A 30-Year Retrospective of Risk-Based Capital: How Effective Has it Been?

The Financial Reporter, July 2025

By Errol Cramer

Risk-based capital (RBC) was adopted in the mid-1990s as a regulatory tool to identify and act on potentially weakly capitalized insurers. Insurers must annually file an RBC report with their home state and the National Association of Insurance Commissioners (NAIC) setting out their company-specific RBC and capital-to-RBC ratio. This adds to the longstanding requirement of filing statutory annual statements based on conservative assumptions, together with an accompanying actuarial opinion and memorandum on reserve adequacy (AOMR). This article provides the historical context in which RBC developed during the 1980s, its genesis in the asset-heavy life insurance industry, its known limitation at inception, what has transpired in the insurance industry over the past 30 years, and the subsequent development of a third layer of regulatory supervision.

About the Author

I started my actuarial career in the 1970s in group pensions, in 1982 I consulted on Life product development and M&A, and in 1984 I joined Allstate’s Financial Group (i.e. life insurance) where I served as chief actuary until my retirement. I was involved in all aspects of life insurance and served on numerous actuarial and industry task forces and committees at both the state and federal levels. I thought it would be helpful to share my institutional knowledge of work done on life RBC and insurer solvency.

RBC Overview

Insurers must submit annual reports of their total adjusted capital (TAC) and authorized control level capital (ACL). The TAC/ACL ratio determines what action is taken: essentially, below 200%, the insurer submits an RBC plan of improvement; below 150%, the commissioner sets the RBC plan; and below 70%, the commissioner takes control of the insurer. These control levels were based on industry studies of past economic conditions and insolvencies. The RBC factors are periodically updated with emerging experience.

The ACL is based on the insurer’s mix of policy liabilities and assets, Factors are applied within nine risk categories and results aggregated with an offset for risk covariances. Essentially, the risk categories can be grouped into four main risks:

Asset Risk (C-0 decline in holding value of affiliates, C-1cs common stock and C-1o bond/other assets),
Insurance Risk (C-2 Life underpricing/excess claims, C-3 Health Credit risk and C-4 Market risk),
Interest rate Risk (C-3 Asset/Liability mismatch), and
Business Risk (C-4a company strategic/operational risk and C-4b guaranty fund assessments/expenses).

For life insurers, asset and interest rate risks account for about 80% of RBC, insurance risk about 15% and business risk about 5% based on NAIC 2022 reporting data [1]. The high weight given to asset risks is not surprising, as large life insurers may hold annuity deposits and policyholder reserves, which rival bank deposits in size and are therefore subject to similar financial risks, including run-on-the-insurer.

Note that the business risk does not include the full scope of potential gaps in governance and decision-making frameworks and their possible consequences. While business risk is very important, it is outside the scope of a factor-based RBC, though it is discussed a bit in the Own Risk and Solvency Assessment (ORSA) section in this article. Also, note that Affiliate risk is important for insurance groups, and Insurance risk is important for property and casualty (P/C) and health insurers.

Evolution of Life and Health in the 1980s

The 1980s saw consolidation in the insurance industry. Computerization enabled a proliferation of innovative life products such as universal life, selectively underwritten term life, equity-indexed products, nonguaranteed elements, shadow account and other secondary guarantees. For health products there was high medical cost inflation plus a shift to managed health care, such as HMOs and PPOs. These changes were expensive, and many smaller insurers that were no longer viable were either acquired or went insolvent. Note that health insurance today is a separate category of mostly large health managed care providers.

The rising trend in insolvencies did not go unnoticed by the states. In the 1970s only a handful of states had a guaranty association (GA) to cover insurer insolvencies, which resulted in a patchwork of policyholder protection. GAs were expanded in the 1980s to all 50 states and DC. In 1983, the states formed the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA) to coordinate liquidations of insolvent insurers.

The 1980s also revealed a need to modernize the statutory balance sheet and create a better foundation on which to evaluate capital adequacy. The prescribed deterministic valuation formulas at that time did not fit these newer products well. Some of the notable changes made were as follows:

