LIFE INSURANCE CAPITALLIFE INSURANCE CAPITALMarket and Credit Risk QISMarket and Credit Risk QIS
Sylvain St-Georges, FSA, FCIA
November 19, 2009
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QIS – MARKET AND CREDITQIS – MARKET AND CREDIT
Introduction Market Risk Credit Risk Participating Products Closing Comments
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INTRODUCTIONINTRODUCTION
Main purpose: Test the practicality of the methods Estimate the potential impact
Approach based on shocks Actual requirements will require
calibration
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MARKET RISKMARKET RISK
Interest Rate Risk Equity Risk Real Estate Risk Pass Through Products Risk Currency Risk Liability Market Options Risk Asset Market Options Risk
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Interest Rate RiskInterest Rate Risk
Cash Flows Risk Free Interest Rates Interest Rate Shock Method Additional Scenarios
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Cash FlowsCash Flows
CALM cash flows No reinvestment Asset – fixed cash flows Asset – non-fixed cash flows Off-CALM assets and liabilities
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Risk Free Interest RatesRisk Free Interest Rates
Spot rates for Government of Canada Bonds
Provided rates for Canada and U.S.A. Rates for the first 30 years
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Interest Rate Shock MethodInterest Rate Shock Method
Economic impact of a sudden change in interest rates at time zero
Discount cash flows after 30 years to the year 30 using a flat 6% rate
Discount cash flows from years 0 to 30 to the year 0 using the prescribed interest rates
Net PV = Asset PV – Liability PV Buffer = Net PV of the base scenario
- min(Net PV of the test scenarios)
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Interest Rate Shock MethodInterest Rate Shock Method
Tests (estimated 99.5% percentile) Potential upward or downward change in 30
day T-bill rate over one year Potential upward or downward change in 30
year spot rate over one year Linear interpolation of shocks between
these two rates Shocks based on a simplified Cox-Ingersoll-
Ross model fitted to historical data
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Interest Rate Shock MethodInterest Rate Shock Method
Universal Life Products Guaranteed credited rates considered CFs consistent with the scenario interest
rates, for example, account values No adjustments due to anticipated
changes in lapse rates and expense charges (considered in insurance risk)
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Additional ScenariosAdditional Scenarios
Additional information to assist in calibrating the metrics
Shocks based on a 95% confidence level
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Equity RiskEquity Risk
Common shares (preferred shares included in the credit risk component)
Immediate shock (at time 0) Equity index stocks – 20% decline Managed equity portfolio – 30% decline
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Pass Through Products RiskPass Through Products Risk
Existing capital requirements New threshold of CF<70% Use of the CF based requirement is
optional
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Currency RiskCurrency Risk
Immediate shock (at time 0) Shock applied to the net mismatch of
CFs in each currency 20% rise or decline in currency’s value
against the Canadian dollar
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Liability Market Options RiskLiability Market Options Risk
Risk related to minimum interest rate guarantees reflected in the interest rate risk solvency buffer
Risk related to segregated fund guarantees is based on deterministic shocks
Additional segregated fund scenario requested for supplementary information
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Liability Market Options RiskLiability Market Options Risk
Risk related to segregated fund guarantees – maximum of these two scenarios:
Equity market falls 30% and bond market falls 20% (no recovery)
Equity index is assumed to increase 100% over 44 months, then drop to 75% of its starting value and fixed income market drops 20% in the 45th month (no recovery)
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Asset Market Options RiskAsset Market Options Risk
Products described in section 3.7 (Assets replicated synthetically and derivatives transactions) of MCCSR guideline
Current requirements
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CREDIT RISKCREDIT RISK
Short Term Investments Public Bonds Private Bonds Asset Backed Securities Mortgages Preferred Shares Other Items
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Short Term InvestmentsShort Term Investments
Current requirements Current factors consistent with factors
established for public bonds
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Public BondsPublic Bonds
Factors set up by rating and remaining term to maturity
Factors established using the Basel Foundation IRB approach, except
99.5% confidence level (instead of 99.9%) A modified maturity adjustment appropriate for
longer duration of bonds held by Canadian life companies
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Public BondsPublic Bonds
0-1 1-2 2-3 3-4 4-5 5-7 7-10 10+Standard
BaselCurrent
AAA 0.25% 0.25% 0.50% 0.50% 1.00% 1.05% 1.18% 1.25% 1.60% 0.25%
AA 0.25% 0.50% 0.75% 1.00% 1.25% 1.35% 1.60% 1.75% 1.60% 0.50%
A 0.75% 1.00% 1.50% 1.75% 2.00% 2.20% 2.70% 3.00% 4.00% 1.00%
BBB 1.50% 2.75% 3.25% 3.75% 4.00% 4.15% 4.53% 4.75% 8.00% 2.00%
BB 3.75% 6.00% 7.25% 7.75% 8.00% 8.00% 8.00% 8.00% 8.00% 4.00%
B 7.50% 10.00% 10.50% 10.50% 10.50% 10.50% 10.50% 10.50% 12.00% 8.00%
Other 15.50% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 12.00% 16.00%
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Private BondsPrivate Bonds
This category also includes leases and other loans
Factors based on the inferred rating from other issues by the same issuer
If it is not possible: factors are an average of the Public Bond BBB and BB factors for the equivalent term to maturity
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Asset Backed SecuritiesAsset Backed Securities
Calculated as a separate category of assets
To be grouped according to maturity and rating of the issue, on a similar basis as set out for Public and Private Bonds
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MortgagesMortgages
Commercial Mortgages Factor: 6% (current: 4%, Basel: 8%) Based on evidence from the 1990 real
estate downturn Single Family Residential Mortgages
Current factor Some data from the industry seems to show
numbers in line with the current factors
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Preferred SharesPreferred Shares
Current categorization Factors consistent with Public Bonds
factorsQIS Current
PFD-1 3.00% 1.00%
PFD-2 5.00% 2.00%
PFD-3 10.00% 4.00%
PFD-4 20.00% 6.00%
Other 30.00% 15.00%
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Other ItemsOther Items
Other items are: Miscellaneous Items Off-Balance Sheet Exposures Securities Lent
Current requirements
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PARTICIPATING PRODUCTSPARTICIPATING PRODUCTS
The “gross” reduction is based on the maximum reduction in present value of future dividends
The reduction included in the other components is subtracted from the “gross” reduction
The “net” reduction is applied to the market and credit risk components