Session 31PD: Life Insurance Capital Framework in Canada
Moderator:
Presenters:
Ritchie Hok FSA Lisa Marie Peterson FSA,FCIA
SOA Antitrust Disclaimer SOA Presentation Disclaimer
A New Chapter in Capital Requirements for Canadian Life Insurers: The Life Insurance Capital Adequacy Test (LICAT)
Lisa Peterson, Director, Life Insurance CapitalRitchie Hok, Capital Specialist, Life Insurance Capital
Office of the Superintendent of Financial Institutions (OSFI)
August 28, 2017
Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements
Implementing the LICAT International Perspective
What we hope to accomplish today…
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Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements
Implementing the LICAT International Perspective
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What we hope to accomplish today…
Our mandate is to protect depositors, policyholders and other creditors by:– developing guidance on risk management and mitigation, – assessing the safety and soundness of financial institutions, and– intervening promptly when corrective actions need to be taken.
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Who is OSFI?
OSFI’s Structure
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Internal Audit SuperintendentOffice of the Chief
Actuary
• Accounting Policy Division
• Capital Division• Legal Services Division• Legislation & Approvals
Division• Research Division• Private Pension Plans
Division
Regulation Sector Supervision Sector Corporate Services Sector
Insurance Deposit Taking Risk Support• Life
Insurance Group
• P&C Group• Mortgage
Insurance Group
• ActuarialDivision
• Conglomerate Group
• Small and Medium Sized Banks
• Risk and Analytics• Corporate
Governance• AML• Risk Measurement• Credit Risk• Capital Markets
Risk• Operational Risk
Common Supervisory Services
• Communications and Consultation
• Finance and Corporate Planning
• Human Resources & Administration
• IM/IT Services
How is OSFI Structured?
• Who OSFI regulates 71 life insurance companies C$ 1.4 trillion in assets
13 fraternal benefit societies C$ 18 billion in assets
• Three major playersHold 90% of assets
More than 50% of net income from outside Canada
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Life Insurance Sector in Canada
Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements
Implementing the LICAT International Perspective
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What we hope to accomplish today…
LICAT represents an evolution in OSFI’s solvency expectations • Better aligns capital and risk measures with the life insurance business• Incorporates lessons learned from financial crisis• Framework more compatible with future IFRS changes (e.g. IFRS 17)• Considers advancements in international standards
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New Regulatory Capital Framework for Life Insurers
Old Framework
• Minimum Continuing Capital and Surplus Requirements
(MCCSR)
New Framework
• Life Insurance Capital Adequacy Test (LICAT)*
* Foreign insurers operating in Canada on a branch basis are subject to the Life Insurance Margin Adequacy Test (LIMAT)
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LICAT Development Timeline
QIS’sDraft LICAT
v.1
LICAT v.1
Test Run 1
Draft LICAT v.2
Final LICAT
v.2Test
Run 2 Effective
Mar 2016 Sep 2016 Oct 2016 Jan. 1, 20182009 - 2015 Jun 2017 Fall 2017 May-Dec 2017
• LICAT development through Quantitative Impact Studies (QISs), adding one risk component at a time
• OSFI and industry are in Implementation phase• LICAT v.2 needed to add clarifications and address outstanding issues, calibration following
Test Run 1
Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements
Implementing the LICAT International Perspective
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What we hope to accomplish today…
LICAT – General Approach
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• A mix of factor-based approaches and prescribed shock assumptions• Most risks are measured at target, at a level of confidence of CTE99
over a one year horizon• More advanced risk-based techniques to measure Credit, Market and
