RBC

Question 1

RBC

Answer 1

Helps provide an early warning of a potential impending insurer insolvency

Question 2

RBC FORMULA PURPOSE

Answer 2

RBC tells you the minimum level of capital that the insurer should hold, based on risk

the surplus indicated by the RBC formula should tell you the MINIMUM surplus level not the OPTIMAL surplus level

Question 3

RBC MODEL ACT FOR INSURERS

Answer 3

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

Question 4

RISK-BASED CAPITAL overview

Answer 4

has been used since 1994 to provide a means for the early detection of insurance company insolvency.

These reports emerged in the wake of four of the largest property/casualty
insurance company insolvencies in the history of the U.S. insurance industry:
1) Mission Insurance Company,
2) Transit Casualty Company,
3) Integrity Insurance Company and
4) Anglo-American Insurance Company

Question 5

two components of the RBC system

Answer 5

1) Formula: calculates the ACL benchmark which reflects capital needed to support the risks faced by IC. The company’s actual recorded capital and surplus is compared to the min required capital to produce the RBC ratio

2) RBC for Insurers Model Act: provides state regulators authority to take action when a IC’s RBC ratio falls below certain thresholds

Question 6

RBC formula Overview

Answer 6

Applies factors to asset, reserve, recoverable and premium items.

The size of the factor depends on the level of risk associated with the item

The larger the risk, the larger the factor.

application of the factors to the associated Annual Statement items results in “risk charges.’’

Question 8

INPUTS INTO RBC CALCs

Variables R(i)

Answer 8

Ro Subsidiary Insurers/ Misc.
R1 Asset Risk - Fixed Income
R2 Asset Risk - Equity
R3 Asset Risk - Credit
R4 UW Risk - Reserves
R5 UW Risk - NPW
Rcat Catastrophe Risk
Operational Risk**

**Operational Risk is added as a final step in the calculation, after applying the covariance adjustment between other risk types, and does not have a corresponding “R” indicator.

one IMPORTANT risk is missing (reserve adequacy)

Question 9

R_0

Subsidiary Insurance Companies and Miscellaneous Other Amounts

Answer 9

Considers the risks associated with:
1) investments in affiliated entities (2 categories)
- insurance affiliates & alien insurance affiliate subject to RBC
- insurance affiliates not subject to RBC

2) miscellaneous off-balance sheet which consists of:
-non-controlled assets,
- guarantees for affiliates,
- contingent liabilities and
- deferred tax assets admitted under SAP

Question 10

R_1 - R_3

Asset Risks

Answer 10

Asset risk is a much smaller portion of the property/casualty total risk charge compared to
the life industry.

P&C companies tend to invest in short-term, liquid investments (which are generally considered to be lower risk) due to the relatively shorter duration of liabilities.

R1 and R2 deal with admitted invested assets (those not captured in R0).

Question 11

R_1 - R_3

R1 Asset risk - Fixed income

Shown on lines 1 through 11, column 3, on the asset side of the stat balance sheet on page 2

Answer 11

R1 = considers changes in interest rates and potential default of fixed income investments

(e.g., cash, bonds, mortgage loans)

Question 12

R_1 - R_3

R2 Asset risk - Equity

Shown on lines 1 through 11, column 3, on the asset side of the stat balance sheet on page 2

Answer 12

R2 charge = considers changes in asset valuations for non-fixed income
investments

(e.g., stocks, real estate).

Question 13

R_1 - R_3

R3 Asset risk - Credit

lines 14 and subsequent, column 3, on the asset side of the stat balance sheet on page 2 and risk associated with reinsurance recoverables

Answer 13

R3 = considers the credit risk associated with receivables on the balance sheet

if a company has written 5% or more of its premiums in accident & health lines in the last three years, it is also subject to a Health Credit Risk charge.

Question 14

R4 - R5

Underwriting Risk

R4 Underwriting risk - Reserves

Answer 14

R4 (Reserve Risk) = concerned with past business

Risk that reserves will develop adversely given the current reserve balance is adequate

Question 15

R4 - R5

Underwriting Risk

R 5 Underwriting risk - Net written premium

Answer 15

R5 (premium risk) = concerned with future business

Risk that the company’s business in the following year will be unprofitable.

This is the LARGEST portion of the RBC charge for P&C ICs

Question 16

R_Cat

catastrophe risk charge (R cat)

Answer 16

Added in 2017.

risks associated with earthquake and hurricane events and considers modeled losses at the worst year in 100

charge applies on a net of reinsurance basis, with a corresponding contingent credit risk charge for certain categories of reinsurers.

