Risk-based capital is a certain amount of capital that insurance companies must have on hand in order to hedge against their risks. This capital is there to make sure that the company can maintain solvency, and can fulfill all of its financial operating needs. The NAIC developed the requirements for risk based capital for insurance companies.
Insurance companies often invest money that they take in. However, if they make too many investments, then they can face insolvency if these investments do not pay off. This can also happen if they take on too much underwriting risk or other types of risk. Because large numbers of people may depend on an insurance company to cover their claims, the NAIC has requirements for the minimum amount of risk-based capital that insurance companies must possess. This figure is based on a company's asset risks, credit risks, underwriting risks, and off balance sheet risks.
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