Insurance risks • Explicit measure of Operational risk requirement• Risk sensitive measure of credit for par and adjustable products• Diversification credits
Available Capital (AC)+ Surplus Allowance (SA): Specified GAAP risk margins using CALM*:- All risk margins for risk free interest rate assumptions associated with insurance contracts, and - All risk margins associated with insurance assumptions (e.g. mortality, morbidity, lapse)+ Eligible Deposits (ED):Unregistered reinsurers’ deposits in excess of liabilities ceded, subject to limits
Base Solvency Buffer (BSB): (capital requirements – credits) x scalar
*Canadian Asset Liability Method
Construct of LICAT Ratios
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𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻 𝑹𝑹𝑻𝑻𝑻𝑻𝑹𝑹𝑻𝑻 =𝑨𝑨𝑨𝑨 + 𝑺𝑺𝑨𝑨 + 𝑬𝑬𝑬𝑬
𝑩𝑩𝑺𝑺𝑩𝑩
𝑨𝑨𝑻𝑻𝑪𝑪𝑪𝑪 𝑹𝑹𝑻𝑻𝑻𝑻𝑹𝑹𝑻𝑻 =𝑻𝑻𝑹𝑹𝑪𝑪𝑪𝑪 𝟏𝟏 𝑨𝑨𝑨𝑨 + 𝟕𝟕𝟕𝟕𝟕 × 𝑺𝑺𝑨𝑨 + 𝟕𝟕𝟕𝟕𝟕 × 𝑬𝑬𝑬𝑬
𝑩𝑩𝑺𝑺𝑩𝑩
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Supervisory RatiosTotal Core
LICAT MCCSR LICAT MCCSR
Target 100% 150% 70% 105%
Minimum 90% 120% 55%/50% 60%
Where:
AC = Available Capital
SA = Surplus Allowance
ED = Eligible Deposits
BSB = Base Solvency Buffer
Construct of LICAT Ratios
Updated qualifying criteria for instruments:→ No step-ups, no innovatives→ The 2015 MCCSR guideline incorporated updated criteria for
all capital instruments issued on or after August 7, 2014→ Transition measures outlined in LICAT for instruments issued
prior to August 7, 2014
Most deductions from Tier 1:→ Intangibles→ Deferred tax assets→ Encumbered assets
Restrictions:→ Capital instruments issued by consolidated subsidiaries to
3rd parties may be subject to a limit→ Revised limits
Still reviewing application of NVCC for life insurers:→ Pending developments on NVCC & bail-in internationally,
and review of resolution framework for insurers in Canada → If NVCC applies to life insurers, outstanding instruments,
other than common shares, would likely be non-qualifying and transition would be needed to the new regime
Better Quality Capital
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LICAT – Available Capital
Common Equity ≥ 75% Net Tier 1
Net Tier 1 ≥ Net Tier 2
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LICAT – Base Solvency BufferCredit Risk• Factor-based approach
Base Solvency Buffer = Factor x Exposure Amount• Factors depend on both rating and maturity of underlying assets
• If an asset is backed by collateral or has a guarantee, credit risk factor may be reduced (substitution approach)
• All unrated bond, loan, and derivatives exposures receive factor of 6%• Internal ratings are not used• Registered reinsurance assets subject to a 2.5% credit risk factor• Derivatives and commitments: factors applied to credit equivalent amount (rather than full value)
Rating Effective Maturity In Years 1 2 3 4 5 10
AAA 0.25% 0.25% 0.50% 0.50% 1.00% 1.25%
AA 0.25% 0.50% 0.75% 1.00% 1.25% 1.75%
A 0.75% 1.00% 1.50% 1.75% 2.00% 3.00%
BBB 1.50% 2.75% 3.25% 3.75% 4.00% 4.75%
BB 3.75% 6.00% 7.25% 7.75% 8.00% 8.00%
B 7.50% 10.00% 10.50% 10.50% 10.50% 10.50%
Lower than B 15.50% 18.00% 18.00% 18.00% 18.00% 18.00%
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LICAT – Base Solvency BufferMarket Risk
Interest Rate Risk:• Risk of loss from changes in interest
rates• Shock-based scenarios, discount
rates as per LICAT• Required Capital = MAX (Scenario 1,
Scenario 2, Scenario 3, Scenario 4) Shock 1 Shock 2 Shock 3 Shock 4
4 scenarios
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LICAT – Base Solvency BufferMarket Risk
Equity Risk:• Risk of loss due to potential changes
in prices of equity investments• Factors apply to market value of
exposures
Common Equity Preferred Shares
35% Developed markets, listed and non-substantial
3% P1
40% Developed markets, non-listed/ substantial
5% P2
45% Other markets, listed and non-substantial
10% P3
50% Other markets, non-listed /substantial
20% P4
Common equity risk
factor
Commonand unrated
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LICAT – Base Solvency BufferMarket Risk (cont’d)
Real Estate Risk:• Risk of loss due to changes in amount and
timing of CF from investments in real estate
• Investment properties vs. owner-occupied properties
