OSFI.MCT

Reading: Office of the Superintendent of Financial Institutions Canada Guideline, “Minimum Capital Test (MCT) for Federally Regulated Property and Casualty Insurance Companies, Effective January 1, 2020.” Candidates are not responsible for the following sections: 1.2.2., 2.1.1.1., 2.1.2., 2.1.3., App. 2-A, 3, 4.6., 5.1.1.5., 5.1.1.6., 5.2.2., 5.3.4.1., 5.3.4.2., 6.1.1., 6.2.1., 6.2.2., 6.2.3., 6.3. Candidates are not responsible for risk factors relating to insurance, market, or credit risk.

Synopsis: This guideline outlines the capital framework, using a risk-based formula, for target and minimum capital/margin required, and defines the capital/assets that are available to meet the minimum standard. The MCT determines the minimum capital/margin required and not the level of capital/margin required at which property and casualty companies must operate.

Note that the original syllabus released for Spring 2021 indicated a Jan. 2020 edition for this reading. On Jan 20, 2021, we noticed the syllabus has been changed and this reading reverted back to the 2019 edition.

Study Tips

This is the most important paper on the syllabus and accounts for roughly 10% of the points on each exam. OSFI considers the MCT ratio (Minimum Capital Test ratio) to be a prime indicator of an insurer's health. This ratio compares capital available (CapAv) to capital required (CapReq). The benchmark MCT ratio is 150%. If an insurer's ratio falls below this benchmark, it may be in danger of having insufficient assets to cover its liabilities, and may come under increased regulatory scrutiny.

You must first understand how to calculate the MCT ratio. You must also have a conceptual understanding of how items in the financial statements affect the final ratio. The MCT ratio is the first of several financial health ratios listed in the paper MSA.Ratios.

Here are a few suggestions for how to study this reading:

• Get an overview: Peruse the table of contents of the source text, and read the first paragraph of each of the 8 chapters, excluding chapter 3. This should take about 10 minutes. The point is to make sure you've downloaded the current version of the reading from the CAS website and have a basic understanding of the layout. (Since this is the most important reading on the syllabus, I highly recommend that you do refer to the OSFI's source text as you study.)

• Practice the basic calculation: BattleActs has numerous practice templates that cover basic components of the MCT calculation. Links to these are provided later in this article, but you can also access them using the Calculation Problems link. Once there, click the button at the top of the page Retrieve BattleActs practice templates only

• Previous exam questions: Once you're comfortable with the basic versions of the calculations, try solving old MCT exam problems. Again, links are provided later in this article, but you can also access them using the Calculation Problems link. But instead of clicking on the button for the practice templates, use the Show CPs button for the appropriate section. (CP stands for Calculation Problem)

• Daily practice: At first, you should practice these calculations daily. Once you know them, you should return to them every week or two while you're studying other parts of the syllabus. Then when you get close to exam day, go back to daily practice. This might seem like overkill, but MCT consistently accounts for almost 10% of the exam, and it's usually a hard question. That's why the OSFI.MCT paper comes first in your study plan. It gives you 3 months to battle it into submission and slay it! There is a LOT to learn, but it will come together if you persevere.

• Intuition: As you get better and better at the calculations, you'll develop intuition about how the components relate to each other. Remember the simple example above where I asked what would happen to the MCT ratio if the company shifted from short-tail to long-tail lines? You don't have to do the actual calculation to know that the MCT ratio would go down. That's a so-called Bloom's taxonomy type of question because you have to have a higher level of understanding to be able to see the answer at a glance.

Estimated study time: 2 weeks (not including subsequent review time)

Pop Quiz

1. For a healthy company, which is greater: CapAv (Capital Available) or CapReq (Capital Required)?
2. Does OSFI think margins are a good or bad idea?

Answers at bottom of this wiki page

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• OVERALL: how to calculate MCT capital available, capital required, and final MCT ratio
• risk margin for an earthquake catastrophe
• interest rate risk margin (these problems involve significant premium liabilities calculations that are covered in CIA.PrLiabs)
• other components of the MCT capital required: insurance risk, market risk, credit risk, operational risk
• diversification credit (calculation and interpretation) and final MCT ratio
• impact of unregistered reinsurance

The exam questions at the bottom of the BattleTable (tan-coloured background) are from an old version of the MCT paper. You can ignore these questions.

