session 31pd: life insurance capital framework in canada...a new chapter in capital requirements for...

Session 31PD: Life Insurance Capital Framework in Canada

Moderator:

Presenters:

Ritchie Hok FSA Lisa Marie Peterson FSA,FCIA

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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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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



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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



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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


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


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


• 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



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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



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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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session 31pd: life insurance capital framework in canada...a new chapter in capital requirements for...

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