RiskBasedCapital

Agenda

InsuranceCompanyRegulation RBCBackground MEAF RBCProposal

RiskBasedCapital
I Insurance Company C Regulation R l i

TheU U.S. S Insuranceindustryisregulatedbythestates states. ThestateInsuranceCommissionershaveestablishedtheNational AssociationofInsuranceCommissioners(NAIC),which: Isgovernedbythechiefinsuranceregulatorsfromthe50states, D.C.,andfiveU.S.territories, Providessupport pp tothestateregulators g tohelp pmakeregulation g moreefficient,and Helpscoordinateregulatoryeffortstoenhanceuniformityof regulation. regulation Stateregulatorsfocusonthelegalentitylevel.

RiskBasedCapital
RBCBackground B k d RBCframework was createdbyNAICandbecameeffectivein1992 Responds R d t toi insurancecompanyf failures il i inth the1980 1980scaused d l largely l b by realestateandjunkbondconcentrations Intendedtoserveasanearlywarningtooltoidentifyundercapitalized companies i Setaminimumthresholdforregulatoryaction Regulatesadequateinsurancecompanysolvency TheNAICmodellaw,andeachstateslaw,looktotheNAICformulatocompute RBC.

RiskBasedCapital
RBC Background RBCisusedtosetcapitalrequirementsconsideringthesizeanddegreeof risktakenbytheinsurer RBCisaroughmeasureofrisk Eachelementofriskisassigned g a"riskfactor Eachriskfactorismultipliedbysomemeasureofvolumeforeach riskclasswhicharethenaddedtogetherresultinginatotal"risk requirement requirement Themajorcategoriesofriskinclude: Assetrisk,insurancerisk,interestraterisk,andbusinessrisk

RiskBasedCapital
RBCRatio TheRBCRatioisthemaintestusedto determinewhetheracompany'scapital levelisadequategiventhesizeanddegree ofriskthatfirmhastaken

TotalAdjustedCapital TotalRiskBasedCapital

TotalRiskBasedCapital

TotalRBCiscalculatedbymultiplyingtheriskfactorsbysomemeasureof volumeforeachriskclassandaddingtogethertheresulting"risk requirements

TotalAdjustedCapital

TotalAdjustedCapital(TAC)ismadeupprimarilyofcapitalandsurplus,and theassetvaluationreserve(AVR)

RiskBasedCapital
TheRBCFormula

Determines i the h minimum i i amountof fcapital i lani insurerneeds d given i i itsrisks ik For example, ata300%RBClevel,acompanyholds$3ofcapitalfor every$1ofriskassumed RBCwasdesignedtodifferentiateadequatecapitalfrominadequate capital,butnottodistinguishgoodfrombetter Theratiocanberaisedbyeitherincreasingtotaladjustedcapitalorby loweringriskbasedcapitalrequirements

RBC Ratio =

"Equity" Equity Total Adjusted Capital (TAC) = "Risk Charges" Risk Based Capital (RBC)

RiskBasedCapital
RegulatoryActionLevels RBCLevel Above 200% 150%to200% 100%to150% 70%to100% Below70% RequiredAction Nonegativetrend,Noaction Companysubmitsaplantoimprovecapital Stateregulatorspecifies correctiveactions Stateregulatormaytakecontrolofcompany Stateregulator takescontrolofcompany

RiskBasedCapital
TheRBCFormula AssetRiskRequirements
RiskCategory U S Treasuries U.S. NAIC1(AaaA) NAIC2(Baa) NAIC3(Ba) NAIC4(B) NAIC5 NAIC6 MortgagesinGoodStanding RealEstate RealEstateJV CommonStock PreTaxRBCFactor 0 0% 0.0% 0.4% 1.3% 4.6% 10.0% 23.0% 30.0% 2.6% 15 0% 15.0% 23.0% 30.0%

RiskBasedCapital
MortgageRBCFactors

Mortgages in Good Standing 1 Restructured Mortgages Mortgages 90 Days Overdue Mortgages in Foreclosure
1

2.6% 9.0% 18.0% 23.0%

Before Mortgage Experience Adjustment Factor (MEAF)

RiskBasedCapital
Wh MEAF? Why Mortgages g g areanunratedassetclass Regulatorsneededtodistinguishrisk Therewasminimalamountoflossexperiencedata Therewasapresumptionthatthequalityofacompanysunderwriting wouldemergeovertimeinmeasurablelossexperience Therefore,MEAFwasdeveloped

RiskBasedCapital
MEAFDefined f d MortgageExperienceAdjustmentFactor(MEAF) MortgagesonlyassetclasswhoseRBCfactorcanvarybyrelative experience MEAF Ratioofcompany p yproblem p loanstoindustry yproblem p loans. Through2008,MEAFhasaminimumandmaximumof50%to350%. MortgageRBCfactoris: StandardRBCfactorxMEAF Thenappliedtoentiremortgageportfolio

