Gregg CliftonCFO – Aurigen Reinsurance

Regulatory Capital When it comes to regulatory capital, is there a discernableclicking 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.

Presenters • Marco Fillion

Director, Audit and Assurance GroupPricewaterhouseCoopers

• Bernard Dupont Managing Director, Capital Division OSFI

• Kelly LevyVice President Capital ManagementGreat West Life

Marco FillionLife Actuarial, PwC

Solvency Regime Developments

• Overview of developments

• Key themes

• Conclusions and thoughts

Overview of DevelopmentsEuropean Solvency II

Pillar I – Quantitative• Market consistent• Standard formula &

internal models• MCR & SCR• Own funds

Pillar II – Supervisory • Governance• ORSA• Supervisory review• Supervisory intervention

Pillar III – Disclosure• Public – Annual 

solvency and financial condition report

• Regular supervisory report

OSFI Vision

Supervision Approach• Increased focus on ERM

New quantification• Market consistency• Standard and internal model

approaches• Minimum and target

capital levels• Interdependency with

GAAP/IFRS

Operating Holding Company Stand-Alone Requirements

Consistency with Basel III for banks

US SMI

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

Reinsurance• Facilitate cross‐border 

transactions• Enhance competition 

within US• Policyholder protection

Overview of DevelopmentsAustralia - LGICP

Dual requirements of solvency and capital adequacy replaced with a single measure

Eligible Capital and Required Capital will now be explicitly defined

Three pillar supervisory approach:

Pillar 1 – QuantitativePillar 2 – Supervisory review

process (including supervisory adj.)

Pillar 3 – Disclosure requirements

Available Capital includes:• Elements of Basel III • NVCC

IAIS

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

Timeline2011 2012 2013 2014 2015 2024+……..

Canada – OSFI Vision • QIS 3 • QIS 4 • QIS 5 • New Standard

Approach in 2015

• Use of internal models likely later

Europe – Solvency II• Advice on 3rd

country equivalence

• Development of Level 3 guidelines

• Level 2 advice finalized

• Transposed into law by member states

• Pre launch reporting

• New regime subject to transitional measures

US – SMI• Documentation

of the current Solvency Framework

• Study of int’l solvency systems

• Model HoldingCompany Act passed

• All major policy decisions completed by end of 2012

• SVL and Std Valuation Manual progressed.

• ORSA requirement by 2014?

Australia - LGICP• Draft Prudential

Standards• Final standards• Application for

transitional arrangements

• Effective January 1

Transitional measures on SCR, risk free rate, own funds, equivalence & others

Consider and proceed as appropriate

2016

Transitional arrangements on a case-by-case basis if not meeting req’t. Transitional period for non-admitted assets

Key Themes• Convergence

– Concerted effort to improve/strengthen regimes

– Significant differences in approach beyond that

• Group Supervision– Consolidated Entity level

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

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

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

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

Thoughts

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Less market consistent More market consistent

Thank You

Bernard DupontCapital Division, OSFI

Overview• Objective of Regulatory changes

• New Framework– Description– Process– Specific Modifications– Impacts on Industry– Challenges

• Other Regulatory Changes

ObjectivesMake 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 standardsThe goal is not to make capital requirements more or less onerous

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

ProcessOSFI 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)

ProcessOSFI 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

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

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

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

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

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• ….

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)

Kelly LevyCapital Management, Great West Life

Assurance

Overview• MCCSR and Canadian Operating

Companies

• Foreign Subsidiary considerations

• OSFI Solo Capital

Canadian Multinational StructureCanadian OpCo

Canada Sub.

Can Sub 1

Can Sub 1a

Can Sub 1b

Can Sub 2

US Sub. Europe Sub. Asia Sub.

Asia Sub 1

Canadian MCCSR TestCanadian OpCo

Canada Sub.

Can Sub 1

Can Sub 1a

Can Sub 1b

Can Sub 2

US Sub. Europe Sub. Asia Sub.

Asia Sub 1

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

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

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

Local (Foreign) Capital TestCanadian OpCo

Canada Sub.

Can Sub 1

Can Sub 1a

Can Sub 1b

Can Sub 2

US Sub. Europe Sub. Asia Sub.

Asia Sub 1

Multinational Balancing Act• Europe Subsidiaries

– Solvency I (present) and Solvency II (future)

– Solvency II, a total balance sheet approach• Market consistent• Level of shocks – 99.5th 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

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 Q1 2014.

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 modifications2. ORSA and ERM to promote insurers to have capital management

and capital actions that are integrated with risk management and internal controls

3. Group Supervision4. Statutory accounting and financial reporting5. Reinsurance

– Regulatory RBC capital to be clearly distinguished from economic capital that will be examined under ORSA.

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

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

Canadian OpCo

Canada Sub.

Can Sub 1

Can Sub 1a

Can Sub 1b

Can Sub 2

US Sub. Europe Sub. Asia Sub.

Asia Sub 1

Parental Stand Alone Test

‘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

Solvency Oversight WorldwideCanadian OpCo

Canada Sub.

Can Sub 1

Can Sub 1a

Can Sub 1b

Can Sub 2

US Sub. Europe Sub. Asia Sub.

Asia Sub 1

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?

Thank you for your attention

Questions?