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  • What is a risk based capital system?
  • July 25, 2013
  • Tony Steuer

    By Tony Steuer, CLU, LA

    The Risk Based Capital (RBC) is a risk assessment tool used by insurance commissioners to determine the status of an insurance company. It’s used to identify any current or potential risks that an insurance company may run across.

    In 1992, the National Association of Insurance Commissioners (NAIC) developed this standard, which was first designed to gauge the minimum amount of capital for a given life insurance company.

    RBC was designed to identify inadequately capitalized life and health insurance companies. It was intended to provide a uniformly applied guideline for regulatory intervention and to enable regulators to take specific action before a company becomes insolvent.

    Currently, this system is only used by State Insurance Regulators, but is hoped to be available to the public soon.

    The Risk Based Capital (RBC) is a tool used by insurance commissioners to determine any risks a life insurance company may face.

    Risk Based Capital is the amount of capital – i.e., assets minus liabilities – deemed to provide a minimum financial cushion, in light of a company’s size and risk profile, which is calculated by applying factors to various elements found in the company’s Annual Statement.

    The Annual Statement is a voluminous document that each company must file with every state insurance department, in which the company has a certificate of authority to do business.

    RBC factors are higher for items with greater underlying risk, while lower for less risky items.

    For example, some lines of coverage are considered riskier than others, and RBC takes the relative risk into consideration.

    RBC is not meant to be a measure of the appropriate amount of capital, but rather the minimum amount with which state insurance regulators feel comfortable.

    The RBC standard measures four primary risks – asset default risk, adverse experience risk, interest rate risk caused by changes in interest rate levels and general business risk. Actuaries refer to these as the C-1, C-2, C-3, and C-4 risks.

    It was designed to penalize companies with major investments in real estate and common stock, or those that are engaged in riskier lines of business.

    On the other hand, RBC rewards companies with more conservative investments or in less volatile lines of business.

    The RBC system is a spectrum or continuum of increasingly stringent regulatory responses for companies that trigger one of the following RBC action levels:

    Company Action Level:

    A level where the insurer must submit to the insurance commissioner a comprehensive financial plan. The plan must identify the conditions contributing to the company’s financial condition; contain proposals to correct the company’s financial problems and provide projections of the company’s financial condition both with and without proposed corrections.

    Regulatory Action Level:

    In addition to the company action level, the insurance commissioner performs any examinations or analysis of the insurer’s business and operations that are deemed necessary and issues appropriate corrective actions.

    Authorized Control Level:

    In addition to the following levels, the commissioner may place the insurer under regulatory control.

    Mandatory Control Level:

    The insurance commissioner is required to place the insurer under regulatory control.

    Difference in the makeup of RBC by asset size, makes it difficult to establish meaningful comparisons between an individual insurer’s RBC results and those of the industry.

    Because the general public may misinterpret RBC ratios, they are not available to the public. In fact, release of RBC data to the public is strictly prohibited. State Insurance Commissioners and affected companies should be the only ones to use this information.

    Limited information about RBC can be found on the NAIC website.


About Tony Steuer

Noted insurance author Tony Steuer has spent over 25 years in the life insurance industry. Steuer’s leadership roles include serving on the California Department of Insurance Curriculum board and the National Financial Educator's Council Curriculum Advisory Panel as well as having served as President of the San Francisco Chapter of the American Society of CLU & ChFC, President of the leading Life Insurance Producers of Northern California, and as a board member of the San Francisco Life Underwriters Association. Mr. Steuer is the author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, The Questions and Answers on Life Insurance Workbook and The Questions and Answers on Disability Insurance Workbook - the first two were awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy. Steuer holds a Chartered Life Underwriter (CLU) designation and also holds the Life and Disability Insurance Analyst License, a designation that is held by less than thirty people in California.

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Questions & Answers on Life Insurance by Tony Steuer, CLU, LA, CPFFE is licensed under a Creative Commons Attribution 3.0 Unported License.

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