RBC

Question 1

RBC Ratio Formula

Answer 1

TAC / ACL

TAC = Surplus - non-tabular discount - tabular discount on medical reserves

Question 2

RBC Action Levels (CRAM)

Answer 2

Company Action Level (CAL): 150-200%
Regulatory Action Level (RAL): 100-150%
Authorized Control Level (ACL): 70-100%
Mandatory Control Level (MCL): <70%

Question 3

CAL Company and Regulatory Action

Answer 3

Company Action: Submit action plan in 45 days to commissioner of domiciliary state containing plans on how to raise capital, reduce operations, or reduce risks to meet RBC requirements

Regulator Action: none

Question 4

RAL Company and Regulatory Action

Answer 4

Company Action: Submit action plan in 45 days to commissioner of domiciliary state containing plans on how to raise capital, reduce operations, or reduce risks to meet RBC requirements

Regulator Action: Has right to issue an order specifying corrective action

Question 5

ACL Company and Regulatory Action

Answer 5

Company Action: None

Regulator Action: Commissioner authorized (but not required) to take control of company

Question 6

MCL Company and Regulatory Action

Answer 6

Company Action: None

Regulator Action: Commissioner must rehabilitate or liquidate

Question 7

Trend Test

Answer 7

If company RBC in 200-300% and COR > 120%, then company subject to CAL action

Question 8

Combined Operating Ratio (COR)

Answer 8

(CY Net Loss and LAE) / NEP + (Other UW Exp + Agg Write Ins)/NWP + (PH Dividends) / NEP

Question 9

Risk Components of RBC Framework

Answer 9

R0: Risk associated with investments in subsidiary ins companies
R1: Risk associated with interest rates and default risks for fixed income assets like bonds
R2: Risk associated with changes in market value of equities
R3: Risk associated with default risk for reins or slow-paying customers
R4: Risk associated with adverse development of reserves (largest liability on BS)
R5: Risk associated with writing policies, particularly unexpired portion of written policies
Rcat: risks associated with earthquake and hurricane catastrophes
Operational Risk

Question 10

Operation Risk (L-PIPE)

Answer 10

• Legal Risk
• Personnel Risk
• Internal Systems Risk
• Procedural Risk
• External Risk
  Can be offset by life insurance subsidies
  3% charge

Question 11

RBC Capital Required Formula

Answer 11

(R0 + sqrt(R1^2 + … + Rcat^2)) * 1.03
1.03 term is operational risk charge

Question 12

Reason for Covariance Adjustment

Answer 12

R1 - R5 and Rcat are independent
- unlikely they would reach their max at the same time and reduces RBC capital required

R0 is NOT independent with other 5 risks (correlated with them), so investment in an affiliate does NOT provide a diversification benefit

Question 13

ACL Capital Formula

Answer 13

50% * RBC Capital Required

Question 14

RBC Charges that are usually the highest

Answer 14

R2 and R4 (equity and reserves)

Question 15

Items R0 considers

Answer 15

• Common and preferred stocks in subsidiaries
• Investments in alien ins co affiliates
• off-balance sheet or other items

Question 16

R0 Formulas

Answer 16

Equity Method for Common Stocks
R0 (Comm Stock) = min(affiliate RBC * (ownership% of common stock), value of common stock as recorded by reporting entity)

Market Method for Common Stocks
R0 (Comm Stock) = min(affiliate RBC * (ownership% of common stock), (surplus of affiliate * ownership% of common stock))

R0 (Pref Stocks) = min((affiliate RBC - total value of common stock) * ownership % of pref stock, value of pref stock as recorded by recording entity)

R0 (Alien Ins Affiliate) = 0.5 * Carrying value of Company’s Interest in Affiliate

R0 (Off-Balance Sheet) = 1% * Value of each off-balance sheet item

Question 17

R1 covers what risks

Answer 17

Interest Rate Risk and Default Risk

Question 18

R1 risk charge categories

Answer 18

• unaffiliated bonds
• other non-ins subsidiaries (outdated)
• mortgage loans
• misc assets

Question 19

R1 Formula

Answer 19

R1 = basic charge + BSC + ACC

Question 20

Basic Charge Bond Categories RBC Multipliers

Answer 20

Gov’t Bonds: 0
Class 1: 0.003
Class 2: 0.01
Class 3: 0.02
Class 4: 0.045
Class 5: 0.1
Class 6: 0.3

Question 21

Bond Size Charge (BSC)

Answer 21

Only applies to Class 1-6 bonds, extra charge for level of diversification of portfolio

