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Texas Department of Insurance
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SUBCHAPTER D. Risk-Based Capital and Surplus

28 TAC §7.401

1. INTRODUCTION. The Texas Department of Insurance proposes amendments to §7.401 concerning risk-based capital and surplus requirements for insurers and health maintenance organizations (HMOs). Section 7.401 regulates risk-based capital and surplus requirements for property and casualty insurers, life insurance companies, fraternal benefit societies, mutual life insurance companies, stipulated premium companies, HMOs and insurers filing the National Association of Insurance Commissioners (NAIC) Health blank. These insurers and HMOs are referred to collectively as "carriers" in this proposal. The risk-based capital requirement is a method of ensuring that a carrier has an appropriate level of policyholders' surplus after taking into account the underwriting, financial, and investment risks of a carrier. The NAIC risk-based capital formulas provide the Department with a widely used regulatory tool to identify the minimum amount of capital and surplus appropriate for a carrier to support its overall business operations in consideration of its size and risk exposure. Section 7.401(d) adopts by reference the NAIC risk-based capital formulas. The proposed amendments to §7.401(d) are necessary to adopt by reference the 2005 formulas, including the 2005 NAIC Life Risk-Based Capital Report Including Overview and Instructions for Companies, the 2005 NAIC Fraternal Risk-Based Capital Report Including Overview and Instructions for Companies, the 2005 NAIC Property and Casualty Risk-Based Capital Report Including Overview and Instructions for Companies, and the 2005 NAIC Health Risk-Based Capital Report including Overview and Instructions for Companies. Copies of the documents proposed for adoption by reference are available for inspection in the Financial Division of the Texas Department of Insurance, William P. Hobby Jr. State Office Building, Tower Number III, Third Floor, Mail Code 303-1A, 333 Guadalupe, Austin, Texas.

In addition, an amendment is proposed to §7.401(b)(4)(C) to update the Insurance Code reference for consistency with the revised code project enacted by the Texas Legislature.

2. FISCAL NOTE. Ms. Betty Patterson, Senior Associate Commissioner, Financial Program, has determined that, for each year of the first five years the amendments will be in effect, there will be no fiscal implications for state or local government as a result of enforcing or administering the amendments. The proposal will have no anticipated effect on local employment or local economy.

3. PUBLIC BENEFIT/COST NOTE. Ms. Patterson has also determined that for each year of the first five years the amendments are in effect, the amendments will enable the Department to more efficiently and effectively utilize existing resources in the review of the financial condition of carriers, to more efficiently monitor solvency of the carriers subject to the section, and to implement the most current risk-based capital requirements. The risk-based capital requirement is a method of ensuring that a carrier has an appropriate level of policyholders' surplus after taking into account the underwriting, financial, and investment risks of a carrier. The NAIC risk-based capital formulas provide the Department with a widely used regulatory tool to identify the minimum amount of capital and surplus appropriate for a carrier to support its overall business operations in consideration of its size and risk exposure. The cost to complete the risk-based capital report varies from carrier to carrier. Under the proposal, each carrier subject to the section would be required to acquire NAIC risk-based capital software at a cost of approximately $600 per entity for each carrier. The labor cost to transfer the information from a carrier's records to the applicable report will vary depending on the size of the carrier and the character of its investments. If a carrier uses the annual statement software that conforms to NAIC specifications provided by authorized vendors to prepare its annual report, and if that software is linked to the risk-based capital formula software, the Department estimates that the information can be transferred and the formula completed in four hours or less. If the annual statement software is not linked to the risk-based capital formula, the Department estimates that a carrier will be able to transfer the information from its records to the risk-based formula in 8 to 16 hours. The Department's estimations are based upon discussions with industry representatives who are responsible for maintaining accounting records for insurers and carriers. Based upon information obtained by the Department from these industry representatives, a carrier would utilize an employee who is familiar with the accounting records of the company and accounting practices in general and who is compensated from $17 to $30 an hour. On the basis of cost per hour of labor, there is no anticipated difference in the cost of completing the formula between carriers who are micro, small, and large businesses. After the completion of the formula, it will likely be reviewed by an officer of the carrier who is responsible for the preparation of the financial reports of the carrier. Such officers for small carriers are compensated at approximately $40 per hour, while such officers for large carriers are compensated at approximately $100 per hour. Based on the Department's experience, the cost of compliance for small carriers would be less than the cost of compliance for large carriers in reviewing the risk-based capital report. Therefore, the Department anticipates that the proposal will have no adverse economic effect on small or micro businesses. The Department does not expect the formulas to require a level of capital that is significantly different from the current capital requirements since the Department has been using the risk-based capital levels for several years. For those carriers previously subject to the risk-based capital requirements, the Department does not anticipate any material increase in cost resulting from a required capital contribution. However, the function of the risk-based capital formula is to protect policyholders from the effects of insolvency, which may require some carriers to increase their capital. To the extent any carrier must increase its capital as a result of the risk-based capital requirements, that cost is the amount of capital required and is a result of the statutory requirement of TEX. INS. CODE ANN. §§822.210, 841.205, 884.206. Regardless of the fiscal effect on an individual carrier, the requirements of this section are mandated by statute. Although the Department does not believe that the proposed amendments would have an adverse effect on small or micro businesses, the Department has considered the purpose of the applicable statues, which is to protect policyholders and carriers from the effects of insolvency, and has determined that it is neither legal not feasible to waive the provisions of the proposed amendments for small or micro businesses. Additionally, it is the Department's position that to waive or modify the requirements of the proposed amendments for small and micro businesses would result in a disparate effect on policyholders and other persons affected by the amendments.

