RBC Decline and Dividend Decision After Catastrophes
Coastal Mutual Insurance has a 340% company action level RBC ratio, down from 375% after two years of hurricane losses and $40M of reserve strengthening on its commercial property book. Statutory surplus is $520M, and the board is considering a $25M policyholder dividend. The company has $1.1B in net written premium, a 112% combined ratio, and $35M of remaining cat reinsurance limit above a $50M retention. Rating agency capital requirements for an A- rating are estimated at 360% RBC. The CFO projects a 1-in-100 hurricane loss of $140M net and a 1-in-250 loss of $210M net. The investment portfolio has $80M of unrealized losses on available-for-sale bonds. The company has a $50M bank line but no holding company cash. The board wants to maintain the A- rating and continue writing new business. Management is evaluating a quota share, a surplus note, or reducing the dividend. The state regulator has requested a capital plan.
1. Assess the company's capital adequacy relative to the rating agency threshold and the proposed dividend.
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At a 340% RBC ratio and $520M surplus, the authorized control level capital is $520M / 3.40 = $152.9M. To reach the 360% rating agency threshold, capital must be 3.60 x $152.9M = $550.6M, so the company is already $30.6M short. Paying the $25M dividend would reduce surplus to $495M and the RBC ratio to 495 / 152.9 = 323.7%, increasing the shortfall to the 360% target to $55.6M. The $80M of unrealized bond losses already reduce surplus and are a warning about interest rate risk. The cat reinsurance remaining limit of $35M above a $50M retention is thin. A 1-in-100 net hurricane loss of $140M would reduce surplus to $380M and RBC to 248%; a 1-in-250 loss of $210M would reduce surplus to $310M and RBC to 203%. Both are far below the rating agency target and would likely trigger regulatory action. The proposed dividend is not prudent before restoring capital and buying more cat protection.
2. Compare the quota share, surplus note, and dividend reduction, including rating agency and regulatory considerations.
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A quota share, for example 25% of $1.1B premium, would cede $275M of premium and a share of losses, reducing net cat exposure and required capital. It also brings ceded reserves and may improve RBC, but it cedes profit and requires reinsurer credit quality. Rating agencies generally view risk transfer positively if it is economically substantive. A $50M surplus note would increase total adjusted capital to $570M and RBC to 373%, above the 360% threshold, but it adds interest cost and leverage and may be treated as debt-like by rating agencies. Regulators may approve it if the proceeds support capital, but it does not reduce risk. Reducing or suspending the $25M dividend preserves capital, but alone it leaves the company at 340% RBC, still below the 360% target. The best combination is to suspend the dividend, execute a quota share to reduce risk and capital strain, and consider a surplus note only as a bridge to restore the rating agency buffer. The bank line is not capital and should not be used for dividends.
3. Outline the capital plan you would submit to the regulator.
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The plan should start with the current RBC ratio, the 360% target, and the $30.6M shortfall. It should state that the $25M dividend is suspended. It should include a 25% to 30% quota share or another risk transfer to reduce net cat exposure, with projected RBC impacts under base, 1-in-100, and 1-in-250 scenarios. It should include a $50M surplus note as a contingent step if the quota share does not restore the target. It should reduce growth in commercial property until the cat reinsurance limit is increased above $35M and the retention is reviewed. It should address the $80M unrealized loss position with a de-risking plan and duration review. It should include monthly monitoring, board reporting, and triggers for further action if RBC falls below 325% or if a second cat event occurs. The plan should also show that policyholder obligations are protected and that the company can continue writing new business without a rating downgrade.