Surplus Sensitivity vs. MCT - 2018 Spring - Q24

chrisboersmachrisboersma
in CIA.DCAT

The AA ranks scenarios according to MCT. The AA should rank scenarios based on surplus sensitivity.

The guide doesn't prescribe what said ranking should look like. Is there a huge difference between "Surplus" and "Capital Available"? Couldn't the MCT be used as a measure of "surplus sensitivity"? What measure do DCAT reports typically rank based on? How do you measure "surplus sensitivity" is doesn't appear to be defined in the DCAT guide?

Google "surplus sensitivity" and the only thing you'll find is the DCAT report instructions and research papers: which leaves the analyst with the requirement to create their own definition - a ratio between surplus and liabilities would appear reasonable (a drop is equity with the same drop is liabilities is far less concerning than the same drop in equity with no drop in liabilities).

Comments

  • javidjavid

    This is a good question. I'll first refer you to https://www.battleactsmain.ca/vanillaforum/discussion/74/satisfactory-condition-min-mct-100-or-surplus-0#latest where there has been some discussion on this in the past. This other post may have some relevancy: https://www.battleactsmain.ca/vanillaforum/discussion/82/possible-exam-question.

    For your question, I looked at three items:
    1. https://www.cia-ica.ca/docs/default-source/2013/213077e.pdf: Specifically section 3 where they speak to the capital/surplus model. It can be deterministic, or stochastic, or a combination.
    2. MCT: Compared to what is mentioned in 1. above, MCT is more of a static factor-based model.
    3. http://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/Pages/e15_final.aspx: Specifically section 1. b. where they note the role of the AA is to produce a DCAT to assess the financial condition of the company.

    Putting these three together, it seems the CAS wanted you to point out that the DCAT capital/surplus model should be used to rank scenarios, and not the MCT.

    If you need me to elaborate more, let me know.

  • chrisboersmachrisboersma

    I don't see how this answered what is "surplus sensitivity" and how do we go about calculating it?

    1. Not sure the relevance of the model choice: deterministic, or stochastic, or a combination. It's not specified in the question which model is used. However, some model was used to calculate the balance sheet items. I cannot conclude if the correct /incorrect model was used because it isn't specified.
    2. MCT is not a model (see below)
    3. The AA does produce a DCAT report as per "Finally, the AA produces the DCAT report,"

    Model:

    MCT is more of a static factor-based model.

    MCT is not a model:

    Calculating a life annuity factor where the formula and assumptions are prescribed, for example, by standards or regulation. This is not a model because the calculation does not allow for any discretion.

    There is no mention of what model was used, but the question implied there was some sort of model being used to calculate balance sheet items (otherwise how would you determine the MCT?). Furthermore, there's no indication the selection was based on the MCT ranking either: The AA then selected three scenarios...further analysis (the basis of selection was not provided). All it says about the scenarios is that they are "The worst five scenarios"

    But my only question is: "what is surplus sensitivity and how do I measure it?"

  • grahamgraham

    The CIA.DCAT reading doesn't give a definition of surplus sensitivity or how to measure it. I think they use the term very loosely.

    I would guess that in practice a company would perform surplus sensitivity the same way as any sensitivity analysis: Using a model, change the input variables by a small amount and check the corresponding change in surplus.

    • If the surplus also changes by a small amount, then the surplus is not sensitive to changes in inputs
    • If the surplus changes by a lot (whatever that may mean in practice) then the surplus is sensitive to changes in input

    Just apply this idea to adverse scenarios: How much does the surplus change under the changes that correspond to the various adverse scenarios.

    The point in this exam problem was nothing deep. They just wanted you to know that the most important adverse scenarios to report on were those with the biggest surplus sensitivity, not those with the lowest MCT scores.

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