Supervisory Target Capital Ratio

Study guide: Exam 6C

The Supervisory Target Capital Ratio is the MCT ratio at which OSFI expects every federally regulated P&C insurer to operate: $150\%$ . It is above the $100\%$ minimum, and the space between them is deliberate — it gives the regulator room to act while the insurer still has capital to work with.

$\text{Supervisory target} = 150\%$

$\text{Minimum} = 100\%$

Not a minimum, and not optional. An insurer below $150\%$ has not breached a legal requirement, but it has fallen below the level at which OSFI considers it soundly capitalised, and heightened supervision follows.
The three-level ladder: the insurer's own internal target (set through ORSA, above $150\%$ ), the supervisory target ( $150\%$ ), and the minimum ( $100\%$ ). Each breach triggers a stronger response, and the ladder exists so that action begins early rather than at the point of failure.
What a breach brings: a required capital restoration plan with dates, restrictions on dividends and other capital distributions, increased reporting frequency, likely limits on growth (since growth raises the Base Solvency Buffer), and escalation through OSFI's intervention stages.
Trend beats level. A ratio of $160\%$ falling $20$ points a year is a more urgent problem than a stable $145\%$ — the first will breach the minimum within three years, the second will not. Supervisory attention follows direction.
The target is uniform; the internal target is not. OSFI applies $150\%$ to all, and expects each insurer's own target to reflect its risks — catastrophe exposure, business concentration, reserve uncertainty, growth plans — through ORSA and tested in FCT.

How Much Room Is There? An insurer holds a $158\%$ MCT ratio with capital available of $\$237$ million and a base solvency buffer of $\$150$ million. Its FCT report models a $1$ -in- $100$ earthquake costing $\$46$ million net of reinsurance, after tax.

Does it survive the scenario, and what should the internal target be?
Answer After the event, capital available falls by $\$46$ million. The buffer also changes — an earthquake consumes reinsurance and changes the risk profile — but take it as roughly unchanged for a first pass:
 $\begin{align*} \text{MCT} &= \frac{\$237\text{M} - \$46\text{M}}{\$150\text{M}} \\ &= \frac{\$191\text{M}}{\$150\text{M}} \\ &= 127\% \end{align*}$ 
It survives — above the $100\%$ minimum — but lands below the $150\%$ supervisory target, in escalation, with an earthquake to pay for and reduced access to capital markets precisely when it needs them.

What the internal target should be. If the insurer wants to remain at or above the supervisory target after its largest modelled event, it needs:
 $\begin{align*} \text{Required CA} &= 1.50 \times \$150\text{M} + \$46\text{M} \\ &= \$271\text{M} \\[4pt] \text{Implied target} &= \frac{\$271\text{M}}{\$150\text{M}} = 181\% \end{align*}$ 
So an internal target of roughly $180\%$ , not the $158\%$ currently held — and that is before allowing for the possibility of a reserve strengthening or a market decline occurring in the same year, which FCT would test as a combined scenario.

The general principle: the internal target is not a comfort margin chosen by feel. It is derived from how far the insurer's own scenarios say the ratio can fall, and the supervisory target is the floor those scenarios must respect.