By: Marife Umali and Pearl Mabutas

Term Paper

Compliance of Phil. Non-Life Insurance Companies to Risk-Based Capital as

Imposed by the Insurance Commission

Problem Statements

What is the current measurement being used by the Insurance Commission (IC) to monitor the capitalization of an insurance company with respect to its risk exposure?

What are the underlying factors of the Risk-Based Capital (RBC) requirement as formulated by IC?

What are the reasons why most of the non-life insurance companies are not complying with the RBC requirement?

Objectives

To know the possible adjustment in the RBC requirement.

To know the possible regulatory measure to ensure compliance of the RBC requirement.

Assumptions

Most of the non-life insurance companies are not complying with the RBC requirement.

Insurance Commission has no regulatory measure to ensure compliance of RBC requirement.

The RBC framework formulated by the Insurance Commission is not applicable in the Philippines

Scope and Limitations

Phil. Non-Life Insurance Industry

Compliant and Non-compliant Insurance Companies (Random Sampling)

Insurance Commission’s Regulation on Capitalization

Review of Related Literature

Capitalization Defined

- Shareholder’s equity (for publicly traded insurance companies) and retained earnings (for mutual insurance companies). (Insurance Information Institute)

- Equity interest of the owner in the business, e.i. the difference between asset and liability, also called equity or networth. (www.allbusiness.com)

- The money contributed by the proprietors to an organization to enable it to function. (www.encyclopedia.com)

Review of Related Literature

Capitalization as Defined in the Insurance Industry

- Is the cushion in a financial institution’s balance sheet that protects the interests of claimants of the company.

- Specifically, for insurance companies, the role of capital is to provide assurance to policy holders that their claims will be honored.

- The amount of capital an insurer requires should be related to the size of the potential losses the company could sustain under adverse circumstances.

Review of Related Literature

NAIC Risk Based Capital

- Measures minimum amount of capital require to support overall business operations.

- Considers the size and the degree of risk taken by the insurer.

Purposes of NAIC Risk Based Capital

- Is to determine a level of required capital that varies from company to company in accordance with the deemed riskiness of each company.

- Is to help regulators identify companies that are weakly capitalized before they actually become insolvent.

Review of Related Literature

Goals of NAIC Risk Based Capital

- Universally recognized capital standard.

- Protection against short term adverse deviations.

- Prevents companies from taking extraordinary risks.

- Assured interested parties that the risk of insolvency is low.

- Authorize regulators to enforce compliance with more capital requirements.

Review of Related Literature

Components of RBC Framework

- RBC formula that establishes a hypothetical minimum capital level that is compared to a company’s actual capital level.

- RBC model law that grants automatic authority to the insurance regulator to take specific actions based on the level of impairment.

Review of Related Literature

RBC Formula

_______________________ R0 + √R12 + R22 + R32 + R42 + R52

R0 – Asset Risk – Subsidiary Insurance Companies; R1 – Asset Risk – Fixed Income; R2 – Asset Risk – Equity; R3 – Asset Risk – Credit; R4 – Underwriting Risk – Reserves; R5 – Underwriting Risk – Net Written Premium.

RBC is compared to TAC

Review of Related Literature

Total Adjusted Capital

TAC = Capital and Surplus + AVR + 50% of dividend liability

- AVR is included even though it shows as a liability on the balance sheet.

RBC Level of Action

- Ratio between TAC and RBC determines the level of actions by the regulators.

Review of Related Literature

Different levels of actions

- None.- Company Action Level… submit RBC plan- Regulatory Action Level… corrective actions- Authorized Control Level… regulatory actions- Mandatory Control Level… regulatory control

Review of Related Literature

Capitalization Requirement of Non-life Insurance Company

New Insurance Company – Paid-up capital to at least Php75M and a contributed surplus fund of at least Php25M.

Increase of paid-up capital of existing Non-life Insurance Company – Php50M

- Insurance Code of the Philippines

Secs. 184-193 Title 1 – Insurance Companies: Organizations, Capitalization, and Authorization

Review of Related Literature

Top Non-Life Insurance according to Paid-Up Capital

1. Malayan Insurance Company, Inc. 845,292,500.00

2. Standard Insurance Company, Inc. 600,000,000.00

3. Philam Insurance Company, Inc. 581,056,700.00

4. Mapfre Insular Insurance Corporation 500,000,000.00

5. UCPB General Insurance Co., Inc. 400,000,000.00

6. BPI/MS Insurance Corporation 350,000,000.00

7. New Hampshire Insurance Company 329,276,092.00

8. PNB General Insurers Company, Inc. 312,000,000.00

9. Pioneer Insurance & Surety Corporation 300,000,000.00

10. Alliedbankers Insurance Corporation 282,500,000.00

Review of Related Literature

RBC Framework as formulated by IC

______________________________________ RBC Requirement = √R12 + R22 + (0.5 * R3)2 + (0.5 * R3 + R4)2 + R52

R1 – Fixed Income Securities; R2 – Equity Securities; R3 – Credit Risk; R4 – Loss Reserves; R5 – Net Written Premiums.

