RBC Action Level, Dividend Capacity, and a Non-Risk-Transferring Treaty
Summit Insurance Company's total adjusted capital (TAC) is $38 million. Its authorized control level (ACL) RBC is $20 million; the company action level is 200% of ACL, or $40 million. The CFO proposes a $5 million dividend to the parent and a $20 million affiliate 'reinsurance' treaty. The treaty purports to transfer $20 million of aggregate losses above a $5 million deductible for a $5 million premium, but the actuarial review shows the ceding insurer retains essentially all economic loss and the affiliate has no capital at risk. The CFO says the treaty will add $15 million to statutory surplus and improve the RBC ratio. The board asks for advice before year-end.
1. Calculate the RBC ratio and identify the regulatory consequences.
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The RBC ratio is TAC divided by ACL, or $38 million / $20 million = 190%. The company action level is 200% of ACL, or $40 million; because TAC of $38 million is below $40 million but above the ACL of $20 million, Summit is at the company action level. It must submit an RBC plan to the commissioner that identifies the conditions causing the decline and proposes corrective action. The plan is subject to regulatory review and possible revision. If TAC fell below the ACL, the commissioner would have grounds for regulatory control, including seizure. The 190% ratio is not a technicality: it signals that capital is below the first regulatory threshold, and any transaction that artificially inflates TAC without real risk transfer would misstate the ratio and could undermine the regulator's ability to supervise the company.
2. Assess the proposed $5 million dividend.
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The dividend would reduce TAC to $33 million and the RBC ratio to 165%, moving the company further below the company action level. Statutory dividend rules vary by state, but a dividend that causes or worsens a company action level event is very likely to require prior regulatory approval and may be prohibited as an unsafe or unsound practice. The board should not approve the dividend based on the CFO's plan to restore surplus through the affiliate treaty. The parent may have its own liquidity needs, but the insurer's capital belongs to policyholders and cannot be upstreamed if it leaves the insurer below regulatory thresholds. The board should obtain a legal and regulatory opinion, document the solvency analysis, and consider whether the parent has alternative funding sources.
3. Evaluate the reinsurance treaty for statutory accounting and ethics.
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The treaty does not qualify for reinsurance accounting. Reinsurance accounting requires transfer of significant insurance risk, meaning there must be a reasonable possibility of a significant loss to the reinsurer. Here, the actuarial review shows the affiliate has no capital at risk and the ceding insurer retains essentially all economic loss. The transaction is a financing arrangement and should be accounted for as a deposit, not as reinsurance; the $15 million surplus benefit cannot be recognized. Booking it as reinsurance would misstate statutory surplus, RBC, and the financial statements, and could constitute a misleading filing. The CFO's proposal raises an ethics issue: the board and audit committee should reject it, document the analysis, and consult counsel and the regulator if there is pressure to proceed. Artificial surplus is not a substitute for capital.