The Financial Services Commission (FSC) has overhauled the framework for the minimum capital test (MCT) for general insurance companies which has seen the regulatory requirement fall from 250 per cent to 150 per cent and open up space for billions to be invested elsewhere.

This development has been in progress since 2021 when the FSC made a gradual adjustment in the MCT ratio and tested the calculations under the old and new regimes. At the end of 2021, the FSC stepped down the MCT ratio to 200 per cent, 175 per cent in 2022 and 150 per cent in 2023.

This was communicated to general insurance companies on January 30 as seen from notes in Key Insurance Company Limited’s 2022 audited financial statements. Key had an MCT ratio of 264.38 per cent in 2021 and 234.36 per cent in 2022.

“It’s not just the number, but the way they treat assets and liabilities that has been completely overhauled. The whole basis for calculating required capital has been overhauled. It’s not apples and apples. One of the new effects of the new MCT is that there is more flexibility in allocation of assets, but with the knowledge that riskier assets require higher capital requirements,” said director of the Insurance Association of Jamaica (IAJ) Peter Levy during a recent call with the Jamaica Observer.

Levy further stated, “In addition to explicit liabilities that we already have, the MCT set requires certain amounts to be put aside as reserves to provide for various adverse developments in terms of asset values.”

One of the tools used by the FSC to assess the strength of general insurance companies is the MCT. It is a risk-based capital adequacy test, which requires that insurers hold a minimum level of capital that is sufficient to withstand a range of adverse events. The solvency requirement was implemented in 2011 and was a shift from the minimum asset test (MAT) used before for general insurers.

“The MCT is a risk-based measure that considers the risks faced by an insurance company based on the lines of business it undertakes, as well as the types and amounts of assets and liabilities that it holds. The MCT computes the total capital required by a company to adequately cover its risks, and then compares this to the capital actually available to the company,” said a January 2017 FSC bulletin on the relaxation of the FSC MCT requirements.

This has come as a celebration for some like former Private Sector Organisation of Jamaica (PSOJ) President Paul Barnaby “PB” Scott, who has been advocating since 2016 for the change which could release billions of dollars that insurance companies could deploy into other investment options or more productive use.

Even at the General Accident Insurance Company Jamaica Limited annual general meeting (AGM) last September, Scott referenced the constraints which existed under the 250 per cent requirement and old regime which effectively locked many insurers into largely government securities and limited exposure to other possible asset classes.

“During the equity run up of 2017 to 2019, most insurance companies were very limited with equities because the MCT then made it difficult for us to have more than 10 per cent of assets in equities. We had very little flexibility and, essentially, a little bit of equities and a whole lot of government securities was what most insurance companies ended up in. So, now there’s more flexibility,” Levy opined, regarding the change to the new risk-based regime in calculating the MCT.

While some reads might interpret this as insurance companies being given room to be riskier, this is not the case, according to president of Guardian General Insurance Jamaica Limited Karen Bhoorasingh.

“Despite the reduction, the FSC was very smart. So, it’s not a one-for-one reduction. They did increase the sum of the weightings on the reduction. So, it’s not even though there will be some additional equity available. It’s not a full release as one would have anticipated. Certainly, within the [Guardian] group, those are considerations we will make to see how it is we will deploy any excess that we have,” she said at a Guardian Holdings investor briefing.

She highlighted that there are heavier weightings on longer-term investments and less weightings on short-term investments with respect to the MCT calculations. This is based on a focus for general insurance companies to have as much liquidity as possible.

Levy also gave examples to show why one cannot compare the 250 per cent under the old regime to the 150 per cent under the new regime where the denominator in the calculation is larger.

Let’s say company A has $20 million in cash, $100 million in government bonds and $30 million in equities which means $150 million in total assets. Under the new regime, 15 per cent or $4.5 million has to be allocated as a provision to reserves. If the company had $100 million in liabilities, this extra provision would push them below the 150 per cent requirement.

“You can make a decision that you’re going to put additional capital in to get to the 150 per cent, or you’re going to move those equities into risk free investments or assets, in which case, it eliminates the requirement for the reserve of that $4.5 million,” Levy added.

He also highlighted that assets such as repurchase agreements have a 15 per cent or 0.15 provision and receivables are now calculated under a more scientific approach. Under the old system, receivables over 90 days were written off or had a 100 per cent provision while receivables under 90 days had no provision.

Under the new regime, receivables under 60 days have a provision of 0.25 while receivables between 60 and 90 days have a 0.75 provision which Levy described as a more high-resolution view.

“One of the new things the regime does is that it requires reserves for a bunch of things that never were required. Because you have the flexibility, they’ve had to look at every type of asset class and decide what is the appropriate load for those assets. So, that’s why I said the 250 per cent before is apples and oranges,” Levy explained.

This change puts Jamaica more in line with the global average and alongside Canada which was the model for Jamaica’s MCT approach. The 250 per cent requirement has been described as a remnant after Jamaica’s financial crisis in the 1990s.

“The lower the MCT, the greater free capital an insurance company would have to pursue other risk-adjusted, high-earning yield investments. It does not mean that the insurance company ought not to be risk-averse because we have an obligation to make sure that we contemplate the risk with any action at all, and make sure that the risk we take is very prudent,” said IAJ President Sharon Donaldson.