Capital of Canadian-based insurers able to withstand fourth-quarter TSX drop of 23%: MSA Research

Canadian-based insurance companies (excluding branches) are likely to withstand the 23% drop in TSX share prices that occurred during 2008 Q4 without showing signs of a capital meltdown, according to MSA Research.
In the recent Q3-2008 edition of the MSA/Baron Outlook Report, MSA Research applied a capital stress test on P&C-1 (Canadian) insurance companies and published the results. [The test did not include P&C-2 companies, including Canadian branches of foreign insurers.]
MSA noted that as of the end of nine months in 2008 — despite declines in asset levels, underwriting losses for many players and lower investment income capital levels — “few companies approached the drop-dead regulatory minimum MCT/BAAT level of 150%.”
Still, the report notes, “the big question is how those [MCT capital] ratios will look as at year-end 2008 given that the TSX composite index declined by 23% over the fourth quarter.”
To answer this question, MSA ran a test of its own, subjecting P&C-1 (Canadian) companies to a 23% drop in the TSX.
None of the companies subjected to the test failed at the 150% capital level.
But when MSA applied steeper TSX losses in share value relative to the level at Sept. 30, 2008, some MCT failures began to occur. The test levels included 30%, 40% and 50% drops in the TSX relative to the Sept. 30, 2008 level.
At the 30% drop level, for example, six insurers were exposed to MCT capital scores of below the minimum level of 150%.
At a 40% drop level, eight insurers were exposed to MCT scores below 150%.
At the 50% drop level, 12 insurers were exposed to below-minimum capital scores.
“It is important to note that we simply stressed one factor — a decline in common share holdings,” MSA Research president and CEO Joel Baker notes in his article. “We did not look at P&C-2 companies (branches), we did not look at changes in interest rates, nor did we take underwriting performance into account.
“It is clear that if interest rates climb and/or if underwriting results deteriorate sharply (Alberta MIR rulings or Ontario auto, anybody?), then the number of companies exposed to falling offside and the potential number of policyholders affected will be higher.”
Conversely, Baker notes, improved underwriting results and/or finding other sources of income would help companies be able to avoid MCT capital failures even as the equity markets further decline.