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Last Updated: 5/9/2024
Issue: Regulators are charged with ensuring that insurance companies can fulfill their financial obligations to policyholders. One way they do this is by imposing a risk-based capital (RBC) requirement. The RBC requirement is a statutory minimum level of capital that is based on two factors: 1) an insurance company鈥檚 size; and 2) the inherent riskiness of its financial assets and operations. That is, the company must hold capital in proportion to its risk. RBC is intended to be a regulatory standard and not necessarily the full amount of capital that an insurer would need to hold to meet its objectives.
The purpose of RBC requirements is to identify weakly capitalized companies, which facilitates regulatory actions to ensure policyholders will receive the benefits promised without relying on a guaranty association or taxpayer funds. In essence, the RBC formula calculations are critical thresholds that enable timely regulatory intervention. RBC requirements are not designed to be used as a stand-alone tool in determining financial solvency. Rather, RBC is one of the tools that gives regulators legal authority to take control of an insurance company.
Background: Regulators use RBC requirements to determine the minimum amount of capital required for an insurer to support its operations and write coverage. The RBC standard for life and property/casualty (P/C) companies is based on the Risk-Based Capital (RBC) For Insurers Model Act (#312), which the 不良研究所官方 initially adopted in 1993 (latest revision, 2011). Likewise, the RBC standard for health insurers is the Risk-Based Capital (RBC) for Health Organizations Model Act (#315), which the 不良研究所官方 initially adopted in 1998 (latest revision, 2009). The model laws outline methods for measuring this minimum amount of capital.
Before the RBC standard was established, regulators generally used fixed capital standards as a primary tool for monitoring the financial solvency of insurance companies. Under fixed capital standards, every insurance company was required to hold the same minimum amount of capital, regardless of its financial condition, size, and risk profile. Fixed minimum capital requirements were largely based on value judgements of the drafters of the statutes, and they varied widely among the states.
A large number of insurer insolvencies in the 1980s was the driving force for the 不良研究所官方鈥檚 RBC standard. A by the U.S. General Accounting Office (GAO) details 176 life and health insurer insolvencies from 1975鈥1990; 80% of these insolvencies occurred after 1982. The multitude of insolvencies made clear the inherent problems with fixed capital standards. One problem was that fixed capital standards did not address the variation in fundamental risks across sectors and companies. Another problem was that they did not address the differences in the size of insurers in determining the appropriate minimum amount of capital.
In the early 1990s, the 不良研究所官方 established a working group to look at the feasibility of developing a statutory RBC requirement for insurers. In 1992, the 不良研究所官方 adopted a life RBC formula, which was implemented in 1993. There are now separate RBC formulas for each of the primary insurance lines of business: 1) life and fraternal; 2) P/C; and 3) health. Differences in RBC across lines of business reflect differences in the economic environments facing these companies. Although the components in the RBC calculation differ across lines of business, the formulation is roughly the same. The generic RBC formula works by:
For example, RBC requirements in life insurance are based on five categories of risk:
The health and P/C RBC formulas consider similar types of risk. However, the risk components may vary slightly between formulas. For example, interest rate risk is included only in the life formula.
Under the RBC system, regulators have the legal authority to take preventive and corrective measures. These measures vary depending on the capital deficiency indicated by the RBC result. Capital sufficiency is the ratio of total adjusted capital to Authorized Control Level RBC including Basic Operational Risk. There are four levels of regulatory intervention [3]. If the ratio is at or above 200%, no regulatory intervention is needed. Below that ratio, interventions range from submission of action plans to a regulatory takeover of the management of the company. If the ratio is below 70%, a regulator is obligated to take over management of the company. These preventive and corrective measures are designed to provide for early regulatory intervention to correct problems before insolvencies become inevitable, thereby minimizing the number and adverse impact of insolvencies.
[1] See Tom Herzog, 鈥,鈥&苍产蝉辫;. Solvency II is the European risk aggregation method (or RBC equivalent).
[2] These risks include disintermediation and spread compression. Disintermediation typically is associated with rising interest rates and involves the surrender of insurance products with fixed payouts (such as fixed annuities) in favor of higher-yielding assets. Spread compression is associated with lower interest rates. For products with fixed payouts, the insurer could find itself earning lower returns on its assets with no commensurate fall in interest rates on liabilities with fixed payouts.
[3] See Martin Eling and Ines Holzm眉ller, 2008, ,鈥&苍产蝉辫;Journal of Insurance Regulation, 26(4), 31鈥60.
Status: The RBC system is consistently updated to meet the changing regulatory environment. The Capital Adequacy (E) Task Force and its working groups and subgroups manage the RBC calculations. These groups include the:
RBC formulas are reviewed annually. Adopted Modifications to Risk-Based Capital Formulas and are publicly available on the 不良研究所官方 website. More details on current-year revisions for RBC reporting can be found in the following websites. Newsletters are published annually in August (under the Documents tab):
The Capital Adequacy (E) Task Force鈥檚&苍产蝉辫;working agenda includes numerous efforts to monitor, evaluate, and consider potential improvements in RBC requirements across all lines of business, including refinements to the updated RBC formulas and ensuring consistency in RBC treatment across asset types and the various components of RBC calculations. RBC-related efforts include, among others,
The Risk-Based Capital Investment Risk and Evaluation (E) Working Group is evaluating the appropriate RBC treatment of Asset-Backed Securities (ABS), including Collateralized Loan Obligations (CLO) and similar 鈥渃omplex assets.鈥 The working groups are also charged with reviewing the effectiveness of RBC policies and procedures, as well as comparability between RBC formulas.
For 2023, RBC considerations include:
View upcoming meetings or use the completed tab to view the last 150 days.
Media queries should be directed to the 不良研究所官方 Communications Division at 816-783-8909 or news@naic.org.