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Risk-Based Capital requirements are a statutory scheme for regulating the financial health of insurance companies. Developed by the National Association of Insurance Commissioners (NAIC), risk-based capital provides a more flexible measure of an insurers financial health.

Prior to RBC, states required insurers to meet a static net worth requirement. Generally, insurers had to have a flat amount of surplus (say $2 million) over and above their paid-in capital. This surplus requirement stayed the same without relation to the nature of the insurer's business, the volatility of its investments or the amount of insurance it had in force.

RBC uses a complex formula which considers all those factors to create a baseline financial requirement individualized to each insurer. For instance an insurer which issues hundreds of thousands of earthquake policies in Southern California and whose assets are invested in junk bonds, dot com futures and lottery tickets would have a much higher capital requirement than a small credit-life insurer with all its assets in cash.

Theoretically, this benefits both the industry and the consumer. Insurers who are at a greater risk of financial disaster (whether through mismanagement or simply because of the nature of the risks they insure) are required to maintain a bigger cushion, thus protecting consumers. On the other hand, insurers unlikely to experience financial problems are releived from potentially burdensome capital requirements, allowing them to put their funds to better use.

Risk-based capital = zero public accountability.

Given the nature of my business, I have a pessimistic view of human nature, perhaps unduly so. I generally expect greed and stupidity to govern behavior. I’m a lawyer, and I represent a high-risk industry: bars and liquor stores. In the worst case scenario for one of my clients, one of their stupid employees serves an obviously intoxicated customer who then gets in his car and kills somebody. Worse, the victim survives: sometime it’s cheaper to kill people outright. (It keeps the future medical expenses down and you don’t have a pathetic paraplegic in front of the jury through the course of trial.) This type of case is called a “dram shop” case, after English cases involving street-side sellers of spirits in London. The pre-industrial equivalent of drive-up liquor windows, these sellers of “drams” could not monitor the alcohol intake of their customers, and made it all-too-easy to get suicidally drunk.

Due to the substantial risk of high liability, “dram shop” or liquor liability insurance is extremely expensive, if you can get coverage at all. As a result, bar and package store owners frequently have to resort to buying cut-rate insurance wherever they can get it, often from fly-by-night insurance companies. Then when they make a claim, they are informed that the insurance company is in receivership, and hundreds of customers just like my client are filing claims against the reserves mandated by law, each chasing after a few cents on the dollar.

Risk-based capital requirements sound like a good idea at first, particular if you work in a high-risk industry. Your high-risk insurer has to have bigger loss reserves, right? Well, maybe. Try reading a Risk-Based Capital statute and then convince me you are sure about that. Now, instead of an amount of reserves fixed by law (and readily ascertainable by the public) the company submits a risk-based capital plan to the department of insurance. In reality, your protection is only as good as the management of the insurance company, which frankly has always been the problem in this area.

No insult of insurance professionals is intended, but as a lawyer, I must take a dire view of human nature. Any system which relies entirely on the wisdom and good faith of human beings, particularly when the underlying subject is money, is doomed.

And now for the kicker: the whole system requires secrecy and lack of accountability. The company must disclose confidential financial information to the government in order to allow the government to monitor the reserves. The government, in turn, agrees to keep this secret.

Here’s the law as it was adopted in my state, NMSA 1978, Section 59A-5A-9 (probably identical to Section 9 of the uniform law promulgated by the insurance industry):

To the extent not set forth in any other form accessible to the public, all information in risk-based capital reports, risk-based capital plans, results or reports of any examination or analysis of an insurer performed pursuant to the Risk-Based Capital Act {this article} and all corrective orders issued by the superintendent pursuant to such examination or analysis, is and shall be kept confidential by the superintendent. This information shall not be made public or be subject to subpoena, other than by the superintendent and then only for the purpose of enforcement actions taken by the superintendent pursuant to the Insurance Code.

As a result, the protection of insurance consumers depends entirely on the skill and professionalism of insurance investment managers and their cronies in the department of insurance. I say “cronies” because it is frequently the case that regulators and regulated all work for the same industry, in revolving door fashion. I have little faith in “experts”, and I am firmly of the view that wherever government is clothed in darkness, corruption grows.

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