Mandatory Securities Valuation Reserve (MSVR): The MSVR was essentially an historic accumulation of funding contributions and asset gain/loss charges and could be inadequate or redundant for an insurer. MSVR was replaced by the Asset Valuation Reserve (AVR) and Interest Maintenance Reserve (IMR) better aligned with the insurer’s in-force assets and liabilities.
Actuarial Opinion and Memorandum on Reserve Adequacy (AOMR): New York took the lead by requiring an actuarial opinion and memorandum demonstrating that reserves both met New York valuation laws and were adequate based on cash flow testing. It initially covered only annuities and single-premium life. This was later expanded to a statewide NAIC AOMR test for all of an insurer’s in-force business.
Principle-Based Reserves (PBR): This provides a more accurate determination of company-specific reserves. Based on a product’s risk profile, it can be a deterministic reserve with a single prescribed economic scenario, or a stochastic reserve using the 70th percentile cumulative tail expectation (CTE70) of a set of stochastic scenarios; also, it can be based on prescribed conservative assumptions or on company-specific experience with added conservatism.
NAIC Valuation Manual (VM): This was an initiative to standardize the plethora of state-specific valuation requirements. The VM is an extensive document, 365 pages currently, which provides detailed valuation instructions standardized across all states. The VM allows special exceptions or choices, subject to state commissioner approval, so states can retain some level of flexibility.

1991 Junk Bond Wave and Life Insurer Insolvencies

A few months into 1991, five large life insurers went insolvent, impacting over 1.3 million policyholders. These were run-on-the-insurer situations related primarily to asset concentration. The Government Accountability Office (GAO) prepared a U.S. Senate report [2] in 1992 about the events, summarized below:

Company A and its subsidiary recorded the largest loss. Their rapid growth in annuities was supported by investing over 60% in high-yield junk bonds without appearing to have fully weighed the asset risk. Company A reported many of these junk bonds as investment grade on their statutory statements. (Note that it takes time for the NAIC to assign ratings.) Further, the rapid growth in associated acquisition costs depleted the insurer’s surplus. Company A likely had inadequate surplus relief reinsurance and parental funding. A sharp downturn in junk bond prices by 1991 probably sealed the insurers’ fate. (The GAO report includes more details.)
Company B and its affiliate had similar stories, though to a lesser degree, with junk bond investments of 40% and somewhat more surplus.

A fifth insurer became insolvent that year, and the insolvency was likely indirectly related to the junk bond meltdown. Company C was well capitalized with a top rating of A++, though it did have a concentration in commercial real estate, which potentially led to a rating downgrade to A. With the general skittishness of the junk bond failures, there was a run-on-the-insurer, and Company C was shut down. Its largest single commercial holding was Fisher Island in Florida, which turned out very profitable, and is referred to as “America’s Wealthiest Zip Code."

Another large life insurer did not go insolvent but did experience junk bond, commercial real estate, and interest rate-related losses. It did not appear to have fully anticipated the potential for certain asset callability. This probably led to a deterioration in its surplus, and in 1991, the insurer sold the majority of its ownership to another company.

The GAO prepared a second report for the U.S. Senate in 1992.[3] The report noted that life/health insurer insolvencies accelerated from about five per year through 1982 to triple that by 1990. Mostly, these were small companies with less than $50 million in assets, licensed in 10 or fewer states, and they were mainly health insurers. This followed the pattern discussed earlier that emerged in the 1980s for smaller life and health insurers.

2008 Global Financial Crisis and a Bailout

The Great Recession of 2008 was triggered by the U.S. subprime mortgage crisis and spilled over to become a global financial crisis. In a single day in 2008, one global, multi-line insurance and financial services company with $1 trillion in assets, which included a large life insurer, lost $100 billion. It was on the brink of a run-on-the-insurer. Its loss probably resulted from non-insurance-related activities:

Credit Default Swaps (CDS): For a fee, the company offered make-whole market value losses in a bank’s bond portfolio (swap good for bad). As the underlying value of the bonds moved up or down, changes in collateral were posted by either party as applicable. This initially gave the company a net collateral balance, which the company apparently invested in junk bonds and subprime mortgages/collateralized mortgage obligations.
Securities Lending: The company loaned stock it held to an institution for a fee. As for its CDS, the net collateral held by the company was invested in junk bonds and subprime mortgages.

The company did not have to settle the collateral in cash provided its credit rating remained high enough. However, when the market crashed, the company’s heavy exposure to bond credit losses, together with the decline in the value of its junk bonds and subprime mortgages, likely resulted in its rating downgrade to below AA-. This was the trigger rating level at which the company’s counterparties could demand immediate payment in cash of the significant collateral balances. The then-chair of the New York Federal Reserve, swiftly acted to save the company. The Fed took control of 69.9% of the company’s stock (just below the 70% full control level). Ultimately, this company received a government bailout of $183 billion. The company was saved, albeit as a much less valuable company, and the government was eventually paid back with a net profit of $23 billion.

Two Life Insolvencies Related to Business Risk

A couple of illustrative examples are:

The insolvency of one major writer of long-term care (LTC) insurance can potentially be attributed to a few miscues. The LTC insurer appears to have misjudged risk in underwriting and underpriced, relying on optimistic assumptions on lapsation and utilization.
The insolvency of another major writer of deferred annuities with $60 billion in assets was probably related to unprofitable acquisitions of a number of insurance and non-insurance companies.

