54th Annual Canadian Reinsurance Conference
Breakout Session #5
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Session Description
There is a global “tsunami” of change in regulation and supervisory
frameworks and standards for all financial institutions that will
greatly influence future capital standards for the Canadian life
insurance industry. Many driving forces are contributing to a new
paradigm of dramatically increasing challenges in capital planning
and pricing for capital requirements. The panel will outline
emerging developments in regulation and supervision affecting
future capital standards in Canada as well as internationally, give a
regulator's view for the necessity for and benefits of this
revolution and give a reinsurer's view on how this revolution will
impact capital planning and reinsurance pricing and capacity.
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Agenda Item
Panel
Driving Forces & Emerging
Developments
Steven W. Easson
CLHIA
Regulator’s View of Necessity &
Benefits of this REvolution
Bernard Dupont
OSFI
Reinsurer’s View of Impact on
Capital Planning, Pricing & Capacity
Bernard Naumann
Munich Re
Questions
All
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Steven W. Easson
CLHIA
Driving Forces &
Emerging Developments
4
Driving Forces
International
Financial
Reporting
Capital
Canada
 Financial Crisis
 Member of G20
 G20 / Finance Ministers /
 Member of FSB
Financial Stability Board (FSB)
 International Convergence
 Global comparability
 G20 / Finance Ministers / FSB
 IAIS Adherence/Cooperation
 Trend to more risk-based/
principles based standards
 Advances in actuarial and capital
theory; increased complexity and
globalization of products
 Global Convergence (a la Basel)
 Territories and Sectors
 Improve risk sensitivity
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Emerging Developments
International
Financial
Reporting
 International Financial
Reporting Standards (“IFRS”)
 IASB/FASB joint project
Canada
 IFRS mandated in April 2008
 Adopted pre-crisis
 “Phase 1”: 2011
 “Phase 2”: 2013+
 IAIS Papers
Capital
 Solvency II
 NAIC
 Basel “III”
 Life Insurer Solvency Assessment
Framework (next generation to replace
MCCSR)
 “Solo”/“Holdco” capital, Stress Tests
“Reinsurance Response Paper”
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International – Financial Reporting
 2008 Financial Crisis – G20 meetings
 Washington, London, Pittsburgh, Toronto (June 2010)
 Washington Declaration: Finance Ministers to implement principles for reform
 Create high quality accounting standards
 Basis of loan loss provisions to improve
 IASB’s International Financial Reporting Standards
 Insurance Contracts – IASB committed to finalize June 2011
 Other Standards of interest
 Financial Instruments (IFRS 9); IAS37; Credit Risk; Fair Value
 IASB/FASB joint project
 Commitment to achieve convergence, but the Boards at times disagree on
standards and will convergence happen “on plan”?
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International - Capital
 International Association of Insurance Supervisors (“IAIS”) Papers
 Insurance Core Principles  Standards  Guidance Papers
 Target date for revised ICP’s – October 2011
 Group Supervision – “Supervisory Colleges”
 Group vs. Solo Capital requirements
 Common Assessment Framework (“ComFrame”) for Internationally Active
Insurance Groups
 Solvency II
 Total Minimum and Target Capital Requirement
 “Market consistent” valuation of assets and liabilities
 Not just better risk based Capital Standards – Supervision just as important
 “Third Country Equivalence” – Reinsurance Supervision
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International – Capital (continued)
 NAIC
 Solvency Modernization Initiative (“SMI”)
 Reinsurance Regulatory Modernization Act of 2009
 FSB
 “Basel III” (Dec ’09 Draft)
 Revisions to definitions of “Tier” capital and liquidity standards
 Tier 1 – emphasis on common equity and retained earnings
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Canadian – Financial Reporting
 AcSB declared adoption of IFRS in April 2008
 i.e. pre-crisis and pre-G20 declaration.
 “Phase I”: 2011
 Canadian Asset Liability Method (“CALM”) continues to qualify under IFRS4
 “Gross” Accounting for Reinsurance
 “Phase II” : 2013 or Later
 Insurance Contracts Exposure Draft – will be released in June 2010?
