RBC

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Based on past exams, the main things you need to know (in rough order of importance) are:

reference	part (a)	part (b)	part (c)	part (d)
E (2018.Spring #18)	calculate: - change in RBC charge	rapid premium growth: - impact on RBC
E (2017.Fall #17)	calculate: - RBC ratio	calculate: - RBC action level
E (2017.Fall #18)	financial health: - use of RBC ratios	R0 RBC charge: - difference vs R1,2,3,4,5	RBC vs IRIS: - similarity & difference
E (2017.Spring #19)	calculate: - total RBC	calculate: - RBC RAL1	RAL actions: - insurer & regulator
E (2016.Fall #16)	RBC risk categories: - identify 2	RBC purpose: - for regulator
E (2016.Fall #17)	rbc require
E (2015.Fall #17)	r1r2
E (2015.Spring #19)	written
E (2015.Spring #25)	multiple areas
E (2014.Fall #18)	multiple areas	error in exam question	see pg 607 in pdf
E (2014.Spring #20)	multiple areas
E (2013.Fall #21)	rbc require
E (2012.Fall #14)	see Odo 8-9	asset risk of RBC
E (2012.Fall #20)	calc RBC	see IRIS	RBC vs IRIS growth charge
E (2012.Fall #24)	multiple papers (Bloom's Taxonomy)

¹ RAL stands for Regulatory Action Level

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In Plain English!

Alice's 1st Day

On Alice's first day of work as an actuarial intern, her mean boss dumped a stack of financial statements on her desk and told her to find out whether the company was healthy. But before she could ask him anything, he was already down the hall issuing orders to someone else. "Jackass," she thought. Poor Alice had no idea what to do. Fortunately the intern in the next cubicle overheard and peeked over the cubicle wall.

"Just calculate the RBC ratio," her new friend said. "It's all in Odomirok. The boss likes to haze the newbies on their first day, but I can help you. We'll tackle it together."

So Alice and Lakshmi spent an hour pulling the relevant information from the financial statements and here is what Alice learned:

Formula: RBC ratio = TAC / ACL (sounds like tackle)

TAC = Total Adjusted Capital = 31,024,000

ACL = Authorized Control Level = 5,552,182

==> RBC ratio = 31,024,000 / 5,552,182 = 559%

Ok, so far, so good, but WTF does 559% mean? Is that good or bad? (The following table appears near the end of chapter 19 of Odomirok)

action level	threshold	insurance dept action	company action
CAL (Company Action Level)	200%	none (initially)	must submit action plan to meet RBC standards
RAL (Regulatory Action Level)	150%	commissioner may take corrective action	must submit action plan to meet RBC standards
ACL (Authorized Control Level)	100%	commissioner may take control of company	none (initially)
MCL (Mandatory Control Level)	70%	commissioner must take control of company	none (initially)

The RBC ratio of 559% for Alice's company is way above the CAL threshold, so it looks like the company is doing really well. What a great first day of work for Alice! Go home and relax!

Alice's 2nd Day

Over morning coffee, Lakshmi pointed out an ommission from the above "action table" that Alice learned about yesterday. If the RBC ratio is above 200% but below 300%, the company is still not in the clear. They would still have to perform the trend test. Let COR denote Combined Operating Ratio:

Trend Test: If a company's RBC ratio is in the 200-300% range and also has a COR > 120% THEN they are subject to the CAL action from the action table.

Reminder: The COR (Combined Operating Ratio) is the sum of:

• loss & LAE ratio (CY net incurred loss & LAE divided by NEP)
• dividend ratio (policyholder dividends divided by NEP)
• expense ratio (other U/W expenses + small miscellaneous items divided by NWP)

Recall that COR does not include investment income.

Anyway, Alice's new company is well above the 300% threshold so she was ready to report back to her boss that the company is in great shape, but Lakshmi stopped her.

"Not so fast," Lakshmi said. "The RBC ratio is only 1 metric. For example, what about the IRIS ratios? It's like if you had 98% in calculus on your report card but were failing physics, English, and history? It isn't likely, but when you report back to the boss, you should qualify your conclusion on the health of the company based only on the RBC ratio."

You can review NAIC.IRIS for the IRIS ratios, but getting back to the RBC ratio, we need to make sure we understand how the 559% value was calculated. It's a long calculation and that involves 6 different risk components. The charge for each component represents the amount of capital required to support that particular risk. (Each component has it's own calculation but we'll come back to that later.)

risk category	risk component	notation	risk charge for this company
asset risk	affiliated insurance company risk	R0	0
asset risk	fixed income risk	R1	553,398
asset risk	equity risk	R2	4,303,948
asset risk	credit risk	R3	720,373
U/W risk	reserve risk	R4	9,542,613
U/W risk	NWP risk	R5	3,591,141

You might think you'd sum these 6 charges to find the total required capital, but that isn't how it works. Rather than a simple sum, these risk charges are aggregated using this formula:

Formula: RBC Capital Required = R0 + sqrt(R12 + R22 + R32 + R42 + R52)

The part of the forumla with the square root is called the covariance adjustment.

Pop Quiz!    :-o

Question: Is the covariance adjustment less than, greater than, or equal to the simple sum of R₁ through R₅?

Answer: The covariance adjustment is less than the simple sum of R₁ through R₅. (Try testing is with some simple numbers. It's a version the triangle inequality you may be familiar with from calculus.)

temp section

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BattleCodes

Memorize:

Conceptual:

Calculational: