Risk-based capital: how regulators spot a failing insurer early

Risk-based capital, or RBC, is a formula that sets the minimum capital an insurer should hold given the size and riskiness of its business, and regulators compare the insurer's actual capital to that figure. A ratio of 200 percent or below begins a ladder of required responses, from filing a corrective plan to a regulator taking over management, and below 70 percent the takeover is mandatory. It is one early-warning tool among several, and it is built for regulators, not for shoppers.

If your car insurer is weakening, you will probably see the first signs of it in regulatory filings and ratios long before anything reaches your mailbox. This article explains what those tools are, what each trigger point means, what happens when a department escalates, and how much a policyholder can safely read into any of it.

What risk-based capital measures

An insurer's capital (often called surplus in insurance accounting) is the cushion that absorbs bad years: a wave of claims, a reserve estimate that turns out too low, a drop in the value of its investments. Older capital rules in many states were flat dollar minimums that did not change with the risk an insurer took. RBC adds a formula test in which an insurer that writes more business, holds riskier assets or carries thinner reserves must hold more capital.

The NAIC describes RBC as a statutory minimum level of capital that depends on an insurer's size and the riskiness of its assets and operations, used so regulators can identify weakly capitalized companies and intervene early. Separate formulas exist for life, property and casualty, and health insurers; car insurers use the property and casualty formula. The same NAIC page is explicit about limits: RBC is not a stand-alone solvency tool and is not meant to rank insurers.

The core number is the capital sufficiency ratio:

Total adjusted capital divided by authorized control level RBC.

Total adjusted capital is the insurer's statutory capital and surplus with specified adjustments. Authorized control level (ACL) RBC is the amount the formula produces. For a property and casualty insurer, the formula applies charges to categories such as investments, credit exposure, loss reserves, written premiums and catastrophe exposure, then combines them. If you want the underlying accounting concepts, how to read an insurer's combined ratio and surplus covers surplus and the combined ratio.

The action levels

The NAIC's RBC page gives the broad bands: at 300 percent or above "no regulatory intervention is needed"; from 200 to 300 percent an insurer is subject to a trend test; below 200 percent the range of interventions runs from submitting action plans to a takeover; and below 70 percent a regulator "is obligated to take over management of the company."

States put the details in their own statutes and rules, which follow the NAIC's model act. The clearest statement I opened is Texas's rule on RBC, 28 Texas Administrative Code section 7.402, which spells out four levels for the ratio of total adjusted capital to ACL:

Two more details matter. First, the rule applies a trend test to property and casualty insurers between 200 and 300 percent: if the formula's trend test comes back "yes," the insurer triggers regulatory attention at the company action level even though its ratio is above 200. The idea is that a company that looks adequate today but is sliding fast needs a look before it crosses the line. Second, the commissioner has discretion at every level above, and the rule says that the level "is calculated and reported annually." That one sentence explains a lot about what RBC can and cannot catch, which we return to below.

The names of the four levels (company action, regulatory action, authorized control, mandatory control) come from the NAIC model act, and other states use the same structure. The percentages and procedures can differ in other states' wording, so confirm with your state's insurance department, or look for the state's RBC statute in its insurance code.

A worked example

This example is hypothetical and uses made-up numbers; it is not data about any insurer.

Say an insurer's formula produces authorized control level RBC of $50 million. The table shows what different amounts of total adjusted capital would mean under the Texas bands described above.

The same company can move down this table in a single year. A $60 million reserve increase would take the $130 million insurer to $70 million of capital, a ratio of 140 percent, without any change in its formula result. That is why regulators care about reserves so much, and why the IRIS ratios (next section) include three reserve-development measures.

The filings regulators rely on

RBC is calculated from the annual statutory financial statement, so the quality of the early warning depends on what insurers report and how often. In Texas, 28 Texas Administrative Code section 7.68 requires licensed insurers to file:

• An annual statement, due on or before March 1 for the preceding calendar year, with the Texas Department of Insurance in paper form and electronically with the NAIC.
• Quarterly statements, due on or before May 15, August 15 and November 15.
• A statement of actuarial opinion, due March 1, in which an appointed actuary opines on whether the insurer's reserves are reasonable.
• Various supplements adopted by the NAIC, including Management's Discussion and Analysis.

Texas also directs carriers to file their RBC reports electronically with the NAIC by the dates in the RBC instructions. Other states have their own statutes and rules, and the dates often follow the same pattern, but verify them for the state where an insurer is domiciled. The state where an insurer is headquartered or chartered, called its domiciliary state, takes the lead in monitoring it; other states in which it is licensed rely heavily on that work.

