1. NAIC Risk-Based Capital
Walter Bell
NAIC President and
Alabama Insurance Commissioner
Vice Chair of IAIS Executive Committee
ASSAL ANNUAL CONFERENCE
Santiago, Chile

2. History of Risk Based Capital
Risk based capital concept began in 1989
September 1990, Examination Oversight Task Force of NAIC determined Risk Based Capital requirements were preferable to minimum capital and surplus requirements
December 1990, NAIC formed two RBC working groups (one life and one property and casualty)
The NAIC began to explore concept of risk based capital in 1989 in an effort to enhance the ability of regulators to detect potentially weak insurers and to take appropriate action well before such an insurer becomes insolvent
In September 1990, the Examination Oversight Task Force of the NAIC determined Risk Based Capital requirements were preferable to minimum capital and surplus requirements.
The current statutory minimum capital requirements provide very little help to regulators in solvency regulation.
Statutory minimums vary from state to state.
At its December, 1990 meeting, the NAIC formed two working groups (one life and one property and casualty). These groups developed RBC formulas and related model laws. The laws were to provide legal mechanisms for regulatory intervention when capital and surplus fell below thresholds (as calculated in the RBC formulas) that were meaningfully related to the amounts and types of exposure faced by a specific insurer.

3. History of Risk Based Capital (Continued)
1991 and 1992 Risk-Based Capital survey distributed to companies
Life RBC formula finalized in 1993
P/C RBC formula finalized in 1994
RBC standards for health organizations were implemented in 1998
Surveys of the draft life RBC calculations were distributed to companies for two years prior to implementation. The calculation was then phased in for the first few years.
After much deliberation, the property and casualty RBC formula was finalized late in 1993 with minor changes during The first RBC filing for property and casualty insurers is based on the 1994 Annual Statement and was to be filed on or before March 1, 1995.
Risk based capital standards for health organizations were implemented for year-end 1998.

4. History of Risk Based Capital (Continued)
The NAIC RBC formula is generally a formula-based calculation of a minimum level of capital
Total Adjusted Capital is compared to 4 action levels of RBC where action is taken by the company or the regulator:
The NAIC RBC formula is generally a formula-based calculation of a minimum level of capital
Total Adjusted Capital is compared to 4 action levels of RBC where action is taken by the company or the regulator:

5. History of Risk Based Capital (Continued)
RBC Action Levels:
Company Action Level
Regulatory Action Level
Authorized Control Level
Mandatory Control Level
Those RBC action levels are as follows:
Company Action Level – The insurance company files a plan with the state
Regulatory Action Level – The insurer files a company plan or revised plan. The state performs such examination or analysis as deemed necessary of the company operations.
Authorized Control Level – The state is authorized to take over the company at the states discretion.
Mandatory Control Level – The state is required to take over the company.

6. History of Risk Based Capital (Continued)
The number of companies at action levels has remained relatively constant for life and property/casualty (non-life) RBC since inception:
The number of companies at action levels has remained relatively constant for life and property/casualty (non-life) RBC since inception though the RBC formulas continue to be refined and changes occur to them every year due to the review of the NAIC RBC Working Groups and Capital Adequacy Task Force:

7. Life and P/C RBC Statistics
2000
1999
1998
1997
1996
1995
Company 44 41 37 55 60
Regulatory 25 18 14 22 20
Authorized 5 8 9 11
Mandatory 30 27 28 34
Total Action
104 94 92
127 98
Total Co’s
3,628
3,546
3,781
3,843
3,925
3,933
% of Total
2.9%
2.7%
2.4%
3.2%
2.5%
Generally, the number of companies at an action level has ranged between 2 ½ and 3 ½ percent since inception of the formula.

8. Life and P/C RBC Statistics
2006
2005
2004
2003
2002
2001
Company 28 37 44 43 60 38
Regulatory 19 29 16 32
Authorized 7 6 8 11
Mandatory 35 39 33 40
Total Action 89 97
125
109
136
116
Total Co’s
3,526
3,501
3,532
3,475
3,594
3,625
% of Total
2.5%
2.8%
3.5%
3.1%
3.8%
3.2%
The percentage of life companies at action levels would generally be around 2% where the P/C companies percentage on average would be higher between 3% and 4% of P/C companies.

9. History of Risk Based Capital (Continued)
As a result of P/C insolvencies in the early 2000’s, a ‘trend test’ was added to P/C RBC in 2005
The ‘trend test’ may trigger a company action level if a ratio of the companies claims and expenses to premiums is unfavorable
As a result of property and casualty insolvencies in the early 2000’s, a ‘trend test’ was added to P/C RBC for year-end 2005.
The trend test’ may trigger a company action level if the RBC percentage (calculated as Total Adjusted Capital divided by Authorized Control Level RBC) is between 200% and 300% and the combined ratio (which is a ratio the companies claims and expenses to premiums) is greater than 120%

10. History of Risk Based Capital (Continued)
The number of health companies at action levels started high and has declined subsequently:
The number of health companies at action levels started high and has declined subsequently:

11. Health RBC Statistics 2002 2001 2000 1999 1998 Company 37 48 19 30
Regulatory 33 43 16 22
Authorized 17 23 46 29
Mandatory 21 26 42 36
Total Action
108
140
123
117
Total Co’s
672
578
543
563
% of Total
16.1%
24.2%
22.7%
20.8%
The first few years of the health RBC formula the number of health organizations at action levels was generally between 16 and 24%.

