19 May 2004
The NAIC Risk-Based-Capital
Formula Revisited
Robert F. Wolf, FCAS, MAAA
Principal, Mercer Oliver Wyman
G. Chris Nyce, FCAS, MAAA
Manager, KPMG LLP
American Academy Committee Structure

P/C RBC Committee
– Reports to Joint AAA RBC Committee

Reports to Risk Management and Solvency Committee
- Reports to Risk management and Financial Reporting
Council
– Works with NAIC Capital Adequacy Task Force
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Prescribed Goal of the NAIC US Risk Based
Capital Formula

Provide regulators with the authority to enforce
compliance with more appropriate capital requirements.

NAIC Endorsed Uses
– Minimum Capital Requirements
– Solvency Monitoring
– Legal Authority

NAIC Non-Endorsed Uses
– Ratemaking
– Marketing
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US P&C RBC Ratio and Levels


RBC Ratio = Adjusted Capital / Calculated Capital
Supervisory intervention is required at the following RBC ratio levels:
– company action level (RBC ratio 150-200%) - the insurer must file a
comprehensive financial and business plan.
– regulatory action level (RBC ratio 100-150%) - in addition to the
above, the regulator must examine and require corrective action of an
insurer.
– authorized control level (RBC ratio 70-100%) - in addition to the
above, the regulator may take control of an insurer.
– mandatory control level (RBC ratio less than 70%) - the regulator is
required to place the insurer under regulatory control unless it is
reasonable to believe the situation will correct itself within 90 days.
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Current and Recent Research

Raising the Bar in ACL

New Risk Charges and Considerations
– Catastrophes
– Terrorism Risk
– DTAs/DTLs
– Risk Charge for Credit/Unauthorized Reinsurance

Updating Premium and Reserve Charges

Trend Test
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Subcommittee for Reserve and Premium Risk Factors
Mission
The mission of this subcommittee was to
update the Risk Base Capital (RBC)
charges for the reserving and premium
and to also update the investment
income offset factors.
The committee was to achieve this by
not “reinventing the wheel” but rather
update using the same methodology as
before.
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Preliminary Directional Indications
Most lines decreasing
Medical malpractice
and Products
Increasing
Current ResearchNot ready to provide
recommendations
Changing the
Methodology?
Not Changed in Over 10
Years -Soft to Hard Market
Reserve Releases and
Reserve Strengthening
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Does NAIC RBC Properly Award Good Risk/Return
Decisions?

Incentive to Increase RBC Ratio
offsets incentive to properly
diversify assets and apply optimal
investment strategies
– Less incentive to invest in
common stocks relative to
treasuries and higher class
bonds because of relatively
higher risk charges
– If an interest rate charge is
included
Asset/Liability Matching
Strategy is favored to reduce
RBC charges
Contrary to recent research
by CAS VFIC Committee that
such an investment strategy
may be sub-optimal



Other Adverse Incentives
– Reserve Charge Double Play

Largest Risk Charge

Lowest Rigor in RBC Calculation

Incentive to underreport
Reserves
-
Increases Statutory Surplus
- lowers RBC charge
- both effects increase RBC
Ratio
– Disincentive to Reinsure


Doesn’t Differentiate between the
quality of reinsurers
Doesn’t differentiate between
collateralization of reinsurance
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Responsiveness
– “...It's hard not to read news about property-casualty insurers whose
financial strength ratings tumble from "A" to "B" in a heartbeat, only to
have their hearts stop beating soon after, without wondering what's
going on….”

Suzanne Sclafane, National Underwriter
Same Question have been raised for RBC
Ratios !
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American Academy of Actuaries Committee on
Risk Based Capital
Working Group of the Committee on Trend Tests
– Chair: G. Chris Nyce, KPMG LLP
- Wendy Germani, Texas Department of Insurance
- Jim Hurley, Tillinghast-Towers Perrin
- Bob Wolf, Mercer Oliver Wyman
Charge:

“Provide recommendations regarding possible trend test(s) for P&C RBC and for Health
RBC and provide recommendations regarding any changes to the Life RBC trend test.
Any trend test should strive to provide regulatory action level reporting prior to a company
entering an action level which may be based on a significant deterioration in RBC ratios.
Considerations and support should be provided for recommendations made.
Chris Nyce, Chair of the Subgroup will now
provide his presentation………
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See Presentation Slides from Chris Nyce
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Imagine That !!!!
A trend Test based on the company’s
reported calendar year profit
Preliminary/ Not Final
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Further Research Underway


Lessons from past Failures
– Micro Analysis

Look at past insolvencies

Back Test
…….Stay Tuned
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Thank You !
Q&A?
Robert F Wolf, FCAS, MAAA
312-930-0648
Mercer Oliver Wyman Actuarial Consulting, Inc.
Chicago, IL, US
phone +1 312 930 0648
cell +1 312 560 5228
rwolf@mow.com
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