Which statement about the RBC charge's credit risk components is correct?

• A. It accounts only for default risk.
• B. It accounts only for estimation risk.
• C. It accounts for both default risk and estimation risk.
• D. It accounts for market risk.

Answer: (C)

The credit risk portion of the RBC charge is designed to reflect two kinds of risk: the actual likelihood and severity of credit events (default risk) and the uncertainty in our estimates of those losses (estimation risk).

Default risk captures the possibility that a counterparty or asset issuer may fail to meet its obligations, leading to losses that the RBC charge should cushion. Estimation risk accounts for the fact that the inputs used to measure credit losses—such as default probabilities, loss given default, exposure at default, and even discount rates—are themselves uncertain and could be misspecified. The charge thus needs to cover both the potential for true credit losses and the possibility that our models and assumptions understate those losses.

Market risk, by contrast, is driven by broad price/interest rate movements affecting asset values and is handled by a separate RBC component, not the credit risk portion.