Question 17

commercially available catastrophe models

Answer 17

AIR, RMS, EQECAT
Through which, projected losses can be calculated

Question 18

Covariance Adjustment

Answer 18

R0 + SQRT ( [R1]^2 + [R2]^2+ [R3]^2+ [R4]^2+ [R5]^2+[Rcat]^2 )
= Total RBC After Covariance Before Basic Operational Risk

assumes that the individual risk charge categories are independent of one another
(I.E aggregate risk is less than the sum of risk of the independent components)

e.g “ risk of default on an insurance company’s invested assets (e.g., bonds, stocks) is independent of the performance of its loss reserves.”

increases the dependency of the
larger risks in the calculation and decreases the significance of the smaller risk categories in
the overall aggregate RBC requirement

Ro is kept outside because the risk for investments in insurance company subsidiaries is believed to be directly correlated with the combination of the risks specific to the reporting entity (i.e., the other risk charges Ri through Rcat).

Therefore, the risk for investments in insurance company subsidiaries is additive to the aggregate of the investment and underwriting risks of the reporting entity for which RBC is being calculated.

In other words, RBC should not depend on the organizational structure of the insurance company and investments in insurance company subsidiaries that are subject to RBC do not provide a diversification benefit.

Question 19

Basic Operational Risk Charge

Formally introduced in 2018 (was 0% in 2017)

Answer 19

Considers the risk of financial loss
resulting from operational events (I.E inadequacy / failure of internal systems, personnel, procedures / controls, external events)*

*includes legal risk but excludes reputational risk arising from strategic decisions and excludes any operational risks not reflected in the other risk categories

Question 20

THE RBC CHARGE FOR SUBSIDIARY INSURANCE COMPANIES AND MISCELLANEOUS OTHER
AMOUNTS (Ro)

Answer 20

R0 only consists of:
1) US domiciled entities subject to RBC *
2) alien insurers (i.e., foreign to the U.S.)

Not subject to RBC: title insurers, monoline
mortgage guaranty insurers and monoline financial guaranty insurers.

*all other US dom entities not subject to RBC are covered in R2

Question 21

R0

Insurance Affiliates Subject to RBC Example

Answer 21

An insurance company owns another company (a subsidiary).

That subsidiary has its own RBC requirement (a cap on how much risk it has).

The parent company owns stocks in that subsidiary (common or preferred stock).

The parent gets an Ro risk charge for owning those stocks.
But:
- The total Ro charge cannot be bigger than the subsidiary’s own RBC.
- And if the parent owns only part of the subsidiary, it only counts its share.

Question 22

R0: Charge calculation from Ownership of Common Stock

Answer 22

Check Excel

Question 23

R0: Charge calculation from Ownership of Preferred Stock

Answer 23

depends on whether the subsidiary has excess RBC*.

If XS RBC > 0 then, min(pro rata share of the excess RBC, adjusted carrying value of the preferred stock > 0 as recorded by the reporting entity)

pro rata share = to the % of the affiliate’s total outstanding preferred stock value that is owned by the company

value of total outstanding common stock or total outstanding preferred stock = (book/adjusted carrying value of the investment) / (percentage of ownership)

*Excess RBC is defined as the amount of RBC of the affiliate that exceeds the total value of the outstanding common stock.

Question 24

R0: Charge calculation from Alien Insurance Affiliates

Answer 24

charge = 50% x (Annual Statement carrying value of the company’s interest in the affiliate)

For indirectly owned alien affiliates, this amount is further adjusted to reflect the reporting entity’s ownership on the holding company.

Question 25

R0: Charge calculation from Off‑Balance Sheet Items

Answer 25

These items are disclosed in the Notes to Financial Statements and General Interrogatories and fall into four categories: 1) Non‑controlled assets 2. Guarantees for the benefit of affiliates 3. Contingent liabilities 4. Deferred tax assets (DTAs) Standard charge: ✅ 1.0% applied to almost all off‑balance sheet items Exception – conforming securities lending programs: ✅ Reduced charge of 0.2%, because specified program features lower risk Deferred tax assets: ✅ Standard 1.0%, but ✅ Reduced to 0.5% if the insurer: Filed its own separate federal tax return, or Was part of a consolidated return where the parent is an insurance company

Question 26

R0: Charge calculation from Off‑Balance Sheet Items 1) Non‑controlled assets

Answer 26

Assets where the insurer does not have exclusive control or may have to take them back, including: Collateral loaned under securities lending programs Assets on the balance sheet but controlled by another party Assets sold or transferred with a put option allowing the buyer to return them

Question 27

R0: Charge calculation from Off‑Balance Sheet Items 2. Guarantees for the benefit of affiliates

Answer 27

Guarantees that could create a contingent obligation, such as guaranteeing an affiliate’s loan to a third party if the affiliate cannot pay.