Review of Related Literature

RBC Framework as formulated by IC

RBC Ratio = Networth / RBC Requirement

wherein:

“Networth” shall include the company’s paid-up capital, contributed and contingency surplus and unassigned surplus.

Review of Related Literature

RBC Ratio = Y Event Description

100% < Y <125% Trend Test

Linear extrapolation if next year's ratio < 100%. If so, move to Company Action Event

75% < Y < 100% Company Action

Submit RBC plan and financial projections. Company implements the plan.

50% < Y < 75%

Regulatory Action

IC authorized to examine company and issue Corrective Orders.

35% < Y < 50%

Authorized Control

IC authorized to take control of the company.

Y < 35%Mandatory

ControlIC required to take control of the company.

Levels of Regulatory Intervention

R1 Asset Risk – Fixed Income

RBC Factor

Bonds, Treasury Bills, Short-term Investments

Government, domestic in local currency 0%

Government, in foreign currency 1.6%

Investment Grade Corporate/Government agency 1.6%

Below Investment Grade 10.0%

Near default 30.0%

Mortgage Loans in good standing (otherwise, 30.0%) 10.0%

Collateral, Guaranteed and Other Loans

Of best security 0%

Adequately secured 10.0%

Others 30.0%

Cash (bank deposits at 0.3%, not in good standing at 20%) 20.0%

Security Fund 0%

Electronic Data Processing Machines, hardware 20.0%

Software 10.0%

R2 Asset Risk – Equity

RBC Factor

Stocks

Common Stocks 30.0%

Preferred Stocks (Non-traded or rated at 30%) 15.0%

Real Estate

Company-occupied, up to quota 8.0%

Company-occupied, above quota 15.0%

Investment Real Estate 15.0%

Foreclosed 30.0%

Other Investments 20.0%

R3 Asset Risk – Credit

RBC Factor

Premiums Receivable – Jumbo policies, Others at 30%

15.0%

Premiums Due from Ceding Companies 30.0%

Premium Reserve / Loss Reserve withheld by Ceding Companies

30.0%

Reinsurance Recoverable on Losses 30.0%

Other Reinsurance Accounts Receivable 30.0%

Commission Accounts / Notes Receivable 10.0%

Salvage Recoverable 20.0%

Investment Income Due and Accrued 20.0%

Other Assets 20.0%

R4 Underwriting Risk – Reserves

RBC Factor

Claims Reserves 15.0%

Excessive Growth Charge

Loss / LAE Reserves 45.0%

R5 Underwriting Risk – Written Premium

RBC Factor

Net Premiums Written 20.0%

Excessive Growth Charge

Net Premiums Written 25.0%

Theoretical/Conceptual Framework

IC Regulation

IC RBC

COMPLIANCE OF NON-LIFEINSURANCE

INDUSTRY

NON-LIFEINSURANCEINDUSTRY

NAIC RBC

Insurance Code

Compliant

Non-compliant

adjustment

adjustment

Methodology

Check records from Insurance Commission to know which non-life insurance companies are complying and not complying with the RBC requirement.

Conduct interview with the compliant and non-compliant companies to know their opinions on the RBC requirement as formulated by the Insurance Commission.

Check the submitted financial statement of the company to know the values behind the formula of the RBC requirement as formulated by the Insurance Commission.

Review the current regulatory measure being used by the Insurance Commission with respect to capitalization.

Review regulations under the Insurance Code of the Philippines with respect to capitalization.

References

Insurance Code of the Philippines, 1998 Edition Insurance Commission 2007 Annual Report Stone, C.A and Zissu, A., Global Risk Based Capital

Regulation Volume II: Management and Funding Strategies

http://www.soa.org.files/pdf/08-RMTF RiskBasedCap.pdf http://www.allbusiness.com http://www.encyclopedia.com http://www.iii.org http://www.insurance.gov.ph/_@dmin/upload/reports/IMC

%207-2006.pdf http://www.naic.org/documents/

committees_e_capad_RBCoverview.pdf