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Capital Management
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Outline
• NAIC Risk Based Capital Model– Goals – Formula– Risk Categories– RBC Level of Action– C-3 Phase II
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Outline
• S&P Capital Model– Description– Formula– S&P Rating Level– Risk Categories
• Conclusion
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NAIC Risk Based Capital
- Measures minimum amount of capital required to support overall business operations.
- Considers the size and the degree of risk taken by the insurer.
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Goals of NAIC RBC Requirement
• Universally recognized capital standard.
• Protection against short term adverse deviations.
• Prevents companies from taking extraordinary risk.
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Goals of NAIC RBC Requirement
• Assures interested parties that the risk of insolvency is low.
• Authorize regulators to enforce compliance with more capital requirements.
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RBC Formula
• Estimate RBC levels required to manage losses that can be caused by a series of catastrophic financial events.
• Probability of all losses to occur simultaneously is very low.
• Covariance adjustment … combined effect not equal to the sum.
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RBC Formula
• Company Action Level RBC = C-0 + C-4a + [(C-1o + C-3a)^2 + (C-1cs)^2 + (C-2)^2 + (C-3)^2 + (C-4b)^2) ^0.5]
• RBC is compared to TAC.
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Total Adjusted Capital (TAC)
• TAC = Capital and Surplus + AVR + 50% of dividend liability
• AVR is included even though it shows as a liability on the balance sheet.
• AVR absorbs capital gains and losses, whereas in determining the C-1 risk factors it is ignored.
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Types of Risk -
• C-0 - Asset Risk Affiliate• C-1 - Asset Risk Other• C-2 - Insurance / Pricing Risk• C-3 - Interest Rate Risk• C-4 - Business Risk
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C-0 Affiliate Asset Risk
• Measures default risk of affiliates.
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Asset Risk Other (C-1o, C-1cs)
• Default of principal or interest.
• Fluctuation in MV.
• Risk factors are adjusted for the portfolio size and concentration risk factor.
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Insurance Risk (C-2)
• Capital needed to cover excess claims over expected .
• Excess claims could be due to random fluctuations or inaccurate pricing for future claims.
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Insurance Risk (C-2)
• Factors are applied to NAR.
• NAR broken down by size.
• Factors reflect the decrease in risk for larger blocks of business.
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Interest Rate Risk (C-3a, C-3b)
• Risk of loss due to changes in interest rate level.
• Covers mismatch b/w liability and asset cash flows.
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Interest Rate Risk (C-3a, C-3b)
• Impact of interest rate is greater where guarantees are in favor of the policyholder.
• Risk categories vary by withdrawal characteristics.
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C-3 Phase I
• Cash Flow Testing Exemption worksheet.– C-3 Significance Test and Stress Test.
• Performed on Annuities and Single Premium Life.
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C-3 Phase I
• Mostly annuity companies get picked for scenario testing.
• Floor of 50% and cap of 200%.
• Well matched companies usually fall below the 50% floor, hence C-3 factors are reduced by 50%.
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Business Risk (C-4a, C-4b)
• General business risk.
• Factors cover Procedural, Personnel, External and Disaster risk.
• Charge assessed against premiums or annuity considerations subject to guaranty fund assessment.
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Business Risk (C-4a, C-4b)
• No charge for Separate Account business premium.
• There is a charge on the separate account liability.
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RBC Level of Action
• Ratio b/w TAC and RBC determines the level of action by the regulators.
• Different levels of action …• None.• Company Action Level… submit RBC plan• Regulatory Action Level…corrective actions• Authorized Control Level… regulatory actions• Mandatory Control Level… regulatory control
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RBC C-3 Phase II
• Planned to go in effect on 12-31-2004.
• Many companies are suggesting that it be delayed.
• The scope of this regulation includes…• VA and Group VA w/ GMDB and GLB.
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Why S&P?
• Companies rated by S&P.
• S&P more conservative than RBC.
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S&P Capital Adequacy Model
• Determines the amount of capital that S&P expects the company to hold as a safety cushion.
• The model produces Capital Adequacy Ratio (CAR).
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S&P Capital Adequacy Model
• CAR compares adjusted capital to a base level of surplus appropriate to support liabilities.
• CAR is only a starting point.
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S&P Capital Adequacy Model
• S&P Analyst plays a critical role in adjusting the model to assess company specific risks.
• Besides CAR, the company’s mgmt, corporate strategy, liquidity etc. are also considered.
• At the same time analyst maintains a standard of comparability among companies.
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Capital Adequacy Ratio
• CAR = Total Adjusted Capital (TAC) - C-1 (asset related risk)C-2 (pricing risk) + C-3 (int rate risk) + C-4 (oper risk)
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S&P Rating Level
CAR Rating Assessment
< 100% BB or lower Various100% - 125% BBB Good125% - 150% A Strong150% -175% AA Very StrongMore than 175% AAA Extremely Strong
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Total Adjusted Capital
• TAC = Statutory Capital and Surplus + AVR + 50% of the policyholder dividend liability
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Asset Default risk (C-1)
S&P BondCharge
S&PPreferred
Stock Charge
NAIC RBCBond
Charge*
NAIC RBCPreferred
StockCharge*
Class 1 .0051 .0084 .0029 .0081Class 2 .0391 .0652 .0095 .0221Class 3 .0936 .1504 .0339 .0531Class 4 .1740 .2744 .0737 .1106Class 5 .2756 .4036 .1696 .1844Class 6 .3 .6 .1950 .1950
* After tax factors.
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Asset Default risk (C-1)
• Concentration Risk Charge– additional charge– assets w/ credit risk associated with single
issuer are aggregated to assess concentration risk.
• Size factor
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Liability Pricing Risk (C-2)
• Approach similar to RBC.
• Factors for Life Insurance are applied to NAR.
• C-2 factors are more conservative for S&P than RBC.
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Interest Rate Risk (C-3)
• Risk categories are similar to RBC … low to high.
• Some products are classified differently.
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Interest Rate Risk (C-3)
• Low Risk– Life Insurance Reserves– Synthetic GICs
• Medium Risk- Annuity Reserves not withdrawable (xcl.
SPIAs) … considered low risk under RBC.- Annuity Reserves with surrender charge.
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Interest Rate Risk (C-3)
- Structured Settlements- GICs … considered low risk under RBC.- Annuity Reserves with MVA … considered
low risk under RBC.
• High Risk- Annuity Reserves with no adjustments- SPIAs (incl. Pension Buyouts) … considered low
risk for RBC.
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General Business Risk (C-4)
• Approximated by applying factors to Premiums subject to Guaranty Assessment Fund.
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To conclude ...
- S&P factors are more conservative… especially for an annuity company.
- Based on Statutory Accounting, same as NAIC RBC.
- S&P excludes Goodwill.
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To conclude ...
- C3 CFT test in NAIC RBC. S&P recognizes the significant research and is monitoring the effects.
- RBC Factors … after tax
- No covariance adjustment in the S&P formula.