Property-Casualty Risk-Based Capital Requirement - A Conceptual Framework

This paper develops a conceptual framework for a risk-based capital requirement for property-casualty insurance companies. It has been written to assist the National Association of Insurance Commissioners (NAIC) as they work on developing appropriate risk measurements in the context of a series of initiatives designed to improve solvency regulation. We believe the NAIC will find this paper useful. Risk-based capital is the theoretical amount of capital needed to absorb the risks involved in the operation of a business. Different companies face different risks and, therefore, should have different levels of capital based on those different risks, rather than on some arbitrary basis. The major areas of risk facing a property-casualty insurance company include asset risk, reserve risk, pricing risk and credit risk. State regulators of property-casualty insurance companies have had two tools with which to monitor required capital. One is a statutory minimum capital and surplus requirement which has been characterized as unrealistic and archaic, and the other is a premium-to-surplus rule-of-thumb, which does not effectively reflect relative riskiness. Many regulators feel they lack the statutory authority to require a company to increase their capital until the company’s surplus falls below the statutory minimum. A risk-based capital requirement would help raise that safety net up off the floor and could apply uniformly in all states as a threshold capital requirement.