• Required capital determined on a property-by-property basis
• Other PPE: balance sheet value – 70% fair value
2 Components: Investment Properties:
Leases in force Interest Rate Risk Credit Risk = PV(CF)
Residual Value 30% risk factor
Owner-Occupied Properties:
If FV available BS Value – 70% FV
Otherwise 30% BS value
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LICAT – Base Solvency BufferMarket Risk (cont’d)
Currency Risk:• Risk of loss due to changes in amount and
timing of CF arising from changes in currency exchange rates
• Two steps to calculate required capital:1. Measure exposure in each currency
position2. Calculate required capital for the
portfolio of positions in different currencies
Required Capital = 30% x (MAX[Net open long positions per currency*, Net open short positions per currency] + Net open position in gold)
*[Actual net long positions per currency can be reduced by 120% of BSB in the currency to calculate the net open long position for LICAT purposes]
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LICAT – Base Solvency BufferInsurance Risk
Mortality Risk
Morbidity Risk
Longevity Risk
Lapse Risk
Expense Risk
Level Trend Volatility Catastrophe
• Required Capital for each component = 𝑅𝑅𝑅𝑅𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 + 𝑅𝑅𝑅𝑅𝑡𝑡𝑡𝑡𝑙𝑙𝑡𝑡𝑡𝑡 + 𝑅𝑅𝑅𝑅𝑙𝑙𝑣𝑣𝑙𝑙2 + 𝑅𝑅𝑅𝑅𝑐𝑐𝑐𝑐𝑡𝑡2
• Prescribed shocks applied to projected CF for each risk sub-component • Required Capital sub-component = PV( shocked values - best estimate)
Components:
Sub-Components:
LICAT – Base Solvency Buffer
Mortality Risk:• Level – Fixed (11%) and variable (based on
volatility of underlying company exposure) components to the shock
• Trend – Shock to mortality improvementassumption
• Volatility – Requirement based on the underlying standard deviation of a portfolio
• Catastrophe – Flat increase in mortality rates applied over the next year for all lives. Increase varies by geography.
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Insurance Risk (cont’d)
Level
Lifetime shocks 1yr shocks
Trend CatVol
LICAT – Base Solvency Buffer
Lapse Risk:• Designation Test – Categorize portfolios into lapse-
supported and lapse sensitive groupings. The designation determines the catastrophe risk shock and the diversification credit between the two lapse categories.
• Level and Trend – Dynamic shock of ±30% that can vary for each policy year, depending on which produces the worst result
• Volatility – Dynamic shock of ±30% in the first policy year, calculated independently of the shock for level and trend
• Catastrophe for lapse-supported = 40% proportionalreduction in lapse assumption over the next year
• Catastrophe for lapse-sensitive = 20% absolute increase in lapse assumption over the next year
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Insurance Risk (cont’d)
Designation Test
Lapse Supported
Lapse Sensitive
Catastrophe for Lapse
Supported
Catastrophe for Lapse Sensitive
Diversification
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LICAT – Base Solvency BufferCredits
Total Requirements
Net of Credits
Total Requirements
for Diversifiable
RisksBefore Credits
0
50
100
150
200
Credit Market Insurance Sub-Total Diversific. Par & Adj Operational Seg Funds Total
$Bn LICAT Required Capital ComponentsCredits
• Within insurance and its sub-risks: • Within Mortality and Within Morbidity• Across Insurance sub-risks (correlation matrix)
• Between risks: • Credit/Market risks and Insurance risk
• Participating and Adjustable: credit depends on loss absorption capacity, combined with a minimum required capital for each risk and limits on gross adjustability
• Other smaller credits (e.g. policyholder deposits, groups business)• Must meet specific LICAT criteria to qualify for credit
LICAT – Base Solvency BufferCorrelation
Matrix Mortality Longevity Morbidity Claims
Morbidity Termination
Lapse Sensitive
Lapse Supported Expense
Mortality 100% -25% 50% -25% 25% 0% 50%
Longevity -25% 100% -25% 50% 25% -25% 25%
Morbidity Claims 50% -25% 100% 25% 50% 0% 50%
Morbidity Termination -25% 50% 25% 100% 50% -25% 50%
Lapse Sensitive 25% 25% 50% 50% 100% -50% 50%
Lapse Supported 0% -25% 0% -25% -50% 100% -25%
Expense 50% 25% 50% 50% 50% -25% 100%