Question 28

R0: Charge calculation from Off‑Balance Sheet Items 3. Contingent liabilities

Answer 28

Potential obligations that are not recorded because the amount is uncertain, but the insurer could still be responsible. Example: structured settlements where an annuity issuer fails and the insurer must step back in.

Question 29

4. Deferred tax assets (DTAs)

Answer 29

Admitted adjusted gross DTAs disclosed in Note 9 of the Annual Statement.

Question 30

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1)

Answer 30

includes the charge for interest rate and default risk associated with fixed income investments in the following categories: 1. Bonds 2. Off-balance sheet collateral and Schedule DL, Part 1, Assets 3. Other long term assets, including mortgage loans, low income housing tax credits and working capital finance investments 4. Miscellaneous assets, including cash, cash eguivalents, other short-term investments and non-admitted collateral loans 5. Replication (synthetic asset) transactions and mandatorily convertible securities

Question 31

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) 1. Bonds

Answer 31

the charge relating to bonds overwhelmingly dominates this risk category for p&c there are two charges reflecting the level of diversification: BOND SIZE FACTOR and ASSET CONCENTRATION FACTOR The fewer the bond holdings and greater the concentration in individual issuers or borrowers, the greater the associated charge

Question 32

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) 1. Bonds - bond Class Factor

Answer 32

determined "based on cash flow modeling using historically adjusted default rates for each bond category."

Question 33

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) 1. Bonds - bond Size Factor

Answer 33

measures the degree of diversification in the investment portfolio The bond size factor is calibrated such that the break-even point where the factor equals 1.0 is set at 1,300 bonds. Portfolios containing 1,300 or more bonds will receive a discount to their RBC charge for bonds. 0.03 = [[(50*2.5) + (50*1.3) + (300*1.0) + (600*0.9)] / (1,000)] – 1.0

Question 34

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Off-balance Sheet Collateral and Schedule DL, Part 1, Assets

Answer 34

considers the risk associated with securities lending programs risk associated with these programs is that the reporting entity will lose money on the reinvestment of collateral posted by the borrower. Held in 1 of 3 ways in AS: 1)investment schedules that correspond to the invested collateral (e.g., Schedule A, B, BA, D, DA and E), which roll up into the balance sheet 2) In Schedule DL, Part 1, of the Annual Statement, which rolls into line 10 of the asset side of the balance sheet 3) Off-balance sheet, due to not being recorded in the financial statements

Question 35

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Off-balance Sheet Collateral and Schedule DL, Part 1, Assets: Calculation

Answer 35

The R1 charge considered herein includes a provision for these assets as included in items 2 and 3 above. The charge is equal to the book/adjusted carrying value multiplied by a factor, where the factor is equal to that for the particular asset class. For example, the same factors by class applicable to bonds are also used in this calculation.

Question 36

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Other long term assets - Mortgage loans

Answer 36

The RBC charge for mortgage loans for property/casualty insurers is computed as the book/adjusted carrying value of the loans multiplied by a factor of 0.050

Question 37

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Other long term assets -Working Capital Finance Investments

Answer 37

The booked/adjusted carrying value of working capital finance investments can be found in the Notes to Financial Statements, lines 5M(01a) and 5M(01b) in column 3, of the Annual Statement. Those in line 5M(01a) - NAIC Designation 1 - get a risk charge of 0.0038, while those in 5M(01b) - NAIC Designation 2 - have a factor of 0.0125.

Question 38

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Low Income Housing Tax Credits (LIHTC)

Answer 38

five categories of LIHTC investments listed below (based on SSAP 93) ► Federal guaranteed - 0.0014 ► Federal non-guaranteed - 0.0260 ► State guaranteed - 0.0014 ► State non-guaranteed - 0.026 ► All other - 0.1500 The associated NAIC factor used to calculate the RBC charge varies by category.

Question 39

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Federal guaranteed - 0.0014

Answer 39

must have an all-inclusive guarantee from an ARO -rated entity which guarantees the yield on the investment

Question 40

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Federal non-guaranteed - 0.0260

Answer 40

must include the following risk mitigation factors: a) A level of leverage below 50%. For an LIHTC fund, the level of leverage is measured at the fund level b) A tax credit guarantee agreement from a general partner or managing member, requiring the general partner or managing member to reimburse investors for any shortfalls in tax credits due to errors of compliance. For an LIHTC fund, a tax credit guarantee is required from the developers of the lower-tier LIHTC properties to the upper-tier partnership.

