What to Know About the 2021 Risk-Based Capital Formulas

Thoughtware Alert Published: Nov 23, 2021
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It is normal that the Risk-Based Capital (RBC) formulas change every year. Some years see major changes, and other times changes are minor or routine. Regardless of why the formulas change, it is often hard to predict how those changes will affect individual insurance companies. It is never too early to try to analyze the effect revisions will have on company results.

Changes for the 2021 formulas have been in place for several months now, but it is probably a good idea to refresh everyone’s memory as to what those changes are. Items in bold are meant to help those who like to scan an article for applicable subjects instead of reading it in its entirety. 

Let’s start with changes that will be seen in all, or at least more than one, formula.

Multiple Formulas

Back in July, we posted an article entitled “A Short History of the Risk-Based Capital (RBC) New Bond Factors.” The article included details of this year’s bond changes, which will not be repeated here. It might be a good idea to review that article. 

Many companies, however, are trying to gauge how much of an impact these changes will have on their RBC calculation and thus on their capital and surplus requirements. That is hard to quantify. At the beginning of the bond project, most anticipated the changes would be “surplus neutral.” That is not the case. 

Results will vary greatly between different-sized insurers. One source has provided the following guesstimates:

Property RBC

TAC Size
0–5M 5M–25M 25M–75M 75M–250M 250M–1B More Than 1B Total
R1 % change 141.2% 189.0% 168.7% 145.2% 116.8% 81.2% 94.5%
ACL % change 0.5% 3.7% 2.9% 1.6% 0.6% 0.2% 0.3%

Health RBC

TAC Size
0–5M 5M–25M 25M–75M 75M–250M 250M–1B More Than 1B Total
H1 % change 7% 24% 28% 26% 15% 16% 17%
ACL % change 0.204% 0.161% 2.345% 0.393% 0.734% 1.439% 1.008%

But the most important influencer of a company’s change will be its bond portfolio. Those companies having more risk in their portfolios will see different effects than those with “safer” portfolios. For example, in the PRBC only two bond designation categories are seeing a reduction in their factors. All other designation categories have factor increases, with many of 100 percent and several above 200 percent. In the HRBC, all of the designation categories had increases in factors except for those with a 1A, which had no change. Now, the good news is the assets part of both of these formulas are not heavily weighted in the formulas; the underwriting and investments sections affect formula results much more heavily.

In looking at just the change in the bond factors, it has been estimated that Property/Casualty and Health companies will most likely see a change in their RBC ratio in the range of -5 percent to +5 percent.

It is a different story in the Life/Fraternal RBC where assets significantly influence the LRBC results. In this formula, overall factors are higher for bonds with an ARO (accepted rating organization) rating of A, BBB, BBB-, BB-, B-, and CC bonds, but are lower for the BB+, B+, and CC+ rated bonds. However, unlike the other two formulas, there are only two designation categories where the factor increase was more than 100 percent. The estimated effect on Life and Fraternal insurers would require around an 18 percent increase in capital and surplus for industry as a whole. 

The receivables for securities factor was updated for all of the formulas. This part of the formula is not usually significant for most insurers but can be a contributing factor for an overall change in RBC results. The new factors are as follows:

  2021 Previous
Life/Fraternal .015 .014
Health .024 .025
Property/Casualty .020 .025

Most of the other changes applicable to all of the formulas will only affect those insurers reporting health business. Those revisions were:

  1. Deletion of the ACA Fee Sensitivity Test.
  2. Clarification that both incentives and bonuses are to be included in the Managed Care Credit
  3. Changes in the Health Underwriting Risk factors for comprehensive medical, Medicare supplement, dental, and vision coverages to include a 5 percent investment income adjustment, but also increase the factor to four decimal points. The result is a slight (very slight) decrease in these factors. 

Wrapping up this section, there are a couple of changes that are being applied to only the PRBC and HRBC. The method for pulling in bond amounts from the annual statement was changed. There’s no change in what is being pulled in, only how. In addition, beginning this year, hybrid securities will no longer be treated as equity investments, but instead will be reported as bonds. (The LRBC already had this treatment for hybrids.)

Now, let’s move on to changes to be found only in the individual formulas.

Life/Fraternal RBC

The real estate factors have been revised and are significantly lower than in the past.