 Discount Rate - Huge Issue
 Basis still uncertain
 “De-linking” of asset and liability valuations
 Insurance Contract Policy liabilities – potential dramatic increases
 Earnings volatility – potential dramatic increases
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Canadian - Capital
 “ Life Insurer Solvency Assessment”
 More risk based than MCCSR
 Total Minimum and Target Asset Requirement
 Standard Factor Approach; Internal Models Approach
 TBSR = “IFRS liabilities” plus Solvency Buffer
 Solo/Holdco capital standards; Stress Tests
 Reinsurance Response Paper
 More “principles” based
 “Expanded and reinstituted” Guideline B3 – to be released soon
 Consolidation of
 Revoked Guideline B3 (Unregistered Reinsurance)
 Draft Guideline B3 (Sound Reinsurance Practices and Procedures)
 Draft Guideline B13 (Reinsurance Agreements)
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Bernard Dupont
OSFI
Regulator’s View of Necessity
& Benefits of this REvolution
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Overview
• Pressure from everywhere to redesign capital
requirements
• Vision of Future Framework: allowing the use of internal
models for determining regulatory capital
• MCCSR standardized approach: redesign the test to use
more risk-based techniques
13
Driving Forces
Financial crisis
• Lessons learned:
– Capital requirements do not always react as
expected
– Lack of willingness to test and report on
difficult situations
– Events are linked together more than we think
• Lower the guard in the long run?
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Driving Forces
International Developments
• IAIS
– Bring convergence to various jurisdictions’
requirements
• But high level requirements only
– Common Assessment Framework for insurers
– Will we be forced to adopt these
requirements?
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Driving Forces
• Solvency II
– European capital test, greatly improving
supervisory rules
• Basel II
– Allows the use of internal ratings for capital
purposes, as they provide an incentive for
better management and understanding of the
risks
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Driving Forces
• IFRS and CIA standards
– Convergence of accounting rules
• Solvency Modernisation Initiative (USA)
• Awareness and more sophisticated
valuation techniques available
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Vision of Future Framework
• A minimum capital requirement, based on
a standardised approach, will apply to all
companies in Canada
• Standardized approach likely to be similar
to current MCSSR methodology
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Vision of Future Framework
• For companies meeting minimum criteria set by
OSFI, the target capital requirement will be
based on internal models (one risk at a time)
– Subject to limits on possible annual reduction
– Based on a Total Asset Requirement basis
• For others, the target capital requirement will be
based on a standardised approach
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Vision of Future Framework
• Companies will need to demonstrate their
compliance with OSFI’s requirements
– Criteria for the use of models in development
– 3 years of parallel runs
– No diversification between risks
• Reporting and disclosure requirements will
need to be in place
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Vision of Future Framework
• First risks being looked at for life insurers:
– Market risk
– Credit Risk
• Earliest expected implementation date:
– 2014/2015
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Implementation of IFRS
General principles:
- Reduce MCCSR modifications to a
minimum until phase II
- When the company is given the option to
retain the current accounting methodology,
retain current MCCSR treatment.
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Implementation of IFRS
• Allow IFRS valuations using IAS 39 for non-insurance
contracts and non-insurance components bifurcated
from insurance contracts into capital
• Own-use Property:
– Unrealized revaluation gains and losses will not be
included in capital.
– Impact at time of adoption of fair value and valuations
changes going forward will both be excluded from
regulatory capital.
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Implementation of IFRS
• Investment Property:
– OSFI will require that any fair value gains or losses
upon transition and subsequent revaluation gains and
losses be recognized in regulatory capital.
