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. ( -The money contributed by the proprietors to an organization to enable it to function. (

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 + √R1 2 + R2 2 + R3 2 + R4 2 + R5 2  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 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, Standard Insurance Company, Inc. 600,000, Philam Insurance Company, Inc. 581,056, Mapfre Insular Insurance Corporation 500,000, UCPB General Insurance Co., Inc. 400,000, BPI/MS Insurance Corporation 350,000, New Hampshire Insurance Company 329,276, PNB General Insurers Company, Inc. 312,000, Pioneer Insurance & Surety Corporation 300,000, Alliedbankers Insurance Corporation 282,500,000.00

Review of Related Literature  RBC Framework as formulated by IC ______________________________________ RBC Requirement = √R1 2 + R2 2 + (0.5 * R3) 2 + (0.5 * R3 + R4) 2 + R5 2  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 = YEventDescription 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 Control IC required to take control of the company.  Levels of Regulatory Intervention

R 1 Asset Risk – Fixed Income RBC Factor Bonds, Treasury Bills, Short-term Investments Government, domestic in local currency0% Government, in foreign currency1.6% Investment Grade Corporate/Government agency1.6% Below Investment Grade10.0% Near default30.0% Mortgage Loans in good standing (otherwise, 30.0%)10.0% Collateral, Guaranteed and Other Loans Of best security0% Adequately secured10.0% Others30.0% Cash (bank deposits at 0.3%, not in good standing at 20%)20.0% Security Fund0% Electronic Data Processing Machines, hardware20.0% Software10.0%

R 2 Asset Risk – Equity RBC Factor Stocks Common Stocks30.0% Preferred Stocks (Non-traded or rated at 30%)15.0% Real Estate Company-occupied, up to quota8.0% Company-occupied, above quota15.0% Investment Real Estate15.0% Foreclosed30.0% Other Investments20.0%

R 3 Asset Risk – Credit RBC Factor Premiums Receivable – Jumbo policies, Others at 30% 15.0% Premiums Due from Ceding Companies30.0% Premium Reserve / Loss Reserve withheld by Ceding Companies 30.0% Reinsurance Recoverable on Losses30.0% Other Reinsurance Accounts Receivable30.0% Commission Accounts / Notes Receivable10.0% Salvage Recoverable20.0% Investment Income Due and Accrued20.0% Other Assets20.0%

R 4 Underwriting Risk – Reserves RBC Factor Claims Reserves15.0% Excessive Growth Charge Loss / LAE Reserves45.0%

R 5 Underwriting Risk – Written Premium RBC Factor Net Premiums Written20.0% Excessive Growth Charge Net Premiums Written25.0%

Theoretical/Conceptual Framework IC Regulation IC RBC COMPLIANCE OF NON-LIFE INSURANCE INDUSTRY NON-LIFE INSURANCE INDUSTRY NAIC RBC Insurance Code Compliant Non-compliant 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  RiskBasedCap.pdf     