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The new test determines capital adequacy. It assesses the riskiness of assets, policy liabilities and off balance sheet exposures by applying various factors and margins. Capital available is then compared to capital required. This approach is consistent with that used in other financial sectors in Canada.

The regulators plan to have the harmonized test finalized for year end 2000. Subsequent to the development of the MCT, the current Test of Adequacy of Deposit for foreign branches will be reviewed.

Some of the key highlights of the draft test are as follows:

1) The test will be applied on a non-consolidated basis.
2) Capital will be based on GAAP equity according to the following criteria:

a) its permanence;
b) its absence of obligation to make fixed payments from earnings; and
c) its subordinated legal position.

3) Unlike the approach for life insurers and banks, the capital for P/C insurers will not be      tiered, primarily because the capital structure for P/C insurers is generally much simpler. In      cases where the regulators have concerns they will be handled on an individual basis.
4) Capital includes GAAP equity, subordinated debt and redeemable preferred shares (subject      to regulatory approval) and a portion of the excess of market value over book value of most      investments.
5) The Investment Valuation Reserve is eliminated. The difference between market and book      values is calculated and included as follows:

a) For investments where the market value exceeds the book value, 50% of the excess is      included with Capital, except for real estate and "other investments". Any market value      excess for these latter two categories is ignored.
b) For investments where market values are less than book values, the shortfalls are      summed and assigned a 100% capital factor.

6) Capital required consists of five major components:

a) Capital for Balance Sheet Assets: The amount of capital will be determined by applying      a factor to the book value of the asset. The main classifications and factors are:

i) Term Deposits, bonds, mortgages, loans & preferred shares:

(1) Government grade                                                            0%
(2) Investment grade                                                               from 0.5% to 4%
(3) Not investment grade                                                        from 4% to 15%

ii) Common shares, real estate & other investments

(1) Real estate for own use                                                    8%
(2) Common shares, invest. real estate, other invest.        15%

iii) Investments in subsidiaries, affiliates, partnerships

(1) Involving financial institutions                                            variable
(2) Other                                                                                   100%

iv) Receivables & Recoverables from Registered Reinsurers

(1) Government grade                                                             0%
(2) Facility, PRR, registered insurers                                    0.5% - 2%
(3) Agents, brokers, etc.                                                         4% - 8%

v) Other Recoverables, DPAC, Deferred Taxes and Other Assets; the factors for      these vary from 0% for a portion of Deferred taxes to 100% for Other Assets.

b) Margins for Unearned Premiums & Unpaid Claims: A margin is applied to net unpaid      claims and net unearned premiums. The margin is 5% for property, including      automobile property, 10% for automobile liability and personal accident and 15% for      liability and all other classes, including Accident and Sickness.
c) Catastrophes: Additional policy provisions (essentially nuclear risks) and earthquake      reserves require 100% capital.
d) An amount for Reinsurance Ceded to Unregistered Insurers: Several changes were      required to harmonize the coverage required for unregistered reinsurance. The main      ones are:

i) The margin on unearned premiums and unpaid claims is reduced to 10%.
ii) Both In Canada and Out of Canada risks are included. For In Canada business,      all federal and provincial insurers and the registered branches of foreign insurers      will be considered registered. Similar to the approach for life insurers, for Out of      Canada business, regulated insurers from OECD countries will be considered      registered if:

(1) the reinsurer is financially sound;
(2) the reinsurance agreement is recognized by the regulators in the foreign       country; and
(3) the arrangement is satisfactory to the Canadian regulator.

iii) The amount of Letters of Credit that can be used to offset unregistered      reinsurance is reduced to 10%, which is the amount of the required margin on      unearned premiums and unpaid claims. The $3.5 million limit is eliminated.

e) Capital for Off-Balance Sheet Exposures: Two items determine the capital required; the      first is the "credit conversion factor"; the second is the risk factor. The following sets out      the factors:

i) Structured Settlements - credit conversion 50%; Letters of credit - conversion     factor - variable; Derivatives - credit conversion 100%. The risk factors for these     items are:

(1) Government grade                                               0%
(2) Investment grade                                                  0.5%
(3) Not investment grade                                           4%

ii) For Other Off Balance Sheet items, the conversion factors are variable and the      risk factors are 0%, 2% and 8%.

So far insurers have not had much chance to react to the new proposals. Although the objective was to avoid introducing a test which is overly complex, there is no doubt that the proposed approach will require more time and effort to complete than is the case with the current test. On the other hand if the new test represents a more accurate assessment of a company's true capital strength, it is probably worthwhile.