• Phase-in period of 2 years for most insurers
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MCCSR Standardized Approach
• Standardized Approach Working Group created:
participants: OSFI, AMF, Assuris
• Start modifying existing MCCSR elements that will be
most impacted by IFRS Phase II
– Market and credit risk: Reserves will no longer
contain provisions to cover potential losses
– Market risk: Companies required to remeasure capital
under shocks applied to interest rates and other
market risk factors
– Credit risk: More refined factors, derived from Basel
IRB model, based on rating and time to maturity
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MCCSR Standardized Approach
• Calibrate the elements once the results
from QIS are available
• Recalibrate the elements once the results
from modelling are available
• Modifications expected to be in place for
2012 or 2013
• Work on other MCCSR elements after
phase II developments if necessary
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Mortality Improvement
• CIA Standard expected to be in place in 2011
allowing mortality improvement to be taken into
account
• OSFI will reverse the impact on capital until the
capital requirements have been assessed
appropriately, likely including a QIS in 2010
• New capital requirement might be in place in
2012
• Overall review of mortality requirements after
IFRS Phase II
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Reinsurance Counterparty Risk
• Reinsurance rules being changed to better
reflect risks of counterparties and collateral
– Need to ensure rules are consistent with those for
other types of credit risk
• Credit risk factors to be applied to reinsurance
recoverables from registered reinsurers
• Credit risk charge for collateral used in
unregistered reinsurance to be included in
ceding company’s capital required
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Implementation Challenges
• Many moving targets being chased at the
same time
• Limited amount of resources to deal with
these issues
• Increase complexity of products and
valuation techniques
• Impact and priorities different for the
various stakeholders
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Bernard Naumann
Munich Re
Reinsurer’s View of Impact on
Capital Planning, Pricing and
Capacity
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Required MCCSR Capital (2009)
Insurer Required Capital
Asset
Default
15%
37%
17%
Reinsurer Required Capital
14%
Insurance
Insurance
C-3
31%
Asset
Default +
C3 + Seg
Funds
86%
Seg Funds
Source: OSFI
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How Does Capital Affect Pricing?
• After-Tax Internal Rate of Return (AT
IRR) used as Primary Pricing Measure
– 10 out of top 10 companies use AT IRR
– 6 out of top 10 companies target >=15% AT
IRR
– 10 out of top 10 use Canadian CGAAP
Reserves and MCCSR as the capital base in
AT IRR calculation
Source: Munich Re’s 2010 Individual Insurance Survey
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Mortality Improvement Assumptions
The Actuarial Standards Board has drafted a change to its Standards of Practice to
allow mortality improvement assumptions in policy liabilities. This Standard is
expected to become effective in 2011.
Expected Insurer / Reinsurer Effect
Reserves
Decrease
Capital
Increase (set to offset Reserve decrease)
Price Pressure
Minimal expected in short term
Comments
•After Tax IRR takes into account Capital + Reserves
•Net effect on Price Pressure depends how offset is taken
into account (tax effected)
•OSFI will likely revisit in 2012+
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Reinsurance Counterparty Risk
In 2012+, a reinsurance counterparty charge will be implemented for the Life Sector.
•The C-1 factor will be applied against ceded reserves and recoverables
Expected Insurer Effect
Expected Reinsurer Effect
Reserves
No effect
No effect
Capital
Increase (<1%)
Increase (<<1%)
Price Pressure
Increase (<<1%)
Increase (<<<1%)
Comments
•Could solidify a ‘flight to quality’ with the higher rated
reinsurers
•Minimal effect on reinsurer pricing or capacity
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IFRS Phase I Changes
The following changes will be implemented in 2011:
•Gross Accounting of Reinsurance
•Other (e.g. Full Recognition of Pension Plan Deficits)
Expected Insurer/Reinsurer Effect
Reserves
None
Capital
Available capital to decrease e.g. due to increased pension
plan liabilities
Price Pressure
Minimal
Comments
•Despite Gross Accounting of Reinsurance, MCCSR will
continue to apply factors on a net basis
•Pension plan liabilities increase may be significant
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IFRS Phase II Changes
The following changes to be implemented in 2013+:
•Removal of CALM – Liabilities and Assets de-linked
Expected Insurer Effect
Expected Reinsurer Effect
Reserves
Increase
Increase; although not as
significant as Insurers
Capital
Avail capital to decrease Avail capital to decrease
Price Pressure
Increase on long-tailed
business
Comments
•Methodology is unknown
•Canada is only country where stat res = GAAP res
•Expected volatile reserve results = volatile avail cap.
•Pressure to move away from long-tailed business
Increase on coinsurance
business; