The Office of the Superintendent of Financial Institutions reports that its new capital adequacy methodology is working effectively, and has resulted in lower capital requirements for most property and casualty insurers.

In a letter sent to CEOs of federally-regulated Canadian P&C insurance companies today, OSFI reports on the impact of the implementation of the Minimum Capital Test (MCT) in 2003, compared to the former Minimum Asset Test (MAT).

“After experiencing several difficult years, conditions in the P&C industry improved in 2003,” it says. “This was reflected in good MCT results. At year-end 2003 three-quarters of companies had an MCT over 200% and one-quarter had an MCT between 162% and 200%. The industry-aggregate MCT rose to 221%, from 211% in 2002, with MCT Excess Capital rising by $1.1 billion to $6.3 billion.”

OSFI had committed to ensuring that capital adequacy requirements under the MCT method versus the MAT method would be capital neutral, on an industry aggregate basis, in an average year. This has been tested at 10% MAT being equivalent to 150% MCT, it reports.

“At 150% MCT, 88% of companies had lower capital requirements in 2003, while the remaining 12% experienced higher requirements. For the companies whose capital requirements increased, all of them had a year-end MCT above 200%.”

“As experience with the MCT has grown, we have gained greater confidence that it appropriately identifies key risk areas. Companies that have relatively higher exposure to the risk areas assessed by the Test have higher capital requirements,” it concludes.

The MCT/MAT comparison was conducted to fulfill OSFI’s commitment to the industry to review the industry aggregate capital impact of the MCT after the first year of implementation. The results were discussed at a May 27 meeting with representatives of the Insurance Bureau of Canada.

Meanwhile, OSFI has also published a consultative paper on the new capital adequacy framework, known as Basel II.

On June 26, the Basel Committee on Banking Supervision published Basel II, which aims to better target capital requirements to risk. OSFI says that it has been working closely with industry and the Accord Implementation Group regarding the implementation of the new Basel framework.

These efforts have identified a number of issues where industry has suggested it would be helpful to have guidance to assist implementation efforts. The OSFI paper sets out OSFI’s proposed approach on a number of policy issues where Basel II allows national discretion. It also clarifies key aspects of timing/reporting requirements and parallel-run periods for implementation for both credit and operational risk approaches.

Institutions are invited to provide comments regarding the paper by September 30.