RiskBasedCapital
MEAFIssues GivenhistoriclowdelinquencyratesMEAFcanbevolatile NegativeRBCimpactevenifproblemloansdecline NegativeRBCimpactevenwhenlifecompanyachievesoptimaleconomic outcomeinresolvingproblemloans

RiskBasedCapital
MEAFExample

Lifecompanyforeclosedona$140millionloan MEAFincreasedfrom85%to160% ForeclosurenegativelyimpactedRBCbyapproximately20points Lifecompanysoldpropertyafterforeclosurefor$142millionresultingina gain Lifecompanycouldhavetakena$10millionlossandsoldtheloanfor$130 millionpriortoforeclosure RBCimpactwouldhavebeen1point

RiskBasedCapital
MEAFExample Athistorically ylowlossrates, ,theMEAFsability ytoquantify q yrelative companyperformancebreaksdown LifeCompanylevelofproblemloansimprovesby20%(0.005%to 0.004%) ) Industrylevelofproblemloansimprovesby38%(0.008%to0.005%) LifeCompanymortgageRBCrequirementincreasesfrom1.6%to2.1% LifeCompanysRBCratiodecreasesby8points

RiskBasedCapital
RegulatoryGoalsforRBCReplacement

Differentiatecompanies companiesPortfolios Differentiaterisksofloans Factorsarebasedonindependentauditableinformation Relyonobjectivemeasurestoassessrisk

RiskBasedCapital
IndustryGoalsforRBCReplacement Relyonobjectivemeasurestoassessrisk Balanceprecisionwithaframeworkthatisworkableforcompany reporting Canbeaudited/verifiedbyregulators Donotdiscouragesoundeconomicdecisionsbycompanieswithregardto investmentmanagement g Commercialmortgagesareheldtoasimilarstandardasotherassets

RiskBasedCapital
Alt Alternatives ti Evaluated E l t dBut B t Not N tAccepted A t dby b Regulators R l t orIndustry I d t

LTVapproach DSCapproach Modeling(CommercialMortgageMetrics/Compass/Proprietary)only Singlefactor Companylosshistory ModifyingMEAFwithlongtermindustryaverage

RiskBasedCapital
RBCProposal P lOverview: O i Commercial C i lMortgages M t

Mortgageswillbeassignedacapitalrequirementbasedontherisk profileofeachmortgage DSCandLTVwillbeusedasthedriverstodetermineriskcategories DSCdeterminedforeachloanandupdatedannually Actualinterestrate Amortizationstandardizedto25years IncomedefinedbylaststatementactualNOI CREFCstandard

RiskBasedCapital
RBCProposal P lOverview: O i Commercial C i lMortgages M t

LTV Valuedeterminedatorigination,updatedviaNCREIFindex EachloanassignedoneoffiveRBCfactorsappliedtoBookValue SumofloanbyloanvaluesconstitutesRBCforperformingloans RBCfactorsdevelopedbasedonmodelingprovidedbyMoodysCommercial MortgageMetrics

RiskBasedCapital
ProposalOverview:CommercialMortgages
ProposedRBCfactorsforthefiveriskcategoriesforperformingloans:
RiskCategory CM1 CM2 CM3 CM4 CM5 RecommendedRBCValues 0.90% 1 75% 1.75% 3.00% 5.00% 7.50%

DSCandLTVranges g usedtoassign g loantoariskcategory g y DSCisthedominantfactor Broadlyspeaking,CM1:DSC>=1.50xandLTV<85%,CM2: DSC> >=0 0.95x 95 and dLTV>55%b but t<75%

RiskBasedCapital
ProposalOverview:CommercialMortgages

Loanssecuredbyoffice,retail,industrial/warehouse,apartment propertiesusethesameLTVandDSCranges LoanssecuredbyhotelandotherpropertiesusemoreconservativeDSC andLTVranges Delinquent q andinp processofforeclosurefactorsremainunchanged g 18%factorfordelinquentloans,23%factorforinprocessofforeclosure

RiskBasedCapital
RBCProposal P l ReducesRBCvolatilitycausedbyMEAF ProblemloansimpacttheirownRBC,nottheoverallportfolio SinceDSCisthedominantfactor, ,volatility yisreduced Differentiatesriskbycompanyandwithineachcompanysportfolio HighestcreditqualitymortgagesreceiveaRBCrequirement closeto,but stillabove,NAIC1

RiskBasedCapital
St t Update Status U d t

NAICapprovedshorttermRBCextensionthroughDecember2012 2012, whichisMEAFbasedwithafloorof80%andcapof175%x2.6%base requirement SeekingNAICapprovalbyNovember1,2012 Proposaltargetedtobeeffectivein2013 Proposal P lsubmitted b itt dto t the th NAICin i May M ReviewproposalwithNAIC(MaytoAugust) ProposaltobereviewedbytheAmericanAcademyofActuaries(July to August)