Top Questions ← Questions you absolutely need to know!

Note that in the BattleTable below, you can click E in the left-hand column to open a PDF with the question and answer from the examiner's report for just that question.

Questions held out from Fall 2019 exam: #17, 19*, 20, 21, 22. (Skip these now to have a fresh exam to practice on later. For links to these questions, see Exam Summaries.)

* The examiner's report solution for #19 contains an error when checking whether (category B) + (category C) capital exceeds the cap. The right side of the inequality should be 10,500 not 7,500. This is does not change anything else in the solution. (shout-out to NZ!)

reference	part (a)	part (b)	part (c)	part (d)
E (2019.Spring #13)	MCT calc: - MCT ratio
E (2019.Spring #14)	CIA.PrLiabs	CIA.PrLiabs	CIA.PrLiabs	(d) CIA.PrLiabs (e) CapReq for prem. liabs.
E (2019.Spring #18)	earthquake: - calc ER (Eqk Reserves)	MCT impact: - of ER decrease	BCAR.Cat	OSFI.Eqk
E (2018.Fall #15)	MCT calc: - MCT ratio
E (2018.Fall #19)	earthquake: - calc reserves/component	OSFI.Eqk
E (2018.Fall #25)	MCT calc: - MCT ratio	financial health: - early warning?	OSFI.ORSA
E (2018.Fall #26)	CIA.MfAD	diversification credit: - interpretation	CIA.PrLiabs	flood risk: - accounted for?
E (2018.Spring #13)	CIA.Accting	MCT impact: CIA.Accting - HTM bond yield decrease
E (2018.Spring #14)	MCT calc: 4 - interest rate risk margin
E (2018.Spring #17)	earthquake: - calc reserves/component	OSFI.Eqk	OSFI.Eqk
E (2018.Spring #18)	MCT calc: - operational risk	MCT calc: - diversification credit	MCT calc: - MCT ratio	MCT ratio: - regulator action
E (2017.Fall #18)	earthquake: - calc reserves/component	OSFI.Eqk
E (2017.Fall #20)	MCT calc: - insurance risk	MCT calc: - market risk	MCT calc: - operational risk	MCT calc: - total capital required
E (2017.Spring #19)	earthquake: - calc reserves/component	earthquake: - non-modeled approach
E (2017.Spring #20)	define: - interest rate risk	CIA.Duration	MCT calc: - interest rate risk margin
E (2017.Spring #21)	MCT calc: - for PAS 1
E (2017.Spring #24)	MCT calc: - market risk	MCT impact: - unregistered reinsurance	OSFI.ORSA	OSFI.AA
E (2016.Fall #15)	MCT calc: - interest rate risk margin	MCT calc: - market risk
E (2016.Fall #17)	earthquake: - calc reserves/component	OSFI.Eqk	OSFI.Eqk
E (2016.Fall #18)	define: - operational risk	MCT calc: - operational risk	diversification credit: - define
E (2016.Fall #24)	CIA.MfAD	BCAR.Cdn	diversification credit: - credit/market correlation	(d) ICA.Ch47 (e) OSFI.ORSA
E (2016.Spring #13)	MCT calc: (7.75 pts!) - interest rate risk margin
E (2016.Spring #19)	MCT calc: - capital required
E (2016.Spring #20)	impact: - unregistered reinsurance	formula: - Off-B/S items	diversification credit: - define
E (2015.Fall #16)	earthquake: - calc reserves/component	OSFI.Eqk	OSFI.Eqk
E (2015.Fall #18)	MCT concept: - supervisory target capital	MCT calc: - insurance risk	(c) outdated (d) operational risk	(e) diversification credit (f) MCT ratio & OSFI's reaction
E (2015.Fall #19)	considerations: - capital available
E (2015.Fall #20)	CIA.DCAT	CIA.DCAT	CIA.DCAT	MCT calc: - for PAS 1
E (2015.Fall #21)	MCT calc: - MCT ratio
E (2015.Spring #23)	MCT calc: - capital available 5ab	MCT calc: - insurance risk	MCT calc: - operational risk	(d) outdated 2 (e) MCT ratio
E (2014.Fall #22)	outdated 3
E (2014.Spring #20)	outdated
E (2014.Spring #26)	outdated
E (2012.Fall #24)	outdated
E (2012.Fall #27)	outdated

¹ PAS stands for Plausible Adverse Scenario. This term is defined in CIA.DCAT although that reading is now outdated. It has been replaced by CIA.FCT-1. Here is a useful forum discussion on 2017.Spring Q21.