BSF * R1 Charges to Bonds subject to BSF

BSF = (weighted # of issuers / # off issuers) - 1

Weights:
First 50: 2.5
Next 50: 1.3
Next 300: 1.0
>400: 0.9

Question 22

Asset Concentration Charge

Answer 22

Essentially doubles RBC charge for top 10 issuers

Assets not subject to ACC:
- Low risk assets (class 1 bonds or preferred stocks)
- assets that already have max charge of 0.3 (class 6 bonds)

ACC = sum(assets values subject to ACC for TOP 10 issuers * RBC Factor)

Question 23

Ways to reduce R1 without reducing size of bond portfolio

Answer 23

• buy better rated bonds
• shift bond issuers out of top 10 by purchasing from different issuers (lowers ACC)
• also buy bonds from more issuers to reduce BSC

Question 24

R2 formula

Answer 24

Basic Charge + ACC

ACC is calculated same way as with R1

Question 25

Exception to value * factor rule for basic R2 calc

Answer 25

Holding Companies Multiply RBC factor by holding company value in excess of carrying value for indirectly owned ins affiliates

Question 26

R3 Formula

Answer 26

R3 = Basic Charge = sum(assets or recoverables subject to basic charge * RBC factor) Reinsurance Provision allocation depends on: If R4 <= (RBC Charge for non-invested assets) + .5* (RBC charge for reins recoverables) then 100% to R3 (Most of time 50/50 split of reins recoverables between R3 and R4)

Question 27

R3 Components and RBC Charges (AIR GRAFH)

Answer 27

- Agg-Write Ins (0.05) - Investment Income Due and Accrued (0.01) - Reins Recoverables (0.1) - Guaranty Funds on Deposit (0.05) - Recoverables from parents/subsidiaries (0.05) - Amounts Receivable from Uninsured Plans (0.05) - Federal Income Tax Recoverable (0.05) - Health Credit Risk (0.05)

Question 28

R4 Formula

Answer 28

R4 = (basic charge - loss-sensitive discount) * loss concentration factor + excess growth charge + 0.5 * Reins Recoverables** Basic Charge = (((C+1)*A)-1)* Net Reserves C = 50/50 weighting between Industry RBC % and Industry RBC% * (Company Avg LDF) / (Industry Avg LDF) A = Adjustment for Investment Expense (provided) Company Avg LDF = sum of current reserve / sum of initial reserve for prior 9 PYs (capped at 4.00) Loss Sensitive Discount (LSD) = Basic Charge * (0.3 * proportion direct loss sensitive + 0.15 * proportion assumed loss sensitive) Loss Concentration Factor (LCF) = 0.7 + 0.3 * (max reserve by line / total reserve) Excess Growth Charge = Excess Growth * 0.450 * net reserves **Depends on if R4 <= (RBC Charge for non-invested assets) + .5* (RBC charge for reins recoverables) then 100% to R3

Question 29

R5 Formula

Answer 29

R5 = (basic charge - LSD) * premium concentration factor + excess growth charge Basic Charge = ((C*A)+U-1) * NWP LSD = Basic Charge * (0.3 * proportion direct loss sensitive + 0.15 * proportion assumed loss sensitive) Prem Concentration Factor (PCF) = 0.7 + 0.3 * (max NWP by line / total NWP) Excess Growth Charge = Excess Growth * 0.225 * NWP

Question 30

Excess Growth

Answer 30

(Avg last 3 year DWP growth - 10%) - Each individual year's growth capped at 40% - If negative, set to 0

Question 31

Why excess growth increases RBC capital requirement

Answer 31

- less insight into new business (harder to UW and price properly) - excessive growth has historically led to an increased risk of insolvency

Question 32

Rcat Formula

Answer 32

Rcat = sqrt((earthquake risk)^2 + (hurricane risk)^2) Each Peril Risk = (net 1-in-100 yr loss) * 1.0 + (ceded 1-in-100 yr loss) * 0.048

Question 33

Advantages and Disadvantages of RBC

Answer 33

Advantages: - Hard to manipulate (based on audited financials) - facilitates cross-company comparison Disadvantages: - ignores important risks (business strat, reputational risk) - isn't customized to a company's unique characteristics - a good ratio may give an insurer a false sense of security

Question 34

RBC vs IRIS

Answer 34

Similarities: - Quantitative measure of financial health - Excess growth penalites - use data from financials - numeric thresholds Differences - RBC calculates a minimum capital required. IRIS doesn't - RBC has regulatory authority to intervene. IRIS doesn't - RBC doesn't consider reserve adequacy. IRIS does

Question 35

Motivation for creation of RBC (3)

Answer 35

- a tool to monitor insolvency risk and protect policyholders - an objective measure of insolvency risk that facilitates cross-company comparisons - a provision for regulators to take corrective action if necessary

Question 36

Attributes that make RBC useful to regulators (3)

Answer 36

- based on objective data available from annual statement - formulaic and easy to calculate/understand - consistent across companies (so regulators can prioritize attention)