Solvency

Study guides: Exam 6C, Exam CP-341, Exam GI-201, Exam GI-302, Exam RET-301

Solvency is an insurer's ability to meet its obligations to policyholders as they fall due. An insurer is solvent when its assets exceed its liabilities by at least the capital its risk profile requires — so solvency is not merely positive equity, but positive equity of a sufficient margin, which is what MCT measures and what Solvency Regulation enforces.

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

• Three levels of the same idea, and candidates should keep them distinct: balance-sheet solvency (assets exceed liabilities); regulatory solvency (capital exceeds the required amount, so the insurer may keep operating without intervention); and liquidity (cash is available when claims are paid, even if the balance sheet is sound).
• Why insurers fail. PACICC's research is consistent: inadequate pricing and deficient reserves dominate, followed by rapid growth into unfamiliar lines, reinsurance failure or dispute, catastrophe exposure, and fraud. Asset losses are a less frequent primary cause than intuition suggests — the liability side is where Canadian insurers fail.
• Assessment tools: the MCT ratio and its trend; financial condition testing under adverse scenarios; ORSA's own view of required capital; Stress Testing and reverse stress testing; key financial ratios from the Canadian Annual Return (the MSA Ratios set); and Rating Agency assessments.
• Solvency is forward-looking. A ratio measured at a point in time says little; the questions are whether it is rising or falling, what would happen under adverse scenarios, and whether the business plan consumes or generates capital. This is precisely why FCT and ORSA exist alongside the MCT.
• The regulator does not promise zero failures. OSFI's mandate is explicitly to allow reasonable risk-taking; guaranty funds handle the residual. A regime with no failures would be one in which capital requirements had made insurance unaffordable.
• Solvency interacts with pricing: suppressed rates guarantee eventual insolvency pressure, and a solvency regulator that cannot set rates can only observe the consequence.

Is This Insurer Solvent? An insurer reports: assets \$820 million, liabilities \$690 million, Base Solvency Buffer \$92 million. Its supervisory target ratio is 150\% and its internal target is 175\%. One year ago the ratio was 168\%. Two years ago, 181\%.

Assess.

Answer Capital available (before regulatory adjustments) is \$820 - \$690 = \$130 million.

\begin{align*}
\text{MCT ratio} &= \frac{\$130\text{M}}{\$92\text{M}} \\
&= 141\%
\end{align*}

Balance-sheet solvent — comfortably, with \$130 million of equity. Not regulatorily solvent in the operating sense: 141\% is below both the 175\% internal target and the 150\% supervisory target.

The trend is the story. 181\% \to 168\% \to 141\% is a decline of 13 then 27 points — accelerating. Straight-line extrapolation puts the insurer near the 100\% minimum within two years, and by then it would have no capacity to recover.

What the Appointed Actuary must establish: whether the fall is coming from capital available (losses, dividends, unrealised investment declines) or from the buffer (growth in premium and reserves), because the responses differ. The FCT report must model whether plausible adverse scenarios — a reserve strengthening, a catastrophe, a market decline — breach the 100\% minimum, and that report goes to the board.

What OSFI will do: require a capital restoration plan, restrict dividends, and increase reporting frequency. The single most important observation for an exam answer is that a declining ratio above target is a more serious signal than a stable ratio below it — direction dominates level.