Gregg Clifton. CFO Aurigen Reinsurance

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2 Gregg Clifton CFO Aurigen Reinsurance

3 Regulatory Capital When it comes to regulatory capital, is there a discernable clicking sound of a ratchet? More onerous Canadian capital requirements and the inherent volatility in Canadian financial reporting have put the Canadian lifecos at a substantial disadvantage to their U.S. lifeco peers. If anything, the more volatile macro environment has, under a more onerous Canadian MCCSR framework, forced Canadian the lifecos to boost capital to support their U.S. businesses. (BMO Capital Markets April 13, 2012) Canadian lifecos face increasingly restrictive regulations, which could suppress ROEs. We are concerned that regulatory constraints are putting these companies at a competitive disadvantage in certain insurance markets. (ScotiaBank March 2012) Today s focus the landscape for changes in regulatory capital and some of the related issues for the industry.

4 Presenters Marco Fillion Director, Audit and Assurance Group PricewaterhouseCoopers Bernard Dupont Managing Director, Capital Division OSFI Kelly Levy Vice President Capital Management Great West Life

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6 Marco Fillion Life Actuarial, PwC

7 Solvency Regime Developments Overview of developments Key themes Conclusions and thoughts

8 Overview of Developments OSFI Vision European Solvency II US SMI Supervision Approach Increased focus on ERM New quantification Market consistency Standard and internal model approaches Minimum and target capital levels Interdependency with GAAP/IFRS Pillar I Quantitative Market consistent Standard formula & internal models MCR & SCR Own funds Pillar II Supervisory Governance ORSA Supervisory review Supervisory intervention Capital and reserves Modifications to RBC Principle-based reserves Governance & Risk Mgmt ORSA and ERM Group Supervision HoldCo best practices Windows and walls Supervisory colleges Operating Holding Company Stand-Alone Requirements Consistency with Basel III for banks Pillar III Disclosure Public Annual solvency and financial condition report Regular supervisory report Reinsurance Facilitate cross border transactions Enhance competition within US Policyholder protection

9 Overview of Developments Australia - LGICP IAIS Three pillar supervisory approach: Pillar 1 Quantitative Pillar 2 Supervisory review process (including supervisory adj.) Pillar 3 Disclosure requirements Dual requirements of solvency and capital adequacy replaced with a single measure Eligible Capital and Required Capital will now be explicitly defined Insurance Core Principles (ICP): Supervisory system Supervised entity On-going supervision Prudential requirements Markets and consumers ComFrame Closely tied to ICPs: Scope of application Group structure and business Quantitative and qualitative elements Supervisory cooperation and interaction Jurisdictional matters Available Capital includes: Elements of Basel III NVCC

10 Timeline Canada OSFI Vision QIS 3 QIS 4 QIS 5 New Standard Approach in 2015 Europe Solvency II Advice on 3rd country equivalence Development of Level 3 guidelines US SMI Documentation of the current Solvency Framework Study of int l solvency systems Model Holding Company Act passed Australia - LGICP Draft Prudential Standards Level 2 advice finalized Transposed into law by member states All major policy decisions completed by end of 2012 SVL and Std Valuation Manual progressed. Final standards Application for transitional arrangements Pre launch reporting Effective January 1 New regime subject to transitional measures ORSA requirement by 2014? Consider and proceed as appropriate Use of internal models likely later Transitional measures on SCR, risk free rate, own funds, equivalence & others Transitional arrangements on a case-bycase basis if not meeting req t. Transitional period for non-admitted assets

11 Key Themes Convergence Concerted effort to improve/strengthen regimes Significant differences in approach beyond that Group Supervision Consolidated Entity level

12 Key Themes Market Consistent Measurement IAIS ICPs require employment of an economic valuation Regimes have interpreted this differently Harmonization with Banking Requirements Has been analyzed in Europe US Federal Reserve stress test on bank holding companies Elements of Basel III in APRA s draft standards Canada is continuing to harmonize

13 Thoughts Global Convergence Not to be counted on anytime soon Group Supervision Applying domestic solvency standards to all subsidiaries in other territories essentially presumes there is one solvency regime that is superior to all others in all regions

