19.3 Risk-Based Capital Models

Main advances

  • Combining several risk include asset, credit, premium, reserve

  • Factor models:

    • Factors vary with the quality and type of asset or LoB

    • Factors applied to accounting values

Used in UK, AUS, US, CA, JAP, AM Best and S&P

  • Models recognize accumulation risk (cat) and aggregate loss instead of just occurrence amounts (most of them 1-in-100 or 1-in-250)

  • Factors very significantly between jurisdictions

AM Best has much higher factors than the rest:

  • Rating agencies focus on long term viability vs regulatory focus on one year survival

  • Correlation adjustment reduces the combined risk charges especially when the factors are of similar size

19.3.1 Credit Risk

Largest component is reinsurance recoverable

  • Many models vary the factors with the credit quality of the reinsurers

AM Best:

  • Increases credit charge for companies with high \(\dfrac{\text{Reinsurance Recoverable}}{\text{Surplus}}\)

UK:

  • Premium ceded to one reinsurer can not > 20% of gross premium

  • Recoverable from an insurance group cannot > 100% of surplus

19.3.2 Reserve Risk

Similar to premium factors, vary by LoB and applied to net reserves

Japan:

  • Reserve levels are low as payments are made quickly, factor is applied to net loss payment

19.3.3 Accumulation Risk

Some models have started to use accumulation risk (but many do not use it yet)

  • Focus is on 1-in-100 or 1-in-250 events