Question 41

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) State guaranteed - 0.0014

Answer 41

To be classified as a state guaranteed LIHTC investment, it must minimally meet the federal requirements for guaranteed LIHTC investments.

Question 42

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) All other - 0.1500

Answer 42

All other federal and state LIHTC investments that do not meet the requirements of the above categories will be classified in the All Other LIHTC investments category

Question 43

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Miscellaneous Assets

Answer 43

computed as a factor times the book/adjusted carrying value for those assets that are in excess of amounts considered elsewhere in the RBC formula, if any. (CANnot BE less than zero): ► 0.003 times the book value of cash, net cash equivalents and other short-term investments ► 0.050 times admitted collateral loans and write-ins

Question 44

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Replication (Synthetic Asset) Transactions and Mandatory Convertible Securities

Answer 44

insurance companies use derivative transactions for one of three reasons: 1. Hedge or mitigate risk 2. Generate income 3. Replicate an asset that cannot be purchased in the cash market because it is either too expensive or unavailable derivative holdings by property/casualty insurers are small relative to those held by life insurance companies. This somewhat explains the low-risk charge for this category.

Question 45

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) RSATs

Answer 45

RBC charge for RSATs is equal to the RBC factor applicable for the asset the RSAT is replicating, multiplied by the statement value of the transaction from Schedule DB. Credit is given for the RBC charge already applied to the cash instrument. The RBC for RSATs is adjusted to remove the RBC previously calculated for the subject bond.

Question 46

THE RBC CHARGE FOR ASSET RISK ASSOCIATED WITH FIXED INCOME INVESTMENTS (R1) Asset Concentration Factor

Answer 46

The asset concentration factor doubles the RBC charge for the 10 largest issuers that the insurance company is exposed to. The purpose of this charge is to reflect the increased risk associated with large concentrations in single issuers.

Question 47

THE RBC CHARGE FOR CREDIT RISK (R3)

Answer 47

uncollectible reinsurance was deemed partly to blame for the failure of Mission Insurance Company and Transit Casualty Company, which helped set RBC in motion for the property/casualty industry. Furthermore, throughout the years, reinsurance has been used in certain situations inappropriately to enhance a company's financial position or hide poor financial results.157

Question 48

THE RBC CHARGE FOR CREDIT RISK (R3) - Historical Methodology and Criticisms

Answer 48

From its inception, the RBC formula applied a simple 10% loading to all eligible reinsurance recoverables. The 10% charge has been subject to criticism from insurance carriers, who have argued that the charge does not differentiate between high and low rated reinsurers, or give credit for those recoverables that are backed by collateral.

Question 49

THE RBC CHARGE FOR CREDIT RISK (R3) - Updated Methodology

Answer 49

applies differentiated risk charges to each reinsurer counterparty based on their credit guality, as indicated by a rating from an approved rating agency, as well as whether or not the recoverables are collateralized.

Question 50

THE RBC CHARGE FOR CREDIT RISK (R3) - Updated Methodology - Impacts

Answer 50

Overall, the implementation of this new formula has reduced the level of RBC for reinsurance recoverables by almost a half across the industry

Question 51

THE RBC CHARGE FOR CREDIT RISK (R3) - Allocation between R3 and R4

Answer 51

When the Reserve RBC charge > sum of credit risk RBC charge for non-invested assets x 50% of RBC charge for reinsurance recoverables Then: the RBC charge for Reinsurance Recoverables is split 50%/50% between R3 and R4 Else, the full amount of the reinsurance recoverable RBC charge is included in R3

Question 52

THE RBC CHARGE FOR CREDIT RISK (R3) - Allocation between R3 and R4 Reasoning

Answer 52

recognizes there is some dependency between deterioration in reserves and an increase in exposure to reinsurance credit risk. put in place so the insurance company cannot diversify away a portion of its credit risk in situations where the company has limited net reserves.

Answer 53

The factor for investment income due and accrued is equal to the RBC factor applied to unaffiliated class 02 bonds because most of the investment income due and accrued comes from bonds, which are typically the largest holding for a property/casualty insurance company. The receivable assets are generally short-term balances generated in the normal course of doing business. The capital charges for these assets are lower than other long-term recoverables.

Question 54

THE RBC CHARGE FOR RESERVE RISK (R 4)

Answer 54

R 4 is very often the largest of the RBC charges for P&C insurers. Reserve risk contemplates the risk that a reporting entity's loss and LAE reserves will develop adversely.