Two features of the filings are worth noting. They follow statutory accounting, a conservative standard built for solvency rather than for investors, which is different from the accounting a stock insurer shows its shareholders. And because the statements are filed with every state where the insurer is licensed, no one department can examine all of them closely at once, which leads to the next tool.

IRIS ratios: triage for thousands of companies

The NAIC's Insurance Regulatory Information System (IRIS) exists because of a resource problem. The manual (2019 edition) says it plainly: "No state is able to thoroughly review the financial condition of all licensed insurers immediately upon receipt of the financial statements." IRIS generates key ratios from each insurer's annual statement to highlight "those insurers that merit the highest priority in the allocation of the state insurance regulators' resources."

For property and casualty insurers the manual lists 13 ratios in four groups:

• Overall: gross premiums written to policyholders' surplus, net premiums written to surplus, change in net premiums written, and surplus aid to surplus.
• Profitability: two-year overall operating ratio, investment yield, gross change in surplus and change in adjusted surplus.
• Liquidity: adjusted liabilities to liquid assets, and agents' balances in collection to surplus.
• Reserves: one-year reserve development to surplus, two-year reserve development to surplus, and estimated current reserve deficiency to surplus.

Each ratio has a published "usual range." In the 2019 manual, for example, the usual range for gross premiums written to surplus includes results up to 900 percent, and for net premiums written to surplus results up to 300 percent. A result outside the range is flagged. The reason these ratios make sense for car insurers is the same as for RBC: premiums written are a rough measure of how much risk the insurer has taken on, and surplus is the cushion that absorbs it.

The manual is candid about what the numbers do not prove. A ratio outside the usual range "is not necessarily considered adverse," and in some years "it may not be unusual for financially stable insurers to have several ratios with results outside the usual range," because, for instance, a swing in the stock market can change surplus and thereby many ratios at once. Its stated limitations include that the tool "cannot identify a misstatement of financial condition," that "no state can rely on the tools' results as the state's only form of surveillance," and that the criteria "may not be valid for future experience in different economic periods." The manual also says the reports are "made available to state insurance regulators and interested parties" and that it is meant to help the public understand the ratios, but the numbers are screens, not grades.

Analysts, examinations and accreditation

Ratios decide which companies get a closer read. Financial analysts at the domiciliary department then review the statements, the actuarial opinion, the auditor's report and the RBC result, and ask the insurer questions. If concerns persist, the department sends examiners to the insurer's offices.

Whether a department does this work well is itself monitored. The NAIC's accreditation program exists "to develop and maintain standards to promote effective insurance company financial solvency regulation." Departments "undergo a comprehensive review by an independent review team every five years," with interim annual reviews and a desk audit each year, and the program "requires risk-focused financial surveillance including on-site examinations." Accreditation matters because it lets states rely on one another's work: the other states in which an insurer is licensed do not each duplicate the domiciliary state's exam.

For how departments examine claims handling and customer treatment (a different kind of exam from financial exams), see market conduct exams and regulatory actions against insurers.

When the department steps in

If RBC, IRIS ratios or an examination show a serious problem, the commissioner has a set of increasingly forceful tools, all governed by state law. The NAIC's receivership page says that every state, the District of Columbia, Puerto Rico and the U.S. Virgin Islands have enacted statutes patterned on three NAIC model acts, and that the insurance commissioner is typically appointed as receiver. It describes three forms of receivership:

1. Conservation. The receiver studies the insurer's condition and decides what comes next. The NAIC says that conservation "allows the receiver to analyze the company's financial condition."
2. Rehabilitation. The regulator, which must first prove a specific statutory ground, takes the company in hand to correct what led to the receivership and return it to the market. The order may limit new business, suspend claims payments, freeze cash values and halt dividends, and may require capital from a parent or shareholders.
3. Liquidation. If rehabilitation is not feasible, the receiver gathers and distributes the insurer's assets under the state's priority scheme. Courts have held that the liquidation order effectively cancels outstanding policies.

Short of receivership, departments also use less drastic tools: supervision, orders to stop writing new business, restrictions on dividends and approval requirements for transactions. The what happens if your car insurer goes insolvent guide covers what happens to your policy and your claim after a liquidation order, including how a state guaranty fund steps in. For how companies leave a state without failing, see why insurers pull out of a state, or stop writing new policies.

RBC compared with a private rating

A shopper is far more likely to run into an AM Best rating than an RBC ratio. The two measure related things for different audiences.