14 Thoughts Banking regulation for insurers The emphasis for regulatory reform should be on cross-sectoral coordination rather than harmonization Market Consistency Market consistent measurement is unproven and it is unclear if the benefits justify the implementation risks of such a major change

15 Thoughts Implementation Complexity and uncertainty risks Proportionate changes, sufficient field testing, not over focusing on recent issues, manage uncertainty Public Policy We should give appropriate consideration to unintended consequences and public policy implications A profitable, competitive company with a sustainable growth strategy is one of the best ways to provide policyholder security

16 Thoughts Entity focused Consolidated group focused Less market consistent More market consistent

17 Thank You

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19 Bernard Dupont Capital Division, OSFI

20 Overview Objective of Regulatory changes New Framework Description Process Specific Modifications Impacts on Industry Challenges Other Regulatory Changes

21 Objectives Make the Canadian solvency framework: more risk-based (i.e. better reflection of risks) promote better risk management more transparent about level of policyholder protection better coordinated with new accounting and actuarial standards The goal is not to make capital requirements more or less onerous

22 Description Standard Approach (MCCSR) Available for all companies New revised version: implementation in 2015 Advanced Approach (Internal models) Available for companies meeting minimum criteria Already in place for segregated funds but requirements being updated for 2016

23 Process OSFI developing new framework with the help of and/or in consultation with: Standard Approach Advisory Group (SAAG) Industry and professional associations Quantitative Impact Studies (QIS) Building proposed requirements one risk at a time Two more QISs expected (2012 and 2013)

24 Process OSFI developing new framework No global capital test IAIS is developing ComFrame Monitoring developments in other jurisdictions US RBC (SMI project) Solvency II Does not mean we are adopting them

25 Process Internal models may be allowed for other risks in the future (likely after 2015) Discussions being held with industry and CIA through the MCCSR Advisory Committee (Life MAC) Concentrate on segregated funds initially Criteria for model approval being developed

26 Specific Modifications Credit risk: Factors updated based on the Basel II IRB credit risk model (unlikely to be materially modified in the near future) New charge will be implemented for reinsurance counterparty risk Interest rate risk: shock vary with the level of interest rates reduced pro-cyclicality Some adjustments to methodology still required

27 Specific Modifications Insurance Risk: new methodology, depending upon specific sub risk Operational risk: considering a new approach in the future Risk Diversification: considering recognition of risk diversification E.g. within insurance risk and between insurance and asset risks likely part of next QIS Definition and quality of capital being reviewed

28 Impact on industry Difficult to determine at this point A more risk-based approach should provide a greater incentive for better risk management Might influence business decision Lines of business Reinsurance strategy

29 Challenges IFRS 4 Phase II direction is uncertain (used as a basis for our capital framework) Significant work for OSFI and industry Market elements putting pressure on the industry Coordination of all changes for each risk.

30 Other Regulatory Changes ORSA (& A-4 Internal Target Guideline) First draft for discussions expected in 2012 Solo capital IAIS Common Framework for the Supervision of IAIGs Discussions at a high level only at this point Implementation: 2015 for phase I Calibration later Road map paper (2012)

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33 Kelly Levy Capital Management, Great West Life Assurance

34 Overview MCCSR and Canadian Operating Companies Foreign Subsidiary considerations OSFI Solo Capital

35 Canadian Multinational Structure Canadian OpCo Canada Sub. US Sub. Europe Sub. Asia Sub. Can Sub 1 Can Sub 2 Asia Sub 1 Can Sub 1a Can Sub 1b

36 Canadian MCCSR Test Canadian OpCo Canada Sub. US Sub. Europe Sub. Asia Sub. Can Sub 1 Can Sub 2 Asia Sub 1 Can Sub 1a Can Sub 1b

37 Canadian Operating Company Regulated consolidated Canadian Operating Company MCCSR Capital Management Policy operating range x% to y% MCCSR Setting the appropriate range Present - Guideline A4 Considerations Future ORSA (Own Risk Solvency Assessment) All subsidiaries of the Canadian Operating company submit MCCSR reporting on a quarterly basis for consolidation within Capital Management Department

