Solvency Regulations in Canada...zBased 1 in 250 year event for DCAT like scenarios for solvency...

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Solvency Regulations in CanadaIn Focus

By Pierre LaurinTowers WatsonOctober 4-5, 2010

Government in Insurance Seminar


Solvency Regulation: Canadian Context

Main Canadian Regulators:

Office of the Superintendent of Financial Institutions (“OSFI”) – Federal

Provincial Regulators

Companies can be regulated at federal or provincial level

Still require provincial licenses to operate in respective provinces

While regulators such as L’Autorité des Marchés Financiers (“AMF”) and Financial Services Commission of Ontario (“FSCO”) have their own particularities, most provincial regulators follow guidelines as established by OSFI

Will use OSFI regulations for our session


OSFI Context

Regulations established

In an Enterprise Risk Management context

Such that companies take ownership of solvency

On a mixture of principle and prescriptive basis

With a strong communication with industry

Regulations are being revised as we speak

Implementation of IFRS in 2011 replacing Canadian GAAP

Intent to create concordance and mutual recognition with international community

Solvency II


Canadian GAAP and Regulations

One balance sheet for both regulatory and financial reporting purposes

Assets valued at market (depending on classifications of assets)

Claims liabilities are discounted with provisions for adverse deviations

Akin to market value of claims liabilities

Gross of reinsurance balance sheet

Discount rate calculated based on assets supporting the liabilities

Current limitation of 25% of ceded reinsurance to unregistered reinsurers

Most have collateral assets representing 115% ceded liabilities to unregistered reinsurers – similar to Schedule F

Letters of credit limited to 15% of total cessions

Limitations on asset mix of invested assets, such as maximum 25% of invested assets in equities


Appointed Actuary Report (AAR)

Appointed Actuary’s report and actuarial opinionPolicy Liabilities— Claims liabilities — Premium liabilitiesProvision for Adverse Deviations (PfADs): load on claim liabilities and to estimate potential variations on ultimate losses.— Can be calculated using stochastic reserves or by judgment— Three PfADs : claims volatility, discount rate and reinsurance

recoverability— Actuarial Present Value (APV) = discounted best estimate claims liabilities

with PfADsTest on coverage ratio invested assets over claims liabilitiesMateriality standard based on different concept than in the US— US materiality concept based on solvency or change of RBC classification— Canadian materiality concept based on perspective of the reader of the

balance sheet— Typically 1% of claims liabilities or 2% of surplus— Booked claims liabilities must be in the range of the AA’s APV +/-

materiality standard


Appointed Actuary Report (AAR) (cont’d)

Premium liabilities: opinion on the strength of the Unearned Premium

Reserve and ability to establish a Deferred Acquisition Expense Asset

— PfADs may be different than the claims liabilities (can be greater than for

claims liabilities)

— Must have a premium deficiency reserves if UPR < future anticipated

claims liabilities and management costs

— May determine expected profit in the UPR


Solvency Regulations – Minimum Capital Test

Minimum Capital Test (MCT)Ratio based approach similar to Risk Based Capital Ratios applicable on all classes of assets and claims liabilities to estimate required assetsIs a measure of available assets over required assetsAvailable assets calculated as Total Assets less Liabilities less adjustments

Three levels of MCT100% represents minimum capital requirement— OSFI can/will take over the company if MCT is below 100%150% minimum supervisory capital requirement— OSFI will impose significant regulatory restrictions if 100% < MCT < 150%Internal Target MCT— OSFI will expect company to implement a plan to be bring the MCT to above

internal target if 150% < MCT < Internal target


Solvency Regulations – Dynamic Adequacy Capital Test

Dynamic Adequacy Capital Test (DCAT)

Stress test of solvency of the company over the next 3 to 5 years

Based on company business plan and actual performance

Embedded in ERM concepts of managing future risk, i.e. identification of solvency risks and mitigation actions

Stress tests based on 1 in 100 year events or 99th percentile

Classification of risk include

Premium risk

Claims Liabilities risk

Inflation risk

Interest risk

Related party risk

Others (in addition to suggested list, AA may apply any scenario deemed to be representative of company’s expected risks)


Solvency Regulations – Dynamic Adequacy Capital Test (cont’d)

Two requirements

Need to be above the Supervisory Ratio (150%) under the base scenario

— Currently interpreted as need to be above Internal Target

Need to be solvent under adverse scenarios (or stress tests)

May include management actions

Distinction between Solvency and ability to continue writing

Clean DCAT opinion if meet the two requirements

Does not imply that company has ability to continue writing business

Must have ability to restore capital after event to continue writing


OSFI’s expectations

Expect that company will implement ERM processes

Give the ability for company to create their own capital modelMay deviate from pure MCT calculationTypically based on economic capital concepts and stochastic modelsWill be judged on pertinence of calculating respective risks but more importantly on the “Use Test”

Stress Testing (in addition to DCAT)

Rigorous Internal Capital target settingBased 1 in 250 year event for DCAT like scenarios for solvency (i.e. above 0% MCT), and, Above 150% for “Normal” adverse scenarios or 1 in10 year event

Reinsurance and Risk Transfer

Contingent planningBusiness continuity planCorrective management actions to deal with adverse scenarios


OSFI – new developments

Review of MCT calculations

May dispense of PfADs in claims liabilities but increase required assets

Elimination of 25% maximum of unregistered reinsurers

Increase of maximum LOC from 15% to 30%

Market intrinsic inflation risk review

E18: new regulations requiring ERM implementation plans


Questions and Answers

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Solvency Regulations in Canada...zBased 1 in 250 year event for DCAT like scenarios for solvency...

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