Ashley is an actuary who is employed by the Nebraska Department of Insurance. He

Question

Ashley is an actuary who is employed by the Nebraska Department of Insurance. Her duties include monitoring the financial position of insurance companies doing business in Nebraska. Based on an analysis of annual financial statements that insurers are required to submit, she discovered that Mutual Life Insurance has a risk-based capital ratio of 75 percent. Based on this information, answer the following questions:

a. What is the purpose of requiring insurers to meet risk-based capital requirements?
b. What regulatory action, if any, should the Nebraska Department of Insurance take with respect to Mutual Life Insurance?
c. Would your answer to part (b) Change if the risk-based capital ratio for Mutual Life Insurance fell to 30 percent? Explain your answer.
d. Mutual Life Insurance has 25 percent of its assets invested in common stocks. Assume the stocks are sold, and the proceeds are invested in U.S. government bonds. What effect, if any, will this investment change have on the risk-based capital ratio of Mutual Life Insurance? Explain your answer.

Explanation / Answer

a.) Risk-Based Capital (RBC) is a method of measuring the minimum amount of capital appropriate for a reporting entity to support its overall business operations in consideration of its size and risk profile. RBC limits the amount of risk a company can take. It requires a company with a higher amount of risk to hold a higher amount of capital. Capital provides a cushion to a company against insolvency. RBC is intended to be a minimum regulatory capital standard and not necessarily the full amount of capital that an insurer would want to hold to meet its safety and competitive objectives. Thereby RBC safeguards the company against insolvency risk.

b.) The RBC law provides for four levels of regulatory action. The extent of regulatory intervention and action increases as the level of surplus to RBC falls. The first level, the company action level as defined by the NAIC, requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. The regulatory action level, as defined by the NAIC, requires an insurer to submit a plan containing corrective actions and requires the relevant insurance commissioner to perform an examination or other analysis and issue a corrective order if surplus falls below 150% of the RBC amount. The authorized control level, as defined by the NAIC, authorizes the relevant insurance commissioner to take whatever regulatory actions considered necessary to protect the best interest of the policyholders and creditors of the insurer which may include the actions necessary to cause the insurer to be placed under regulatory control, i.e., rehabilitation or liquidation, if surplus falls below 100% of the RBC amount.

c.) The fourth action level is the mandatory control level as defined by the NAIC, which requires the relevant insurance commissioner to place the insurer under regulatory control if surplus falls below 70% of the RBC amount.

d.) This will reduce the risk as goverment bonds are perceived to be of lower risk than common stocks. Thus their RBC will increase for the same level of capital.

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