  2021 Base Factor 2021 Encum Factor 2020 Base Factor 2020 Encum Factor
Occupied RE .110  .0175 .150   .120
Foreclosed RE .110  .0175 .230 .200
Investment RE .110  .0175 .150   .120
Sch BA RE .130 .0175 .230 .200

Factor comparison between periods, however, can be misleading because of a change in the methodology of arriving at the amount to which the factor is applied. Consequently, the above comparison is not exactly fair; it's not the same playing field.

The LRBC has a new section that will definitely cause a change in RBC results—the Longevity Risk. This new section first appeared in the 2020 formula but was for information gathering only; no factors were applied. That means nothing affected 2020 RBC results. Regulators used that provided 2020 information, however, to help determine the factors being applied this year. The new factors are as follows:

New factors

Regulators are cautioning companies to read the instructions for this reporting carefully. Because no factors were applied last year, there was some question as to whether insurers correctly reported amounts. Results will be included in the final RBC calculation this year, making accuracy imperative. 

And finally, for the LRBC, a minor word change in the reinsurance recoverables section indicates recoverables from reciprocal jurisdiction reinsurers are to also be included. 

Property/Casualty RBC

Moving on to the PRBC, the underwriting risk factors underwent their annual update. Below is a comparison of the new and previous factors.

Schedule P Line of Business PR017


H/F .998 .993 .681 .678
PPA 1.026 1.035 .795 .810
CA 1.083 1.078 .761 .759
WD .912 .916 .682 .705
CMP .999 1.016 .673 .672
MM Occ. .874 .861 .731 .726
MM Clms Made .973 .940 .821 .797
SL .976 .963 .593 .603
OL .964 .968 .635 .639
Fidelity/Surety .915 .907 .384 .384
Special Property .978 .977 .559 .553
Auto Physical Damage .989 .993 .726 .732
Other (Credit, A&H) .965 .971 .693 .684
Financial/Mtg Gty .723 .682 .252 .513
International 1.104 1.162 .769 .758
Rein. Pro/Fin .893 .886 .558 .534
Rein. Liability .989 .985 .713 .708
PL .879 .900 .617 .645
Warranty 1.007 1.013 .681 .691

Instructions were modified for the PR027 interrogatories clarifying that insurers with no gross exposure to earthquake or hurricane risks are still supposed to complete the interrogatories. Companies that do not write or assume earthquake risks should indicate so in question three, while those not writing or assuming hurricane risks indicate so in question six. The responses to the interrogatories are needed so those reviewing the PRBC can determine which companies are exempt from the catastrophe risk charge.

Staying within the catastrophe risk, both the earthquake and hurricane contingent credit risk factors were decreased from .048 to .018. The reduction was needed to remove an embedded 3 percent operational risk component, since operational risk is now addressed as a separate part of the formula. 

Examples were added to the R3 – Credit Risk for Receivables instructions regarding the correct method to convert credit ratings for reinsurers into “Secure” ratings for use in the PRBC formula. It should be noted that although the examples were added to the PRBC instructions, the actual Secure Rating is first reported in the annual statement Schedule F – Part 3 and from there is pulled into the formula for use.

The Catastrophe Risk Subgroup has exposed for comment proposal 2021-16-CR, which lists the U.S. and non-U.S. catastrophic events from January through October 2021. The subgroup could adopt the list by an email vote or wait until its next scheduled meeting in December. Either way, it may be amended for any additions prior to year-end. 

Health RBC 

The HRBC isn’t undergoing many formula-specific changes. With the expansion of bond reporting categories, it was necessary to change the reporting format slightly. The reporting for bonds and miscellaneous assets was divided into two pages. 

There was an inconsistency in a calculation occurring on page XR021, line 17 between the published formula (and instructions) and the forecasting spreadsheet made available from the NAIC. The forecasting spreadsheet was corrected to match the formula and instructions by adding a MAX function to the line 17 calculation. 

That’s it for HRBC. But don’t forget there are items discussed in the multiple formulas section that affect this formula. 

There You Have It

Do you feel more prepared for this year’s RBC? If you want to view all of these changes as they were adopted, they can be found here. In addition, the annual publication of the formulas, instructions, and the forecasting spreadsheet is now available through the NAIC. 

Hopefully this information will also give those individuals who have the task of explaining changes in RBC results to management, or even the board of directors, enough information to be able to pinpoint changes caused by formula revisions. Unfortunately, it will not help if a company changed anything else in its risk profile. 

For more information, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.

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