38 Canadian Operating Company Applying the range against a moving target? Available capital in MCCSR IFRS Phase I impacts (phased in over 2 years) Definition of capital presently under review by OSFI Required capital in MCCSR C1 Asset Default Asset risks applied against marked to market values C1 required for unregistered reinsurance related assets Possible future requirement for Registered reinsurance (counterparty risk) Segregated Fund Risk requirements OSFI Segregated Fund Advisory effective Jan 1, 2011 Market consistent advance models review C3 Interest Rate Risk and Lapse Risk Interest rate environment impacting levels of required capital New Standard Approach under design for Credit, Market, Insurance and Operational Risks Future accounting changes and IFRS Phase II

39 Canadian Operating Company Impact on Operations of proposed New Standard Approach Interest rate and Insurance risks are cash flow based rather than formulaic thus, QIS exercises have shown: Audit trail more difficult no natural tie back to reserves Consolidation over all of Canadian regulated Operating Company on a quarterly basis? Pareto s Rule is alive and well! (QIS exercise has allowed for leeway in handling certain blocks of business) Complex regimes are costly to implement (Solvency II) Market consistent approach may lend to increased volatility in capital measure

40 Local (Foreign) Capital Test Canadian OpCo Canada Sub. US Sub. Europe Sub. Asia Sub. Can Sub 1 Can Sub 2 Asia Sub 1 Can Sub 1a Can Sub 1b

41 Multinational Balancing Act Europe Subsidiaries Solvency I (present) and Solvency II (future) Solvency II, a total balance sheet approach Market consistent Level of shocks 99.5 th value at risk but based on different data points then OSFI so result are differing shocks Provides the option of modeling some risks using Internal models Large undertaking to build, calibrate, test, document, review and update Partial Internal Model use must be approved by the Regulator

42 Multinational Balancing Act Europe Subsidiaries Requires production of Technical provisions and Solvency Capital requirements for reporting, business use and ORSA Requires an effective System of Governance including a Risk Management System Pre-defined reporting templates for various Financial Condition and Supervisory reports. First of these due Q

43 Multinational Balancing Act US Subsidiaries RBC (present) and RBC post SMI (future); Average RBC ratios tend to be >400% Solvency Modernization Initiative Task Force focus: 1. RBC Capital requirement modifications 2. ORSA and ERM to promote insurers to have capital management and capital actions that are integrated with risk management and internal controls 3. Group Supervision 4. Statutory accounting and financial reporting 5. Reinsurance Regulatory RBC capital to be clearly distinguished from economic capital that will be examined under ORSA.

44 Multinational Balancing Act IAIS (International Association of Insurance Supervisors) The IAIS began developing a Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) Framework on how Supervisors around the globe can work together to supervise Internationally active insurance groups and close regulatory gaps Goals include: Fostering global convergence of regulatory and supervisory measures and approaches Make group-wide supervision more effective and more reflective of actual business practices

45 Multinational Balancing Act Equivalency and competitive issues (i.e. US subs of European parents versus US domiciled) Diversification recognition (Solvency II QIS5 diversification benefit was 35%) Calibration Transition periods Group Supervision Philosophical issues Market Consistent, Principles based, Economic, Risk Based Pro versus Counter cyclical Consolidated Test vs Stand Alone (or Solo ) Test

46 Parental Stand Alone Test Canadian OpCo Canada Sub. US Sub. Europe Sub. Asia Sub. Can Sub 1 Can Sub 2 Asia Sub 1 Can Sub 1a Can Sub 1b

47 Solo Capital OSFI Parental Stand Alone Capital Test No comparable requirement internationally OSFI is presently informally monitoring the Solo Capital of both Banks and Insurers

48 Solvency Oversight Worldwide Canadian OpCo Canada Sub. US Sub. Europe Sub. Asia Sub. Can Sub 1 Can Sub 2 Asia Sub 1 Can Sub 1a Can Sub 1b

49 Canadian Multinational Desired end game is to achieve: Continued balance sheet strength Unnecessary conservatisms that would diminish global competitiveness International comparability not necessarily global convergence Avoid unintended consequences Avoid pro cyclicality Investigate reinsurance opportunities for particular product lines?

50 Thank you for your attention Questions?