Financial Health

Study guides: Exam 6C, Exam 6U, Exam GI-201, Exam GI-302

Financial Health is an insurer's capacity to keep its promises — to pay claims as they fall due, today and under adverse conditions, while remaining a going concern. It is judged not from one number but from capital adequacy, reserve adequacy, profitability, leverage, liquidity and reinsurance quality read together, using the tools each jurisdiction's regulators and rating agencies supply.

$\text{MCT ratio} = \frac{\text{Capital Available}}{\text{Base Solvency Buffer}}$

$\text{RBC ratio} = \frac{\text{Total Adjusted Capital}}{\text{Authorized Control Level RBC}}$

The dimensions. Capital (level and trend), reserve adequacy (how prior-year estimates have developed), profitability (combined and operating ratios), leverage (premium and reserves to surplus), liquidity, reinsurance collectability and asset quality — see Key Financial Measures. Both regimes compress capital adequacy into a ratio of capital held to capital the risk profile requires, but the ratio is only one dimension.
Canada. The MCT ratio against the $100\%$ minimum, the $150\%$ supervisory target and the insurer's own internal target; the forward-looking tests — FCT, ORSA, Stress Testing and Reverse Stress Testing; the claims development exhibit and MSA Ratios from the Canadian Annual Return; and the Statement of Actuarial Opinion.
United States. The RBC ratio against its action levels (Company Action Level at $200\%$ of Authorized Control Level RBC, Regulatory Action $150\%$ , Authorized Control $100\%$ , Mandatory Control $70\%$ ); the $13$ IRIS Ratios and their usual ranges; Schedule P for reserve development; Schedule F for reinsurance recoverables, overdue balances and the provision for reinsurance; the Insurance Expense Exhibit for profitability by line; and the SAO, whose risk-of-material-adverse-deviation comment states a materiality standard in dollars.
No single measure diagnoses. The NAIC's own IRIS manual says a ratio outside its usual range is not necessarily adverse. Distress shows as a pattern — rapid growth, high leverage, adverse development and a falling capital ratio together — which is also what PACICC's failure research finds.
Capital ratios inherit reserve error. Under-reserving overstates capital, so an insurer with light reserves looks healthier on every capital measure than it is. Reserve adequacy is therefore read before the capital ratio, not after.

Reading a U.S. Insurer's Solvency Tools A U.S. insurer reports Total Adjusted Capital of $\$180$ million and Authorized Control Level RBC of $\$100$ million. Its IRIS results: net premiums written to surplus $340\%$ , change in net premiums written $+45\%$ , one-year reserve development to surplus $28\%$ . The SAO is a determination of reasonable provision, with the carried amount near the low end of the range and a "yes" on risk of material adverse deviation.

Evaluate its financial health.

Answer $\text{RBC ratio} = \frac{180}{100} = 180\%$

That is between $150\%$ and $200\%$ : a Company Action Level event. The insurer must file an RBC plan with its domiciliary commissioner explaining how it will restore capital.

IRIS: three ratios are outside their usual ranges — premium leverage (usual range below $300\%$ ), premium growth (usual range $-33\%$ to $+33\%$ ) and one-year reserve development (usual range below $20\%$ ).

Read together: the insurer is growing fast on thin capital, and its reserves are already developing adversely. The SAO is technically clean, but a low-end carried reserve with a declared risk of material adverse deviation means further strengthening is plausible — and each dollar of it comes straight out of the $\$180$ million. This is the classic pre-failure profile, not a one-ratio blip.

Two Insurers, One MCT Ratio Two Canadian insurers each report an MCT ratio of $210\%$ . Insurer A has claim liabilities of $1.5$ times capital available and favourable development. Insurer B has claim liabilities of $3.2$ times capital available, adverse development in each of the last three years, and $28\%$ premium growth.

If B's claim liabilities prove $10\%$ deficient, what is its MCT ratio? (Treat capital available as moving dollar for dollar with the deficiency and ignore the change in the buffer.)
Answer Let capital available be $C$ , so liabilities are $3.2C$ . A $10\%$ deficiency is $0.32C$ .
 $\begin{align*} \text{MCT}_{\text{new}} &= 210\% \times \frac{C - 0.32C}{C} \\ &= 210\% \times 0.68 \\ &= 142.8\% \end{align*}$ 
Below the $150\%$ supervisory target — and understated, since strengthening reserves also raises the buffer. The same $10\%$ error at Insurer A costs $0.15C$ and leaves it at $178.5\%$ . Identical ratios, very different health: the reserves-to-capital leverage and the development trend are what separate them.