Advisory. Category: Capital. Revised Guidance for Companies that Determine Segregated Fund Guarantee Capital Requirements Using an Approved Model

Transcription

1 Avisory Category: Caital NOTICE* Subject: Date: This Avisory rescribes new minimum calibration criteria for moels that OSFI has arove for use in etermining segregate fun guarantee caital requirements by feerally regulate life insurers. This revise guiance will aly to segregate fun guarantee caital requirements for business written on or after January 1, The existing calibration criteria will continue to aly to business written rior to January 1, 2011 until a new aroach, which is consistent with the vision for life insurance comany caital reviously enunciate, is eveloe an imlemente. For segregate fun roucts with guarantees base on the ate of eosit an where there are searate guarantee erios for ifferent eosits within the same olicy, business written on or after January 1, 2011 inclues eosits mae to existing olicies on or after January 1, Comanies with other tyes of segregate fun guarantee roucts shoul contact OSFI if they require clarification on what constitutes business written on or after January 1, This Avisory comlements the following OSFI guiance: Guieline A: Life Insurance Caital Aequacy Test (LICAT) Instruction Guie: Use of Internal Moels for Determining Require Caital for Segregate Fun Risks (LICAT) (Use of Moels) Avisory: Sulementary Information for Life Insurance Comanies that Determine Segregate Revise Version 255 Albert Street Ottawa, Canaa K1A 0H2

2 Backgroun Section of the March 2002 reort of the Canaian Institute of Actuaries (CIA) Task Force on Segregate Fun Investment Guarantees (CIA ocument ) contains a set of calibration criteria for segregate fun guarantee moels. As art of the valiation rocess for an internal moel use for regulatory caital uroses, section 8.F(g) of OSFI s Use of Moels instruction guie requires that moels comly with the CIA calibration criteria as a necessary conition for aroval. The existing CIA calibration criteria are base on the erformance of the TSX total return inex from January 1956 to December These criteria were eveloe at a time when the majority of exosure in segregate fun guarantee roucts was to large caitalization Canaian equities. Since that time, rouct offerings have evolve to the oint that there is now significant exosure to US an international equities, small an mi caitalization equities an bons. Accoringly, OSFI is revising the minimum calibration criteria for the investment return scenarios use to etermine segregate fun guarantee total requirements to better cature the risks in current segregate fun guarantee rouct offerings an ensure that equity return exerience since 1999, as well for erios rior to 1956, is aroriately reflecte. The new calibration criteria efine minimum statistical characteristics that the scenarios actually use in the etermination of the total requirement must have. Equity Inex Calibration Criteria New minimum quantitative calibration criteria are manate for the scenarios use to moel the returns of the following total return equity inexes (henceforth referre to as liste inexes ): TSX Canaian small ca equity, mi ca equity an secialty equity S&P 500 US small ca equity, mi ca equity an secialty equity MSCI Worl Equity an MSCI EAFE The actual investment return scenarios for each of the liste inexes use in the etermination of total requirements must meet the criteria secifie in the following table. Left tail criteria: Time Perio 6 months 1 year 2.5 th ercentile of return not greater than -25% -35% 5 th ercentile of return not greater than -18% -26% 10 th ercentile of return not greater than -10% -15% Right tail criteria: 90 th ercentile of return not less than 20% 30% 95 th ercentile of return not less than 25% 38% 97.5 th ercentile of return not less than 30% 45% Page 2 of 6

3 Furthermore, the arithmetic average of the actual investment return scenarios for each liste inex over any one-year erio (incluing the one-year erio starting on the valuation ate) cannot be greater than 10%. All of these criteria must be met for the scenarios of a liste inex to be in accorance with the new minimum calibration criteria. Moele scenarios of TSX total return inexes must continue to satisfy the CIA calibration criteria at all ercentiles over the five- an ten-year time horizons as ublishe in the CIA s March 2002 reort, in aition to the criteria above. Moele scenarios of S&P 500 total return inexes must satisfy the American Acaemy of Actuaries calibration criteria for equities 1 at all ercentiles over the five-, ten- an twenty-year time horizons, in aition to the criteria above. The scenarios use to moel returns of an equity inex that is not one of the liste inexes nee not meet the same calibration criteria, but must still be consistent with the calibrate scenarios use to moel the returns of the liste inexes. Correlation: The scenarios use to moel returns for ifferent equity inexes shoul be ositively correlate with one another. Unless it can be justifie otherwise, the correlation between the returns generate for any two equity inexes (whether or not they are liste) shoul be at least 70%. If scenarios are generate using a moel that istinguishes between ositive an negative tren market hases (e.g. the regime-switching lognormal moel with two regimes) then, unless it can be justifie otherwise, the scenarios shoul be such that there is a very high robability that ifferent equity inexes will be in the same market hase at the same time, an a very low robability that ifferent equity inexes will be in ifferent hases at the same time. Bon Inex Calibration Criteria New minimum quantitative calibration criteria are manate for the scenarios use to moel total return bon inexes that track the erformance of Canaian government, US government, or investment grae cororate bons. The actual investment return scenarios for each such inex use in the etermination of total requirements must have the secifie characteristics. Left tail criteria: Uer bouns are lace on the 2.5 th, 5 th an 10 th ercentiles of the one-year total returns of the th inicate bon inexes. For 2. 5, 5 an 10, the ercentile of the total return over one year cannot be greater than 1 r max D, 0 a b r 2 where: r is the effective er annum yiel, at the time of valuation, on a D-year zero-couon government bon in the currency of the bon inex D is the uration, measure in years, of the bon inex at the time of valuation 1 For examle, as ublishe in the American Acaemy of Actuaries ocument entitle Recommene Aroach for Setting Regulatory Risk-Base Caital Requirements for Variable Annuities an Similar Proucts ate June Page 3 of 6

