Risk-Based Capital requirements are a statutory scheme for regulating the financial health of insurance companies. Developed by the National Association of Insurance Commissioners (NAIC), risk-based capital provides a more flexible measure of an insurers financial health.
Prior to RBC, states required insurers to meet a static net worth requirement. Generally, insurers had to have a flat amount of surplus (say $2 million) over and above their paid-in capital. This surplus requirement stayed the same without relation to the nature of the insurer's business, the volatility of its investments or the amount of insurance it had in force.
RBC uses a complex formula which considers all those factors to create a baseline financial requirement individualized to each insurer. For instance an insurer which issues hundreds of thousands of earthquake policies in Southern California and whose assets are invested in junk bonds, dot com futures and lottery tickets would have a much higher capital requirement than a small credit-life insurer with all its assets in cash.
Theoretically, this benefits both the industry and the consumer. Insurers who are at a greater risk of financial disaster (whether through mismanagement or simply because of the nature of the risks they insure) are required to maintain a bigger cushion, thus protecting consumers. On the other hand, insurers unlikely to experience financial problems are releived from potentially burdensome capital requirements, allowing them to put their funds to better use.