Risk-Based Capital Analysis in Punitive Damages Litigation

Forensic accountants are often hired in punitive damages cases to present evidence to a jury of a defendant's financial position and the results of operations. Jurors use this information to determine an appropriate punitive damages award sufficient to punish defendants without financially destroying them. While evidence of a defendant's financial position and results of operations is important, forensic accountants have offered little help to a jury in determining how much of an award could financially destroy a defendant. An analysis of a defendant's risk-based capital position could be useful evidence of the amount, if exceeded that could financially destroy a defendant. This study was performed to determine how accurate risk-based capital levels are at measuring the amount of capital an organization must retain to support operations. In this non-experimental quantitative study, the full population of insurance companies rated by A.M. Best Company and the full population of depository institutions operating from 2007 through 2011 was selected to participate. Data was collected for the five year review period covering 2007 through 2011. Logistic regression was used with archived data to determine whether insolvency rates or financial strength ratings are significantly related to an organization's risk-based capital position. A significant relationship existed in each year from 2007 through 2011 between the risk-based capital ratios and insolvency status of property/casualty and life/health insurance companies and depository institutions as evidenced by a p-value < 0.01 in each analysis. A significant relationship also existed in each year from 2007 through 2011 between the risk-based capital ratios and financial strength ratings of property/casualty and life/health insurance companies as evidenced by a p-value < 0.01 in each analysis. The odds ratios showed an increase in risk-based capital ratios for insurance companies and depository institutions results in an increase in the odds that a company is solvent. The odds ratios also showed an increase in risk-based capital ratios for insurance companies increases the odds of a company having a higher financial strength rating. Further research is required to determine whether a significant relationship exists between risk-based capital ratios and financial strength ratings of depository institutions.