5. The Risk of Poor Internal Risk Management is not explicitly reflected in the LRBC system due to the inability to measure “poor management”. This risk may be covered in C4, at least in part. Companies who cannot identify their net risk positions, or have sound tracking of their major risk exposures do not get charged any additional capital nor do good companies get credit for less required capital. 6. Emerging Risks are assumed to be covered in C4, at least in part. It is virtually impossible to establish capital requirements for an emerging risk that is, by definition, not yet a material risk and the extent of the risk magnitude is unknown. However, the use of a factor driven RBC requirement will likely contribute to a delay in recognizing emerging risks. 7. Regulatory, Political, Sovereign Risks are implicitly covered in C1 for asset risk to the extent that these risks have affected default rates. More generally, these risks are reflected in C4 at least in part, to the extent that these risks affect general business performance. 8. Annuity Mortality/Longevity risks have been “intentionally excluded" rather than "missing". The 1991 RBC Report on the C2 factors discusses the fact that this risk "takes so long to emerge that the solvency threat over a 5 to 10 year time horizon is negligible.” Longevity was not considered a material tail risk that would emerge in the LRBC time horizon and should be reflected in reserves as the risk emerges. 9. The Risks Associated with Writing New Business is not included in the current LRBC system.
In addition to certain risks explicitly excluded from the LRBC formula, certain risk mitigation practices are excluded from the determination of LRBC. For example, some believe that companies writing participating business (e.g., universal life with adjustable pricing, and other experience-rated business) do not consistently receive an appropriate level of credit to RBC for the ability to manage risks by directly reflecting experience in dividends (e.g., non-participating insurance) or by adjusting policy terms. Also, companies engaging in hedging techniques to mitigate credit risk are not receiving credit in the LRBC formula. There is also the risk that the impact of capital requirements may cause companies to manage to a regulatory capital requirement (or to a capital level based on regulatory requirements) instead of managing to the actual risk exposures based on fundamental economics. In recent years, the US life insurance industry has seen elements of the regulatory capital requirements increase, when the risk exposure declined (e.g., for variable annuities with guaranteed living benefits). Exacerbating these counter-intuitive results is the misperception by some observers of results that LRBC can be used as a basis for comparing the safety and soundness of insurers.
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