Can Risk Based Capital Concepts Inform ERM TCOR?
In the U.S., risk-based capital (RBC) is a method developed by the National Association of Insurance Commissioners (NAIC) to measure the minimum amount of capital that an insurance company needs to support its overall business operations. Can the concepts of RBC work for self-insurers with large, complex risk profiles?
In February, we reported the results of our private survey of Chief Financial Officers, Chief Risk Officers and Board Directors related to Total Cost of Risk (TCOR) metrics. Since then, some of our self-insured clients have asked how the concepts of Risk Based Capital could be utilized in various risk profiling analytics for complex risks or operations.
Risk-based capital (RBC) is the amount of money a company should keep on hand to protect against unfavorable or unplanned loss situations. There many different methods and calculations for estimating RBC, however the final results of any formula are an indicator of the financial position of a company related to the risks being undertaken.
For insurers, RBC is typically calculated by applying formulas to financial accounts for various risks assumed by the company. Similarly, self-insurers could apply the same reasoning to various activities of the Enterprise Risk Management (ERM) operations. For instance, a Risk Manager could ask themselves what amount of money is necessary to pay for frequent and severe losses, minus the collectible insurance within a company’s fiscal year. Additionally, the Risk Manager could determine and calculate the Maximum Foreseeable Loss (MFL) for the most risky operations. That calculation would allow the Chief Financial Officer to understand the aggregate total of all measured risk profiles to calculate the company’s RBC ratio.
For example, let’s say a global chemical manufacturing and distribution company is a self-insurer, and maintains a combined total capitalization of $10 Billion. If they become responsible for a major catastrophic event, and are faced with a $20 Billion clean-up event after insurance proceeds, their RBC ratio would be 50%. For any regulators reviewing the prospects of approving a new chemical plant in their country, a low RBC ratio of 50% would raise concerns of the government and its citizens. Conversely, if the MFL developed in the risk profiling were expected to be $5 Billion in the above example, then a more respectable 200% RBC ratio would be maintained. The prospects of approval to build and maintain the operation would likely be raised considerably.
“At risk” capital is an important topic when building appropriate risk profiles for Enterprise Risk Management operations. CFOs and Risk Managers would benefit from being included in discussions about new business development to plan for appropriate RBC ratios. For more about how RBC can influence your ERM Total Cost of Risk (TCOR) calculations, please visit our free online application to consider various options and alternatives.