4 a an b, as set forth below, are arameters relate to the associate increase in interest rates th ercentile, as set forth below, is the reuction in the return at ercentile ue to creit efault an owngrae losses associate with the articular bon inex The values of a for a articular ercentile een on the average term to maturity of the bon inex. For terms to maturity of 1, 3, 5 an 10 years, the values of a are given by the following table: Percentile The values of b are given by the following table: The value of 1 Year 3 Years 5 Years 10 Years a a a a 2.5 th 2.00% 1.60% 1.20% 0.80% 5 th 1.70% 1.35% 1.00% 0.70% 10 th 1.30% 1.05% 0.80% 0.50% Percentile b 2.5 th 5.00% 5 th 4.20% 10 th 3.30% for all government bon inexes is 0. The values of given by the following tables: AAA/AA 0.10% 0.50% 0.75% 1.30% A 0.30% 0.80% 1.20% 2.00% BBB 0.80% 2.00% 2.80% 4.00% AAA/AA 0.06% 0.30% 0.55% 1.00% A 0.20% 0.55% 0.85% 1.50% BBB 0.50% 1.40% 2.00% 3.00% AAA/AA 0.03% 0.15% 0.30% 0.65% A 0.10% 0.30% 0.50% 1.00% BBB 0.30% 0.85% 1.30% 2.00% for other creit classes are Page 4 of 6

5 For terms to maturity between 1 an 10 years, the values of a an are etermine by linear interolation between the nearest terms to maturity in the above tables. For terms to maturity greater than 10 years, the values of a an for the 10-year term to maturity are to be use. For terms to maturity less than 1 year, the values of a an for the 1-year term to maturity are to be use. For inexes containing bons in multile creit classes, for the inex shoul be calculate as the notional-weighte average of taken over each of the bons in the inex. Average return criterion: An uer boun is lace on the execte comoune average total return of each of the inicate bon inexes. The arithmetic average of the scenario-secific comoune average returns calculate over the D-year erio beginning on the valuation ate may not be greater than r s, where D an r are efine as before, an s reresents the average creit risk remium. The value of s is given by the following table: Criteria for other bon inexes: Creit Class s Government 0.00% AA or higher 0.85% A 1.10% BBB 1.45% The scenarios use to moel returns of a bon inex that oes not track the erformance of Canaian government, US government, or investment grae cororate bons nee not meet the same calibration criteria, but must still be consistent with the calibrate scenarios use to moel the returns of these inexes, an must be conservatively etermine. Correlation: The scenarios use to moel returns for ifferent bon inexes shoul be ositively correlate with one another. Unless it can be justifie otherwise, the correlation between the returns generate for an equity inex an a bon inex in the same currency shoul not be greater than 40%. Comanies shoul take into consieration the limite historical exerience with very low interest rate environments when setting assumtions for bon fun moels an ensure that their moels aroriately cature the risks associate with very low interest rate environments. A comany s imlementation of the new calibration criteria shoul not result in less conservative moeling or the use of less conservative scenario sets for bon inexes than is currently the case. Page 5 of 6

6 Criteria for Iniviual Segregate Funs If weighte averages of moele inexes are use to calculate the return scenarios for an iniviual segregate fun (before fee euctions), all of the inex return scenarios on which the segregate fun return scenarios are base must meet the above calibration criteria. Comanies that o not moel segregate fun investment returns (before fee euctions) as weighte averages of inex returns shoul contact OSFI for information on how to calibrate the segregate fun return scenarios. Calculation of Total Requirement for Exosures Subject to this Avisory The total requirement for business subject to this Avisory (i.e., for business written on or after January 1, 2011) will be calculate searately from the total requirement for all other segregate fun guarantee business. The total gross calculate requirement (TGCR) for the segregate fun guarantee exosure as a whole will be the sum of the total requirements for business subject to this Avisory an all other business, where the iniviual comonents have been floore at zero before the sum is calculate. * Avisories escribe how OSFI aministers an interrets rovisions of existing legislation, regulations or guielines, or rovie OSFI s osition regaring certain olicy issues. Avisories are not law; reaers shoul refer to the relevant rovisions of the legislation, regulation or guieline, incluing any amenments that came into effect subsequent to the Avisory s ublication, when consiering the relevancy of the Avisory. Page 6 of 6