Session 31PD: Life Insurance Capital Framework in Canada. Moderator: Presenters: Ritchie Hok FSA Lisa Marie Peterson FSA,FCIA

Transcription

1 Session 31PD: Life Insurance Capital Framework in Canada Moderator: Presenters: Ritchie Hok FSA Lisa Marie Peterson FSA,FCIA SOA Antitrust Disclaimer SOA Presentation Disclaimer

2 A New Chapter in Capital Requirements for Canadian Life Insurers: The Life Insurance Capital Adequacy Test (LICAT) Lisa Peterson, Director, Life Insurance Capital Ritchie Hok, Capital Specialist, Life Insurance Capital Office of the Superintendent of Financial Institutions (OSFI) August 28, 2017

3 What we hope to accomplish today Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements Implementing the LICAT International Perspective 2

4 What we hope to accomplish today Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements Implementing the LICAT International Perspective 3

5 Who is OSFI? 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. 4

6 How is OSFI Structured? OSFI s Structure Internal Audit Superintendent Office of the Chief Actuary Regulation Sector Supervision Sector Corporate Services Sector Accounting Policy Division Capital Division Legal Services Division Legislation & Approvals Division Research Division Private Pension Plans Division Insurance Deposit Taking Risk Support Life Insurance Group P&C Group Mortgage Insurance Group Actuarial Division Conglomerate Group Small and Medium Sized Banks Common Supervisory Services Risk and Analytics Corporate Governance AML Risk Measurement Credit Risk Capital Markets Risk Operational Risk Communications and Consultation Finance and Corporate Planning Human Resources & Administration IM/IT Services 5

7 Life Insurance Sector in Canada Who OSFI regulates 71 life insurance companies C$ 1.4 trillion in assets 13 fraternal benefit societies C$ 18 billion in assets Three major players Hold 90% of assets More than 50% of net income from outside Canada 6

8 What we hope to accomplish today Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements Implementing the LICAT International Perspective 7

9 New Regulatory Capital Framework for Life Insurers Old Framework Minimum Continuing Capital and Surplus Requirements (MCCSR) New Framework Life Insurance Capital Adequacy Test (LICAT)* 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 * Foreign insurers operating in Canada on a branch basis are subject to the Life Insurance Margin Adequacy Test (LIMAT) 8

10 LICAT Development Timeline QIS s Draft LICAT v.1 LICAT v.1 Test Run 1 Draft LICAT v.2 Final LICAT v.2 Test Run 2 Effective Mar 2016 Sep 2016 Oct 2016 Jun 2017 Fall 2017 May-Dec 2017 Jan. 1, 2018 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 9

11 What we hope to accomplish today Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements Implementing the LICAT International Perspective 10

12 LICAT General Approach 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 11

13 Construct of LICAT Ratios 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 12

14 Construct of LICAT Ratios AAAA + SSSS + EEEE TTTTTTTTTT RRRRRRRRRR = BBBBBB TTTTTTTT 11 AAAA SSAA EEEE CCCCCCCC RRRRRRRRRR = BBBBBB Where: AC = Available Capital SA = Surplus Allowance ED = Eligible Deposits BSB = Base Solvency Buffer Supervisory Ratios Total Core LICAT MCCSR LICAT MCCSR Target 100% 150% 70% 105% Minimum 90% 120% 55%/50% 60% 13

15 LICAT Available Capital 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 Better Quality Capital Restrictions: Capital instruments issued by consolidated subsidiaries to 3 rd parties may be subject to a limit Revised limits Common Equity 75% Net Tier 1 Net Tier 1 Net Tier 2 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 14

16 LICAT Base Solvency Buffer Credit Risk Factor-based approach Base Solvency Buffer = Factor x Exposure Amount Factors depend on both rating and maturity of underlying assets Rating Effective Maturity In Years 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% 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) 15

17 LICAT Base Solvency Buffer Market Risk Interest Rate Risk: 4 scenarios 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 16

18 LICAT Base Solvency Buffer Market Risk Equity Risk: Risk of loss due to potential changes in prices of equity investments Factors apply to market value of exposures Common Equity 35% Developed markets, listed and non-substantial 40% Developed markets, nonlisted/ substantial 45% Other markets, listed and non-substantial 50% Other markets, non-listed / substantial Preferred Shares 3% P1 5% P2 10% P3 20% P4 Common equity risk factor Common and unrated 17