𝐼𝐼 = ∑𝑖𝑖,𝑗𝑗=17 𝜌𝜌𝑖𝑖𝑗𝑗 × 𝐼𝐼𝑅𝑅𝑖𝑖 − 0.5 × 𝐿𝐿𝐿𝐿𝑖𝑖 × (𝐼𝐼𝑅𝑅𝑗𝑗− 0.5 × 𝐿𝐿𝐿𝐿𝑗𝑗)
𝐷𝐷 = 𝐴𝐴2 + 𝐴𝐴𝐼𝐼 + 𝐼𝐼2
• Most individual risk requirements set at a CTE(99) level of confidence over one year
• CTE(99) requirement for series of risks may be lower than the sum of the CTE(99) requirements for each risk
• Diversification credits and correlation factors should be valid under stressed conditions
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Diversification Matrix
LICAT – Base Solvency Buffer
Operational Risk Requirement
1.Business Volume
2.Large Increase in Business Volume
3.General Required Capital
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Operational Risk
“Risk on risk”
Premiums & Account Values
LICAT – Base Solvency Buffer
• Work to review standard approach has begun - separate track • Fall 2016: QIS#1 to test methodologies and assumptions• Summer 2017: QIS#2 to test methodologies and assumptions • Summer 2018 – QIS#3 (planned) • New approach will form Chapter 7 of the LICAT Guideline• Planned effective date of January 1, 2020, subject to consideration of potential
impact of IFRS 17
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Segregated Funds Guarantee Risk
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Registered Reinsurance Unregistered Reinsurance
- Generally, reinsurer is regulated in Canada - Generally, reinsurer is not a Canadian-regulated entity
- Reduces base solvency buffer - Does not reduce the base solvency buffer
- No additional credits beyond reduction of base solvency buffer
- Credit for unregistered reinsurance is provided in the numerator of the solvency ratio in the form of Eligible Deposits
- Credit for reinsurance fully reflected as a reduction in the base solvency buffer
- Limit on Eligible Deposits is set so that final reported ratio, with deposits included, cannot exceed the ratio had it been calculated net of all reinsurance
LICAT – Reinsurance
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• Impact on individual life insurers will depend on what businesses they are engaged in, risks that they choose to take on and how these are managed. Insurers are expected to:
• Evaluate overall plans• Reassess internal targets
• Overall level of capital in excess of supervisory targets is not expected to change significantly for the industry as a whole
• LICAT ratios and MCCSR ratios not directly comparable
LICAT – Impacts
Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements
Implementing the LICAT International Perspective
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What we hope to accomplish today…
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• Considerable undertaking for OSFI and the industry
LICAT – Implementation
• Resources• Systems• Sensitivity Analysis• Reporting• Strategic Integration• Learning and Communication
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Extensive stakeholder outreach• Domestic and international general audiences• Life insurers (insurers, branches, reinsurers and fraternals)• Professional associations (e.g. CPAs, actuaries, financial analysts)• Credit rating agencies • OSFI Webcasts accompanying the issuance of draft LICAT guidelines• Upcoming: OSFI videos by major LICAT topic
LICAT – Implementation
LICAT – What is next?
• Fall 2017 – FINAL LICAT Guideline• January 1, 2018 – LICAT effective date
• Annual reviews of the guideline
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2019 LICAT
• IFRS 16
2020 LICAT
• Segregated Fund Guarantee Risk
2021 LICAT
• IFRS 9• IFRS 17
Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements
Implementing the LICAT International Perspective
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What we hope to accomplish today…
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InternationalInsurance Capital
Standard
International Perspective
World view of Capital Standards
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How does LICAT compare to other capital standards around the world?
International Perspective
United States: Risk Based Capital (RBC)Europe: Solvency IIIAIS: Insurance Capital Standard (ICS)
Questions
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