² This question is from the current version of the MCT paper, (Chapter 6 on Credit Risk) but that chapter was removed from the syllabus for 2017.Fall.

³ All questions from this bottom (tan-coloured) portion of the BattleTable are from earlier version of the MCT paper. The calculations are totally different so don't even bother looking at them.

⁴ First note that these interest rate margin problems contain significant material from CIA.PrLiabs so you won't be able to do the full problem until you've covered that reading. Also, you cannot solve this particular problem as given because they did not provide the interest rate risk margin % (interest rate shock factor.) You had to assume it was the same as the interest rate MfAD. Sample answer 1 in the examiner's report used 1.25% as the interest rate risk margin, which you could not have known. Sample answer 2 used 0.5%, which was the interest rate MfAD. This is not correct but it was the only reasonable assumption, otherwise you could not solve the problem. But there is another error in sample answer 2 (shout-out to HC!) - they used 1.03 instead of 1.025 for the calculation of the PVfctr. Addendum: According to the January 1, 2019 version of the source reading, the interest rate shock factor always equals 1.25%. If a specific value is not provided in the question, you should use 1.25%.

^5a There is an error in the examiner's report solution for part (a), although it doesn't affect the final answer. The excess for category C shares was calculated incorrectly. The correct answer is that the category C limit was not breached so there is no category C excess and hence no deduction required from capital available. (The BC deduction however is correct and is required). See also this brief forum discussion on this point.

^5b To fully understand the Capital Available calculation, you need to have memorized Exhibit 30.62 from the sample quarterly annual statement. Note however that according to the current syllabus, the sample quarterly and annual statements are for informational purposes only and will not be directly tested. For that reason, you shouldn't be asked to solved a problem like this in the future. Indeed, all the subsequent exam problems that required you to calculate Capital Available were much simpler. (shout-out to AS!)

In Plain English!

Intro to this mammoth paper

MCT stands for Minimum Capital Test. The OSFI.MCT paper is entirely about calculating & understanding the MCT ratio. The mechanics of the calculation are covered exhaustively in the practice templates within Calculation Problems in the main BattleActs site. (There are direct links to this through the mini BattleQuizzes - see below.) But first, take a look at this extremely simple example (amounts in 000's). Given:

• CapAv (Capital Available) = 62,400
• CapReq (Capital Required) = 50,355

(Assume that the diversification credit has already been taken. This credit is discussed later in this article.)

If minCapReq stands for minimum Capital Required then the formula for the MCT ratio is:

MCT = CapAv / minCapReq

where

minCapReq = CapReq / 1.5

So MCT = 62,400 / (50,355/1.5) = 185.9% This is comfortably above the supervisery target of 150%, so this insurer is probably doing ok. (In practice, we would need much more info than just a single year's MCT ratio to be able to draw meaningful conclusions about an insurer's overall health. The MSA ratios are a great supplement.

Side note

Did you wonder why we used minCapReq in the denominator instead of just CapReq? (CapReq is also called target CapReq)

Explanation: Target CapReq corresponds to a CTE (Conditional Tail Expectation) of 99%, so minCapReq is a less strict requirement. (But then we set the statutory requirement at 150% instead of 100%, so I suppose it all works out the same in the end. The source text provides no real explanation for using minCapReq and setting the minimum MCT ratio at 150% instead of simply using CapReq with a minimum ratio of 100%.)

Note: CTE(Q%) is defined in CIA.MfAD, mini BattleQuiz #3, as the weighted average of the highest (100-Q)% results of a stochastic simulation. This is sometimes approximated by VaR (Value-at-Risk) at 99.5% when a CTE approach isn't practical.