NAIC Solvency Modernization Initiative and Own Risk and Solvency Assessment

The NAIC Solvency Modernization Initiative (SMI) and the ORSA arose from the near collapse of the previously mentioned global insurance and financial services company that the government saved, essentially addressing some of the identified business risks. Larger companies are now required to monitor their current and projected future solvency risks on a continuous basis and provide a confidential, comprehensive ORSA report to their domiciliary state at least annually. The NAIC adopted its ORSA Guidance Manual in 2012 and implemented ORSA in 2017. An insurer has discretion on the form and substance of its ORSA, though it must be integrated into the company’s regular enterprise risk management (ERM) process. The NAIC reaffirmed RBC as the primary solvency monitoring tool for all insurers, with ORSA as an additional requirement for the larger insurers. Currently, approximately 200 large insurers and 100 insurance groups are subject to ORSA.

Conclusions

RBC, together with valuation refinements made to the statutory balance sheet, has fared well as a primary tool for regulatory solvency monitoring since its introduction in 1993. Additional mandatory filing of certain company in-force data allows continual updating and refinement of the RBC factors.

How effective has it been? Twenty-two life insurers were declared insolvent from 1993 to 1994, reflecting the upheaval of the 1991 junk bond collapse. Thereafter, they have averaged less than one per year. So far, so good, during a mild economic environment, at least until recently.

What can we learn from past insolvencies? One large insurer was financially solid. Its demise likely resulted from over-concentration in commercial property, a rating downgrade and then a run-on-the-insurer. This is an example of a sectoral asset concentration risk that remains a key risk focus area today. However, I believe that insolvencies are often related to business risk (i.e., gaps in risk management and decision-making frameworks). The major writer of long-term care discussed earlier appears to have had difficulty due to an insurance risk, though it also appears to have sold underpriced business from the start. One previously mentioned life insurer was hit by the junk bond collapse, but I believe the issues were using the high yields to grow the business without fully weighing the asset default risks, and holding inadequate risk capital. The global insurance and financial services company was hit by the subprime mortgage collapse, mostly in its non-insurance division, and it took chances with money raised by callable collateral loan floats.

ORSA has been well conceived, and I believe will be an effective tool in monitoring business risk in the future. Tying it to a company’s existing ERM process and allowing broad company flexibility on preparing the analysis and report makes it meaningful to both regulators and the company. ERM is typically handled in corporations by the chief risk officer (CRO), but I would like to see some formalized role for the chief/appointed actuary, who is exceptionally positioned to understand the nuances of product design consequences, product mix natural hedge offsets, irrational market competition, and regulatory risk, etc. Also, I think it would be of value to have continuing education learning opportunities on best practices for the chief/appointed actuary (e.g., case study workshops, chief actuary forums, meeting presentations, etc.).

The formation of NOLHGA was a good step in coordinating the management of insolvency runoffs. However, policyholder protection limits are not standardized by state and are undisclosed, to my knowledge, in insurance policy documents. In contrast, banks and investment companies with federal guarantee funds (FDIC and SIPC), have standardized and clear customer protection limits. Not specifying customer insolvency protection arguably makes life insurers more susceptible to a run-on-the-insurer risk.

Overall, life insurer insolvency risk management today appears on solid ground. However, the industry and regulators need to remain vigilant now with the possible tariff changes and potential global market disruption. As a final note, much of the industry research and modeling I was involved in during my career included consideration of economic cycles and recessions. While an important factor affecting insurers’ financial conditions, this is outside the scope of this article.

This article is provided for informational and educational purposes only. Neither the Society of Actuaries nor the respective authors’ employers make any endorsement, representation or guarantee with regard to any content, and disclaim any liability in connection with the use or misuse of any information provided herein. This article should not be construed as professional or financial advice. Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Errol Cramer, FSA, is retired. Errol can be contacted at errol.cramer@gmail.com.

Endnotes

[1] NAIC https://content.naic.org/sites/default/files/inline-files/2023%20Life%20and%20Fraternal%20statistics.pdf

[2] Richard L. Fogel, “The Failures of Four Large Life Insurers,” www.gao.gov, Feb. 18,1992, https://www.gao.gov/assets/t-ggd-92-13.pdf.

[3] Richard L. Fogel, “Insurer Failures: Life/Health Insurer Insolvencies and Limitations of State Guaranty Funds,” www.gao.gov, April 28, 1992, https://www.gao.gov/products/t-ggd-92-15.