excess growth = (average growth over last 3 years) - 10%
- max growth per year 40%
- excess growth minimum 0
- USE GROSS WP TO CALCULATE GROWTH

Question 26

Catastrophe Risk (Rcat)

Formulas

Answer 26

Rcat = sqrt[(total EQ risk)^2 + (total hurricane risk)^2]
- total risk = (net 1-in-100 yr loss) + 0.048 * (ceded 1-in-100 yr loss)