Typical conceptual problem

Let's take the previous example, but make a slight change to the insurer's B/S or Balance Sheet:

• Suppose there is a shift in B/S liabilities from auto physical damage to auto liability.
  • Question: Does this shift cause the MCT ratio to go up or down? Why?
  • Answer: Down, because auto liability has a longer tail than physical damage. In other words, it's riskier, and riskier B/S items require more capital support. That pushes CapReq up, which pulls MCT down.

Layout of the paper

You can see from the table of contents in the MCT source paper that there are 8 chapters.

Chapter 1 Just general info.

Chapter 3 NOT on syllabus.

The critical info is in chapters 2 & 4-8.

Chapter 2: CapAv (Capital Available)

• You need the B/S (Balance Sheet) and possibly other exhibits from the Annual Return to calculate capital available.
• Sometimes CapAv is approximated by the B/S equity (equity = assets - liabilities).

Chapter 4-7: CapReq (Capital Required)

Formula: CapReq = Sum(IMCO) – DC

IMCO are the 4 broad areas of risk and this is where all the complicated calculations are. DC is the Diversification Credit (explained further down.)

Chapter 4: Insurance Risk

Chapter 5: Market Risk

Chapter 6: Credit Risk (most of this chapter has been removed from the syllabus)

Chapter 7: Operational Risk

Memory Trick: In My Crummy Opinion → IMCO

Chapter 8: DC (Diversification Credit)

• This credit is used to reduce CapReq.
• It represents diversification of risk, which is good. If risk is diversified, it's less likely that all risk categories will suffer big losses all at the same time.
• The purpose of the Diversification Credit shows up on exams. (Memorize it!)

Purpose of DC: recognize diversification by reducing CapReq (diversified risks aren't likely to suffer big losses all at the same time)

Start Calculating!

The mini BattleQuiz link below will take you to the BattleCards, which is our word for flash cards. In this selection, there are some fact-based BattleCards, which are self-scored, and one calculation BattleCard. For the calculation BattleCard, click on the button with the pencil and the digits 123 to go to the actual problem. When you answer a BattleCard correctly, your BRQ (Battle Readiness Quotient) will rise. This is shown in the navigation bar next to your name in the main part of the site.

Note that in the mini BattleQuiz below, some of the BattleCards are actually old exam questions. Click E in the left-hand column to open a PDF with the full exam question and answer.

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Chapter 2: CapAv (Capital Available)

Chapter 2 defines CapAv or Capital Available, which is the numerator in the MCT ratio. The calculation of CapAv is not difficult because it involves mostly simple additions and subtractions of financial statement items. A potential complication however is that there are potentially dozens of financial statement items involved. Exam questions normally focus on a small subset of these but occasionally the examiners throw in something new. (More on this later.)

This section of the reading is over 15 pages but several subsections (about 10 pages altogether) are specifically excluded:

2.1.1.1: Qualifying criteria for inclusion of capital instruments in category A for regulatory capital purposes

2.1.2: Category B capital

2.1.3: Category C capital

App. 2-A: Information Requirements for Capital Confirmations

Here's the most important fact/formula you need to know about capital available:

Question: identify the main components of capital available

category A capital: consists of the following items...

• qualifying category A common shares
• contributed surplus
• R/E (Retained Earnings)
• reserves (includes earthquake, nuclear, general contingency reserves)
• AOCI (Accumulated Other Comprehensive Income)

category B capital (not broken out into components → you should be given this value directly on the exam)

category C capital (not broken out into components → you should be given this value directly on the exam)

non-controlling interests (not broken out into components → you should be given this value directly on the exam)

Normally, the first step in calculating capital available is to sum these 8 components, 5 of which are part of category A capital. Often however, the exam question simply gives you the value for capital available directly so you don't have to do anything. There's a practice template in the next quiz that covers this simple calculation.

Aside from being able to calculate CapAv using B/S items, there are some qualitative considerations in defining CapAv for MCT purposes.

Question: identify qualitative considerations regarding MCT capital available [Hint: APAS]

Availability: Is the capital element fully paid & available to absorb losses?

Permanence: Until when is the capital element available?