12. Health RBC Statistics 2006 2005 2004 2003 2002 Company 9 12 8 23 32
Regulatory 7 5 21 25
Authorized 6 1 2 4
Mandatory 10 14
Total Action 34 27 58 83
Total Co’s
791
754
704
698
687
% of Total
4.3%
3.6%
3.5%
8.3%
12.1%
The number of health companies at action levels declined fairly quickly after 2001 and has now seemed to level off close to 4% of the companies.

13. Principles-Based Capital Property and Casualty RBC
Catastrophe Risk
Potentially use modeling of catastrophe risk in the RBC formula
Allow companies to use their own RMS, Equecat, etc. models
For property and casualty RBC, catastrophe risk has been only partially reflected in the RBC formula.
The Property RBC Working Group is currently considering adding a catastrophe risk component to the P/C RBC formula.
The Working Group is looking at using catastrophe risk models most likely hurricanes and earthquakes.
Companies would allowed to use their own models from modeling firms such as RMS, Equecat, etc.
Certain criteria in the models would likely be specified.

14. Principles-Based Capital Life RBC
C-3 – Interest Rate Risk and Market Risk
C-3 Phase I – 2000
C-3 Phase II – 2005
C-3 Phase III – 2008 or 2009
C-3 Phase IV
Future ?
For Life RBC, a principles-based approach for interest rate risk and market risk (which is referred to as C-3 in combination) began for year-end 2000 and is continuing.

15. C-3 Phase I Interest rate risk of annuities and single premium life
Based on cash flow testing of assets and liabilities
Originally, only companies that triggered one of two tests for materiality
May be changed to a CTE methodology for modeling in the future.
C-3 Phase I
Was for the interest rate risk of annuities and single premium life
It was based on cash flow testing of reserves
Originally, only companies that triggered one of two tests for materiality. That was changed to a majority of the companies for year-end 2006.
The current calculation may be changed to a CTE methodology for modeling similar to the C-3 Phase II methodology.

16. C-3 Phase II
Interest rate risk and market risk of annuities with guaranteed benefits
VAGLB (Variable Annuity with Guaranteed Living Benefits)
GMIB (Guaranteed Minimum Income Benefit)
GMDB (Guaranteed Minimum Death Benefit)
Modeling using a CTE approach
Relatively small number of companies
C-3 Phase II
Was for interest rate risk and market risk of annuities with guaranteed benefits
A VAGLB is a Variable Annuity with Guaranteed Living Benefits. This is a feature of certain variable annuities that provides benefits greater than the contract value under certain conditions.
A GMIB is a Guaranteed Minimum Income Benefit. A GMIB would be a VAGLB for which the benefit is contingent on annuitization of a variable deferred annuity contract.
A GMDB is a Guaranteed Minimum Death Benefit. It would be a VAGLB for which a guaranteed benefit is contingent on the death of a contract holder, annuitant, participant, or insured. 
Modeling would be done using a CTE (conditional tail expectation) approach. The modeling would calculate a total asset requirement (TAR)
A relatively small number of companies were affected. Less than 90 companies calculated an RBC amount the first year and less than 70 the second year.

17. C-3 Phase III Interest rate risk and market risk for life products
Modeling using a CTE approach
Affect a large number of companies
C-3 Phase III is currently under consideration. Several AAA reports have been released for comment and a final or close to final report would be expected soon.
C-3 Phase III would cover interest rate risk and market risk for life products
It would also do modeling using a CTE approach similar to C-3 Phase II.
C-3 Phase III would affect a large number of companies unlike Phase II.

18. C-3 Phase IV Interest rate risk for all annuities
Modeling using a CTE approach
Replace current C-3 Phase I and perhaps Phase II
A report on C-3 Phase IV is expected soon.
It would cover interest rate risk for all annuities
Phase IV would also use a CTE approach to modeling.
It replace current C-3 Phase I and perhaps Phase II (that has not been decided at this point)

19. Future Combine C-3 Phases into one ? Asset Risk ? Insurance Risk ?
Comprehensive internal models ?
The future of a principles-based approach for capital might include the following:
All the C-3 Phases might be combined into one consistent methodology.
The modeling of asset risk might be done.
The modeling of insurance risk might be done.
Perhaps the use of more comprehensive internal models addressing all the risks of the company.

20. Future (Continued) NAIC Overarching Consideration:
Capital standards and compliance measurements should be firmly rooted in an auditing, accounting, and actuarial context that is cost-justified, practical, and workable.
Especially, when regarding an adversarial regulatory action that must proceed based on legal findings.
Any future RBC changes will need to fit into the overall RBC framework to ensure the capital standards and compliance measurements are firmly rooted in an auditing, accounting, and actuarial context that is cost-justified, practical, and workable.
This especially true regarding an RBC regulatory action that needs to be justified in a legal proceeding. This was one of the reasons why a formula-based approach had been chosen when the NAIC RBC was first developed.

21. THANK YOU Walter Bell NAIC President and
Alabama Insurance Commissioner
Vice Chair of IAIS Executive Committee