AM Best's rating is a private opinion that includes judgment about things a formula cannot see, such as how a company is managed or how dependent it is on a single line of business. RBC is mechanical, which makes it consistent and hard to argue with but also limited to what the formula captures. For how the grades work and where agencies disagree, see AM Best financial strength ratings explained, Financial strength ratings compared: AM Best, S&P, Moody's, Demotech and what an insurer downgrade means for policyholders and lenders.

The Texas rule also keeps RBC out of rate regulation. It says the RBC instructions and related filings are "intended solely for use by the commissioner in monitoring the solvency of carriers," and may not be used in ratemaking or as evidence in a rate proceeding. A weak RBC ratio therefore does not automatically show up in your premium, and a strong one does not lower it.

What policyholders can and cannot infer

Treat RBC and IRIS as part of why regulators are an early-warning system, not as a grade you can look up.

What you can reasonably infer:

• A licensed (admitted) insurer in good standing has passed through the filing and review system described above. admitted insurer status also determines whether the state guaranty fund covers you.
• An insurer placed in supervision or rehabilitation is under formal regulatory control, which is public information.
• A downgrade by a rating agency or a department announcement is more actionable for a shopper than any internal ratio.

What you cannot infer:

• That an insurer will not fail because it was above 200 percent last year. The ratio is annual and backward-looking, and events such as a catastrophe season, an adverse reserve change or a fraud can move capital quickly.
• That a low ratio means failure is imminent. A company at the company action level is required to file a corrective plan, which the commissioner then reviews.
• That a strong RBC ratio means good claims service. Solvency and service are separate questions; the NAIC complaint index and your state's complaint data speak to service.
• Anything about a specific company from this article. The ratios are computed from filings that insurers make with regulators, and any claim about a named company should come from a current source.

Questions to ask before you rely on an insurer's strength

If you want to check the financial footing of your car insurer, a short routine works better than hunting for an RBC figure.

1. Find the full legal name of the insurer on your declarations page. Several companies often share one brand name.
2. Confirm it is licensed in your state on the department of insurance website.
3. Look up its current financial strength rating from at least one agency and note the date.
4. Read the department's news and enforcement pages for supervision or rehabilitation orders.
5. Check the complaint data the department or the NAIC publishes.
6. Confirm your state's guaranty fund coverage limit (see what happens if your car insurer goes insolvent).

Rules vary by state, so use state car insurance requirements lookup and the department's site for the details that apply where you live.

Common questions

Can I see my insurer's RBC ratio?

Not routinely. RBC reports go to regulators, and the NAIC describes RBC as a regulatory tool rather than a ranking. Texas's rule bars carriers and agents from publicizing components of the calculation except as the rule requires. What is public includes ratings from agencies, the statutory annual statements in many states and departments' enforcement orders. Ask the department what it can release for your state.

Is a company at 200 percent in trouble?

It is at the edge of the first intervention band. The NAIC says the 200 percent level is where interventions begin to be required, and the trend test applies up to 300 percent. But the percentage alone does not predict failure; a regulator reading the plan the company files is in a better position than an outsider to judge it.

How is RBC different from the minimum capital a state requires to get a license?

A license generally requires a minimum capital and surplus set by state law. RBC is a second test tied to the risks actually taken. Texas's rule says its limitations "do not reduce the amount of capital and surplus otherwise required by the Insurance Code," so both apply.

Do the same rules apply to a Texas county mutual, a reciprocal exchange or a surplus lines insurer?

Not necessarily. The Texas rule itself carves out some entity types and treats county mutuals under particular criteria, and unlicensed or surplus lines insurers fall outside most guaranty fund protection. See admitted vs surplus lines insurers: what it means for your protection.

What should I do if my insurer is placed in rehabilitation or supervision?

Keep paying premiums and keeping coverage in force unless the department or the insurer tells you otherwise, and read all notices. The department's notice will explain whether claims are being paid and how policies are being handled. A licensed attorney or the state insurance department can advise on specific situations.

Key takeaways

• RBC compares an insurer's capital to a risk-adjusted benchmark; below 200 percent of authorized control level, state law begins requiring corrective action, and below 70 percent a takeover is mandatory.
• In the Texas rule, the four levels are company action (150-200%), regulatory action (100-150%), authorized control (70-100%) and mandatory control (under 70%), plus a trend test between 200 and 300 percent.
• RBC works with annual and quarterly filings, 13 IRIS screening ratios for property and casualty insurers, analyst review, examinations and NAIC accreditation of departments.
• The NAIC calls RBC a regulatory tool and not a ranking, and IRIS's own manual says an unusual ratio is not necessarily adverse.
• A policyholder is better served by checking a current rating, the department's enforcement pages and guaranty fund coverage than by trying to infer an insurer's health from an RBC percentage.