4. REQUEST FOR PUBLIC COMMENT. To be considered, written comments on the proposal must be submitted no later than 5:00 p.m. on May 22, 2006 to Gene C. Jarmon, General Counsel and Chief Clerk, Mail Code 113-2A, Texas Department of Insurance, P. O. Box 149104, Austin, Texas 78714-9104. An additional copy of the comments must be simultaneously submitted to Betty Patterson, Senior Associate Commissioner, Financial Program, Mail Code 305-2A, P. O. Box 149104, Austin, Texas 78714-9104. Any request for a public hearing should be submitted separately to the Office of the Chief Clerk.

5. STATUTORY AUTHORITY. The amendments are proposed under the Insurance Code Articles 1.10, 1.32, 21.28-A and §§36.001, 541.401, 822.210, 841.205, 843.404, 885.401, and 884.206. Article 1.10 §5 addresses the duties of the Department when an insurer's solvency is impaired. Article 1.32 authorizes the Commissioner to set standards for evaluating the financial condition of an insurer. Article 21.28-A addresses the prevention of insurer delinquencies and in §2(b) provides that the term "insolvency" of an insurer "and the phrases in further identity of insurer delinquency and threatened insurer delinquency" mean and include any one or more of several statutorily specified conditions, including if a company's required surplus, capital, or capital stock is impaired to an extent prohibited by law, and in §11 authorizes the Commissioner to adopt reasonable rules as necessary for augmentation and accomplishment of Article 21.28-A, including its purposes. Section 541.401 authorizes the Commissioner to adopt reasonable rules necessary to accomplish the purposes of trade practices regulation in Chapter 541. Sections 822.210, 841.205, and 884.206 authorize the Commissioner to adopt rules to require an insurer to maintain capital and surplus levels in excess of statutory minimum levels to assure financial solvency of insurers for the protection of policyholders and insurers. Section 843.404 authorizes the Commissioner to adopt rules to require a health maintenance organization to maintain capital and surplus levels in excess of statutory minimum levels to assure financial solvency of health maintenance organizations for the protection of enrollees. Section 885.401 requires each fraternal benefit society to file an annual report on the society's financial condition, including any information the Commissioner considers necessary to demonstrate the society's business and method of operation, and authorizes the Department to use the annual report in determining a society's financial solvency. Section 36.001 authorizes the Commissioner to adopt any rules necessary and appropriate to implement the powers and duties of the Texas Department of Insurance under the Insurance Code and other laws of this state.

6. CROSS REFERENCE TO STATUTE. The following statutes are affected by this proposal: Insurance Code Articles 1.10, 1.32, and §§ 541.401, 822.210, 841.205, 843.404, 885.401, 884.206, 982.105, and 982.106.

7. TEXT.

§7.401. Risk-Based Capital and Surplus Requirements.

(a) - (c) (no change.)

(d) Adoption of RBC formula by reference. The commissioner adopts by reference the following:

(1) The 2005 [ 2003 and 2004 ] NAIC Life Risk-Based Capital Report Including Overview and Instructions for Companies which includes the RBC formula.

(2) The 2005 [ 2003 and 2004 ] NAIC Fraternal Risk-Based Capital Report Including Overview and Instructions for Companies which includes the RBC formula.

(3) The 2005 [ 2003 and 2004 ] NAIC Property and Casualty Risk-Based Capital Report Including Overview and Instructions for Companies which includes the RBC formula.

(4) The 2005 [ 2003 and 2004 ] NAIC Health Risk-Based Capital Report Including Overview and Instructions for Companies which includes the RBC formula.

(e) - (f) (No change.)

(g) Actions of commissioner. The level of risk-based capital is calculated and reported annually. Depending on the results computed by the risk-based capital formula, the commissioner of insurance may take a number of remedial actions, as considered necessary. The ratio result of the total adjusted capital to authorized control level risk-based capital require the following actions related to an insurer within the specified ranges:

(1) - (3) (No change.)

(4) An insurer reporting total adjusted capital of less than 70% of authorized control level triggers a mandatory control level which subjects the insurer to one of the following actions:

(A) being placed in supervision or conservation;

(B) being determined to be in hazardous financial condition as provided by the Insurance Code Article 1.32, and §8.3 of this title (relating to Hazardous Conditions) regardless of percentage of assets in excess of liabilities;

(C) being determined to be impaired as provided by the Insurance Code Articles 1.10, §5 or §841.206 [ 3.60 ]; or

(D) any other applicable sanctions under the Texas Insurance Code.

(5) (No change.)

(6) A property and casualty insurer subject to this section is subject to a trend test if its total adjusted capital to authorized control level risk-based capital is between 200% and 300%. If the result of the trend test as determined by the formula is "YES", the insurer triggers regulatory attention at the Company Action Level on the trend test. For the year 2005 only, the first year of this trend test, the trend test will be for informational purposes only.

(h) - (j) (No change.)

For more information, contact: ChiefClerk@tdi.texas.gov