19 LICAT Base Solvency Buffer Market 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 If FV available Otherwise 30% risk factor Owner-Occupied Properties: BS Value 70% FV 30% BS value 18

20 LICAT Base Solvency Buffer Market 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 position 2. 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] 19

21 LICAT Base Solvency Buffer Insurance Risk Components: Mortality Risk Morbidity Risk Longevity Risk Lapse Risk Expense Risk Sub-Components: Level Trend Volatility Catastrophe Required Capital for each component = RRRR llllllllll + RRRR tttttttttt RRRR vvvvvv + RRRR cccccc Prescribed shocks applied to projected CF for each risk sub-component Required Capital sub-component = PV( shocked values - best estimate) 20

22 LICAT Base Solvency Buffer Insurance Risk (cont d) Mortality Risk: Level Fixed (11%) and variable (based on volatility of underlying company exposure) components to the shock Trend Shock to mortality improvement assumption 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. Lifetime shocks Level Trend Vol 1yr shocks Cat 21

23 LICAT Base Solvency Buffer Insurance Risk (cont d) Lapse Risk: Designation Test Categorize portfolios into lapsesupported 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% proportional reduction in lapse assumption over the next year Catastrophe for lapse-sensitive = 20% absolute increase in lapse assumption over the next year Lapse Supported Catastrophe for Lapse Supported Designation Test Diversification Lapse Sensitive Catastrophe for Lapse Sensitive 22

24 LICAT Base Solvency Buffer Credits $Bn LICAT Required Capital Components Total Requirements for Diversifiable Risks Before Credits Credits Total Requirements Net of Credits 0 Credit Market Insurance Sub-Total Diversific. Par & Adj Operational Seg Funds Total 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 23

25 LICAT Base Solvency Buffer Diversification Matrix Correlation Matrix Mortality Longevity Morbidity Claims Morbidity Termination Lapse Sensitive Lapse Supported Expense II = 7 ii,jj=1 ρρ iiii IIII ii 0.5 LLLL ii (IIII jj 0.5 LLLL jj ) Mortality 100% -25% 50% -25% 25% 0% 50% DD = AA 2 + AAAA + II 2 Longevity -25% 100% -25% 50% 25% -25% 25% Morbidity Claims Morbidity Termination Lapse Sensitive Lapse Supported 50% -25% 100% 25% 50% 0% 50% -25% 50% 25% 100% 50% -25% 50% 25% 25% 50% 50% 100% -50% 50% 0% -25% 0% -25% -50% 100% -25% 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 Expense 50% 25% 50% 50% 50% -25% 100% 24

26 LICAT Base Solvency Buffer Operational Risk Premiums & Account Values 1.Business Volume 2.Large Increase in Business Volume 3.General Required Capital Operational Risk Requirement Risk on risk 25

27 LICAT Base Solvency Buffer Segregated Funds Guarantee Risk 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 26

28 LICAT Reinsurance 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 reinsurance fully reflected as a reduction in the base solvency buffer - Credit for unregistered reinsurance is provided in the numerator of the solvency ratio in the form of Eligible Deposits - 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 27

29 LICAT Impacts 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 28

30 What we hope to accomplish today Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements Implementing the LICAT International Perspective 29

31 LICAT Implementation Considerable undertaking for OSFI and the industry Resources Systems Sensitivity Analysis Reporting Strategic Integration Learning and Communication 30

32 LICAT Implementation 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 31

33 LICAT What is next? Fall 2017 FINAL LICAT Guideline January 1, 2018 LICAT effective date Annual reviews of the guideline 2019 LICAT 2020 LICAT 2021 LICAT IFRS 16 Segregated Fund Guarantee Risk IFRS 9 IFRS 17 32

34 What we hope to accomplish today Overview of OSFI and the Canadian Landscape Developing the LICAT Demystifying the LICAT Available Capital Capital Requirements Implementing the LICAT International Perspective 33

35 International Perspective International Insurance Capital Standard 34

36 International Perspective World view of Capital Standards How does United IAIS: LICAT Insurance States: Europe: compare Risk Capital Solvency Based to other Standard Capital II capital (RBC) (ICS) standards around the world? 35

37 Questions 36