Nowadays, the term “Risk Based Capital” (or in short RBC) is of ever growing importance when it comes to measuring the financial security or solvency of insurance companies.
RBC regulation on solvency of insurance companies was introduced to Indonesian insurance industry by the local government in 1999. Some insurance companies are already under Indonesian government’s very close supervision now for possibility of being closed down because their RBC solvency ratios do not meet government’s minimum requirement.
In two sentences: what does RBC solvency ratio tell you?
Generally speaking, RBC solvency ratio is a measure that tells us the financial security or solvency level of an insurance company. The higher the RBC solvency ratio, the healthier or more solvent the financial condition of the insurance company is.
And what is actually RBC solvency ratio?
RBC solvency ratio of an insurance company is basically the ratio of its net asset value or net worth, being calculated using the standard accounting rules, divided by again its net asset value, but now being recalculated with possible adverse risks included in the calculation.
This inclusion of possible adverse risks in the calculation reflects the uncertainties the company is facing on its daily activities, such as possibilities of short-term fall of asset value due to more risky investments, as well as possibilities of liability increase due to unfavorable future developments in interest rates, death rates, lapse rates, etc.
The latter net asset value, being the denominator of the ratio, is actually the quantity which was originally called the Risk Based Capital, as it gives us a measure of company’s net asset value, or Capital, calculated on a Risk Based basis.