Absence: Ask whether a capital element has an absence of encumbrances & mandatory servicing costs

Subordination: Is the capital element subordinated to the rights of policyholders & creditors in an insolvency or winding-up?

An old exam problem on this topic is:

E (2015.Fall #19)

Adjustments to Capital Available

After you've summed category A, B and C capital and non-controlling interests to get the basic value for CapAv, there are a couple of ways this value may have to be reduced:

• Capital Composition Limits (Section 2.2): This relates to limits on category B & C capital. The calculation is covered in the next quiz. Basically, if the amount of category B & C capital exceeds certain limits then you must deduct the excess from the basic CapAv value. It's an easy calculation.
• Regulatory Adjustments to Capital Available (Section 2.3): A couple of old exam problems that required regulatory deductions from CapAv were:

E (2019.Fall #19)

E (2015.Spring #23)

There are many possible regulatory deductions listed in the source text and it doesn't seem reasonable to expect you to memorize all of them. If you scan the list of 12 deductions from Section 2.3.1 in the MCT source text, you'll see that some of them are very complicated. There are handful that might be worth remembering however:

#2. unsecured & unregistered reinsurance exposures and self-insured retentions (there is a calculation related to unregistered reinsurance in the next quiz)

#3. earthquake premium reserve (EPR) not used as part of financial resources to cover earthquake risk exposure (appeared on the 2015.Spring exam)

#6. accumulated impact of shadow accounting

#7. goodwill and other intangible assets (appeared on the 2019.Fall exam)

#8. deferred tax assets (DTA) (appeared on the 2019.Fall exam)

#11. investments in own instruments

And there are several more pages of these in the remaining subsections of Section 2. The only way to make sure you can calculate CapAv in any situation is to memorize all of it, but that's probably a waste of time. Instead, make sure you can do the 2019.Fall MCT problem (#19) and maybe take a quick look at the 2015.Spring problem (#23). (The 2015.Spring problem is probably more complicated than what you currently need to know however.) Beyond that, here's a tip that might help:

Tip on CapAv deductions: Make sure you know what is included in CapAv (category A, B, C capital, non-controlling interests). Then if the exam question gives you "weird" stuff in the given information, there's a pretty good chance this is a deduction from CapAv.

Be aware there is an error in the examiner's report solution to (2015.Spring #23a). See footnote ⁵ in the BattleTable above or the brief forum discussion on this point.

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Chapter 4: Insurance Risk

Recall the definition of insurance risk:

• risk of loss FROM the potential for claims (from policyholders & beneficiaries)

Broadly speaking, insurance risk deals with uncertainties surrounding the amount and timing of net cash flows for items such as premiums, commissions, claims & LAE. This is slightly more general than the above definition. The idea of timing is crucial – if you're owed $100,000, but the payment is 20 years late, you might as well have just written it off as bad debt. Timing is everything!!!

There are then 4 sub-categories of insurance risk: (Past exam problems have covered all these sub-categories, but earthquake seems to come up more than the others.)

claims liabilities

premium liabilities

unregistered reinsurers

catastrophes (earthquake, nuclear,...)

This is a long section, so you should get started immediately (if not sooner!) on the mini BattleQuiz. It's a mixture of fact-based BattleCards, and BattleCards for practice templates, and will probably take you several days of intensive study.

Important: If you're given claims or premium data in an MCT problem, make sure it's net of reinsurance, salvage/subrogation, SIRs (Self-Insured Retentions), and also that it does not include PfADs (Provision for Adverse Deviation).

Important: The examiner's report answer to (2015.Fall #18b) has an error. When they calculate the capital required for unregistered reinsurance, the formula they use is incorrect. They got the correct answer (by luck), but if you apply that same formula to other problems, for example (2017.Fall #20a), you will get the wrong answer. (Thanks to user nyzf0101 for noticing this!)

