Question

explain how regulators use the risk-based capital (RBC) method to evaluate an insurer’s capital.

Answer 1

The RBC requirement (level of capital required in view of risk undertaken) is calculated by multiplying risk factors times statement values, adding the results together, and then adjusting for covariance between major risk categories. The formula results are compared to the risk-adjusted capital of the insurer to develop the RBC ratio, which is the ratio of risk-adjusted capital to RBC. The ratio results are used to determine the degree to which an insurance company’s surplus is impaired. The model act specifies a series of increasingly stringent regulatory responses, as the RBC ratio decreases below 200%. A trend test is included to test whether insurers that were between the 200% breakpoint and 250% level were trending downward, which will trigger regulatory action, but an RBC ratio over 250% for a life company is sufficient to receive a passing grade on this pass/fail test. There are four “action levels” under the NAIC RBC system. • Company Action Level (CAL). If this level is reached, insurer is required to automatically submit a written, detailed business plan within 45 days that details the causes and actions that have led up to the capital impairment as well as a plan for the restructuring of the insurer’s business to rebuild capital to acceptable levels. Alternatively, the company can detail plans to reduce its risk to a level commensurate with its actual capital level. • Regulatory Action Level (RAL). In this case, insurer must conform to the requirements stated in the Company Action Level, and in addition is subject to an immediate regulatory audit. The regulator can then issue protective orders to force the insurer to either lower its risk profile or increase its capital to a level commensurate with its risk. A company that has reached the Company Action Level and that does not conform to the statutory requirements spelled out in the statute is also automatically deemed to have triggered the Regulatory Action Level. • Authorized Control Level (ACL) is triggered by having statutory capital that is less than the Authorized Control Level RBC, as computed by the RBC formula or by failing to meet regulatory requirements imposed by the Regulatory Action Level. The Authorized Control Level is the capital level at which the state insurance commissioner is authorized, although not required, to place the insurance company under regulatory supervision. • Mandatory Control Level. When that happens, the state regulator is required by statute to take steps to place the insurer under regulatory supervision.