MCT

Study guide: Exam 6C

The Minimum Capital Test (MCT) is OSFI's risk-based capital framework for Canadian P&C insurers. It compares the capital an insurer actually has — Capital Available — with the capital its risk profile requires — the Base Solvency Buffer — and expresses the result as a ratio that drives supervisory action.

\text{MCT Ratio} = \frac{\text{Capital Available}}{\text{Base Solvency Buffer}} \times 100\%

• The build-up. Capital Required is the sum of the insurance, market, credit and operational risk margins, less a Diversification Credit recognising that insurance and market risk do not peak together. The Base Solvency Buffer is then 1.5 times capital required.
• The thresholds: a minimum ratio of 100\%, a supervisory target of 150\% at which OSFI expects insurers to operate, and an internal target each insurer sets for itself above the supervisory target through its ORSA.
• Risk-based, not premium-based. Required capital scales with the actual composition of the balance sheet — line of business mix, reserve duration, asset allocation, catastrophe exposure and reinsurance structure — rather than with a flat percentage of premium. Two insurers of the same size can have very different requirements.
• Reinsurance credit depends on registration. Ceded liabilities reduce the requirement only where the reinsurer is registered or the cession is collateralised; see Unregistered Reinsurance.
• It is a point-in-time measure, which is why it does not stand alone: FCT tests it under adverse scenarios and ORSA asks whether the insurer's own view of required capital exceeds the formula's.
• Provincially regulated insurers are generally subject to the same test, adopted by their provincial regulator, so the MCT is effectively the national capital standard.

Computing the MCT Ratio An insurer reports: capital available \$248 million; insurance risk margin \$92 million; market risk margin \$54 million; credit risk margin \$21 million; operational risk margin \$17 million; diversification credit \$26 million. Its internal target is 185\%.

Compute the ratio and assess.

Answer Capital required:

\begin{align*}
\text{CR} &= \$92 + \$54 + \$21 + \$17 - \$26 \\
&= \$158\text{M}
\end{align*}

Base solvency buffer:

\begin{align*}
\text{BSB} &= 1.5 \times \$158\text{M} \\
&= \$237\text{M}
\end{align*}

MCT ratio:

\begin{align*}
\text{MCT} &= \frac{\$248\text{M}}{\$237\text{M}} \times 100\% \\
&= 104.6\%
\end{align*}

Above the 100\% minimum, far below the 150\% supervisory target and the 185\% internal target. This insurer is in serious difficulty.

What follows immediately: OSFI escalation to a supervisory stage with a required capital restoration plan, a prohibition on dividends and other distributions, increased reporting frequency, and probable restrictions on growth — since writing more business raises the insurance risk margin and therefore the buffer, worsening the ratio.

The available remedies, and their speed: raise capital (fastest, if a parent or the market will provide it); buy reinsurance to reduce insurance risk (fast, and it directly cuts the largest margin here); de-risk the investment portfolio to cut the market risk margin (fast but sacrifices yield); reduce writings (slow, and it hurts the franchise). Note that the insurer needs roughly \$29 million of additional capital to reach the supervisory target and \$191 million to reach its own internal target — the second figure is the one that shows how far the position has fallen.