Before you read the chapter on insurance risk in the MCT paper, here is something to keep in mind:

• (4.3.3) is the subsection on unregistered reinsurers.
  • (4.3.3.3) tells you how to calculate the margin required for the unregistered reinsurance component of insurance risk. The formula is given in the practice template in the mini BattleQuiz (Note that no mention has yet been made regarding the LOC or Letter of Credit limit.)
  • (4.3.3.4) is a detailed discussion of collateral. It is here that first mention is made of the limit on the use of LOCs. Specifically, the limit on the use of letters of credit to obtain capital credit for unregistered reinsurance is

30% of “Unearned premiums ceded to assuming insurer” and “Outstanding losses recoverable from assuming insurer".

• But does this limit apply in every calculation that involves LOCs? Namely:

• deduction to capital available due to unregistered reinsurance (Chapter 2)
• margin requirement for unregistered reinsurance component of insurance risk (Chapter 4)

• If the 30% limit does apply everywhere, why is it not mentioned until after those topics have already been dealt with?
• Another formula involving LOC relates to:

• the reduction in capital required for unregistered reinsurance collateral within credit risk (Chapter 6)

• But the example on how to do this calculation appears in (4.3.3.4), not in Chapter 6. But despite all this, I think the following is a reasonable assumption:

A reasonable assumption: This 30% limit on LOCs applies to all formulas where LOC appears.

So, you should always check whether the limit is breached. (Usually it isn't) Also, as noted further down in this article, most of chapter 6 has been removed from the syllabus, so the credit risk component is no longer a significant issue.

Note that for one of the old exam questions in the mini BattleQuiz, (2017.Fall #18a), you need to know the components of the financial resources of earthquakes from section 4.5.1.2. This is discussed in more detail in the wiki article OSFI.Eqk, so you may want to switch briefly to the relevant section (Other Top Earthquake Questions) in that article before attempting the aforementioned exam problem. They also added something nasty into that problem: You had to know to do linear interpolation between PML500 and PML250 to find PML420 (= 170/250 * PML500 + 80/250 * PML250). (Note that PML500 & PML250 correspond to percentiles of 0.998 & 0.996 on the loss distribution.)

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Chapter 5: Market Risk

Recall the definition of market risk:

• risk of loss FROM changes in prices in various markets

There are then 4 sub-categories of market risk. If you want to remember them, ask Mr. IFER. He's a friend of Alice the Actuary. (Past exam problems tend to focus on interest rate risk.)

Interest rate risk

Foreign exchange risk

Equity risk

Real estate risk

Mr. stands for Market risk, and IFER represents the first letter in each subcategory of risk.

P.S. I know these memory tricks are ridiculously stupid!! But that's the whole point - the stupider the better!! Nobody remembers the boring s**t!!

A few comments on the mini BattleQuiz:

• Problem (2018.Spring #14) was the 3^rd time in recent history where you had to do the whole calculation for interest rate risk margin. It consists of several steps: (You won't understand all of it until you're further along in the syllabus but it's still good to look at it now.)

1. APV(claims liabilities): which is part of CIA.MfAD in the subsection Calculating APV
2. duration of claims liabilities: see CIA.Duration
3. APV(premium liabilities): covered here which is part of CIA.PrLiabs
4. duration of premium liabilities: see CIA.Duration
5. putting the previous steps together to get the final answer for interest rate risk margin (this final step is pretty easy once you have everything else)

Important: As was stated in the BattleTable, you cannot solve the problem as given because the question does not provide the interest rate shock. The first sample solution in the examiner's report assumes it's 1.25%, even though it isn't provided. The second sample solution assumes the interest rate shock equals the MfAD for the investment rate of return, which is 0.5%. This is not a valid assumption but it was the only thing you could do if you wanted to solve the problem. That's why the sample solutions have different answers. This is very confusing for someone studying and I think it's really bad that they didn't bother to explain their error.

• Problem (2017.Spring #20b), on the difference between modified and effective duration, is from Sections (5.1.1.5) & (5.1.1.6) and has been removed from the syllabus. (So this is not included in the mini BattleQuiz.)

• There is a practice template for calculating capital required for interest rate risk. It's quite easy, and is very similar to (2017.Spring #20c)

• Now, (2016.Fall #15a) is a much, MUCH harder problem on the interest rate risk. It's harder because you have to first calculate the both the APV (Actuarial Present Value) of the claim and premium liabilities, and also the duration of these liabilities. That's why it's worth 5.25 points. That means you have to know the calculations from the premium liabilities paper, CIA.PrLiabs Additionally, the calculation for the duration of premium liabilities is outdated. It was based on an earlier version of the CIA's premium liabilities paper, so don't waste time studying that part of the solution in the examiner's report.

• Even crazier is (2016.Spring #13), also with the now outdated method for calculating the duration of the premium liabilities. See CIA.PrLiabs for the updated method. This is similar to the above problem from (2016.Fall), but this was the first time an interest rate risk problem appeared on an exam, and it was worth 7.75 points!! One question, with no sub-parts!! Since this was a first-time question, I simply cannot imagine anyone solving it completely. (Maybe Sheldon from the Big Bang Theory.) But having said that, you can get a clue how to at least start by looking at the given information.
  • You're given a payment pattern, the net unpaid, and the MfADs (Margin for Adverse Deviation)- so they're setting you up to calculate the APV of the claims liabilities. That's probably 1.5 pts right there. The key is not to panic.
  • After you've done the APV for claims, it might then have dawned on you to calculate the APV of the premium liabilities. But I think they were again unnecessarily nasty because they don't give you the unearned premium. They give you the gross written premium and the exposure pattern, and make you calculate the unearned premium. It was just way too much to do. I think that's why the interest rate risk problems got progressively easier on subsequent exams.
  • And the calculation on the duration of the premium liabilities is out of date, so again, don't waste your time on that part of the examiner's report.

• So, before you get started, just keep in mind the 2 basic formulas for capital required for interest rate risk:

CapReq(IntRt)	= absolute value of [ change(value of assets) – change(APV(liabilities)) ]
change(assets or liabilities)	= (Fair Value or APV) x change(interest rate) x (modified duration)

* The change(interest rate) is also referred to as the interest rate shock factor. If this value is not provided in the exam question, you should use the value 1.25%. This is subject to change but the January 1, 2019 version of the source reading specifies the particular value of 1.25%.

Important: If you're given claims or premium liabilities in an MCT problem about interest rate risk, make sure it includes PfADs (Provision for Adverse Deviation). (This is the opposite of when you're calculating insurance risk. Note that from the previous section, the calculations involving claims & premium liabilities EXCLUDE PfADs.)

See section 5.1.2 for the 6-step process for calculating CapReq for interest rate risk. But it basically boils down to the formulas above. Have fun! (groan...)

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Chapter 6: Credit Risk

Recall the definition of credit risk:

• risk of loss FROM counter-party's potential (inability OR unwillingness) to fully meet contractual obligations due the insurer.

There are then 3 sub-categories of counter-party risk: (Past exam problems tend to focus on unregistered reinsurers, but most of this was removed from the syllabus for Fall.2017.)

counter-party default risk for B/S items

counter-party default risk for off-B/S items

counter-party default risk for collateral & guarantees from unregistered reinsurers

The syllabus regarding this chapter in the MCT reading is confusing. Calculation items that were previously tested have been removed from the syllabus without explanation:

(6.1) Capital Requirements for B/S Assets: The short intro remains on the syllabus.

(6.1.1) Use of ratings: removed

(6.1.2) Credit Risk Factors: remains

(6.2) Capital Requirements for Off-B/S Exposures: The short intro remains on the syllabus

(6.2.1) Credit Equivalent Amount: removed

(6.2.2) Credit Conversion Factors: removed

(6.2.3) Risk Factors: removed

(6.3) Capital Treatment of Collateral & Guarantees: removed

That doesn't leave a whole lot to test.

• It's odd that (6.1.2) on credit risk factors remains on the syllabus when most of that section is tables of risk factors, which the syllabus also specifically excludes.
• The only thing I see that might be asked is the 3rd bullet point under list-item 1, the formula for effective maturity. (This is p63 in the 2016 version of this paper.)
  • But the effective maturity is also discussed in CIA.Duration, and in much greater detail.
  • Furthermore, CIA.Duration states that either modified or effective duration may be used in calculating asset/liability duration for the interest rate risk margin. So it feels like concept of effective duration is pretty much a non-issue.
  • The only thing you probably need to know is that modified and effective duration give similar answers PROVIDED interest rate changes do not affect future cash flows. (So, obviously, if interest rate changes do affect future cash flows, then effective duration might be a better choice, at least for calculating in the interest rate risk margin.)
• To summarize then, it appears that detailed knowledge regarding the MCT calculation of credit risk has essentially been removed from the syllabus. As to why bits and pieces of Chapter 6 remain on the syllabus, I really have no idea.

For now, I've kept this material in the mini BattleQuiz, but I've adjusted the scoring weights to reflect these syllabus changes. (You should know the 3 main components of credit risk given in the table above.)

• Note that in 2017.Fall #22c, you were asked to identify an example of an off-B/S risk, (structured settlement, NOD[Non-Owned Deposits], LOC, derivative). You then had to identify a ripple effect and management action, so even that was mainly a topic from CIA.DCAT.

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Chapter 7: Operational Risk

Recall the definition of operational risk:

• risk of loss FROM inadequate or failed (internal processes, people, systems) OR FROM (external events)

There are then 3 sub-categories or components of operational risk. (You then multiply by appropriate risk factor to obtain capital required.)

sum(IMC) (sum of Insurance, Market, Credit risk)

premium volume & growth

intra-group pooling

There was a question in the forum regarding the formula for the premium growth charge. (This is the 5th line of the "A" components in the practice template. See post here.)

Note that intra-group pooling should not be included when determining whether there is a growth charge. See here. shout-out to Dulcinea!

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Chapter 8: Diversification Credit

Recall the definition of the diversification credit:

• a reduction to capital required RECOGNIZING that not all risk categories are likely to suffer maximum loss simultaneously

That and the formula for the diversification credit are all you need to know. (The formula is provided in the practice template in the mini BattleQuiz)

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Summary

Chapter 2 defines capital available. Do you remember APAS, the qualitative considerations in defining capital available. (If not, review the section on Chapter 2 above.)

Chapters 4-8 define capital required, which is the denominator in the MCT ratio. What you need to know from chapters 4-7:

• CapReq has 4 components. Use the mnemonic IMCO. (In My Crummy Opinion)

	risk	sub-risk 1	sub-risk 2	sub-risk 3	sub-risk 4	hint
I	Insurance Risk	claims liabilities	premium liabilities	unregistered reinsurance	catastrophes (earthquake, nuclear,...)	c-puc
M	Market Risk	Interest rate risk	Foreign exchange risk	Equity risk	Real estate risk	Mr. IFER
C	Credit Risk	default on B/S items	default on off-B/S items	default on collateral form unreg'd re	----	create your own
O	Operational Risk	Sum(IMC)	premium volume & growth	intra-group pooling	----	create your own

You then need to know how to calculate CapReq for each of these components. It's a mechanical process but it takes a lot of practice because it's so detailed. All of this is covered in the practice templates for calculation problems, and in the examiner's reports.

What you need to know from chapter 8:

• purpose of, and formula for, the diversification credit (see previous section)

Here are PDFs of all the pieces of the MCT puzzle put together...

MCT Practice Problem A (Full Problem)

MCT Practice Problem B (Full Problem)

And mini BattleQuiz #8 has references to the MCT problems from (2015.Fall). They were worth a total of 7.25 points or about 10% of the whole exam.

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BattleCodes

• This is a long & difficult paper, but the cheat sheet is short:
  • Be able to calculate the MCT ratio from start to finish. This is just a long but straightforward math problem.
  • Acquire a conceptual understanding of how the components interact with each other.
    • A good type of conceptual question is when you're not given any numbers, but simply told that certain input parameters either go up or down. You then have to determine the effect on the MCT ratio, up or down.
• This paper seems insurmountable when you first look at it, but if you spend just a LITTLE time on it every day, it will make sense before you know it!
• You can expect roughly 6-7 pts from this topic on the exam.
• GOOD LUCK!!

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  Forum

OSFI.MCT 2020.02.04

POP QUIZ ANSWERS

1. CapAv should be greater than CapReq for a healthy company. (Duh)
2. OSFI thinks margins are good: CapAv should be much greater than CapReq to account for uncertainty. (Who knows - we might be on a collision course with an asteroid. Yikes.)

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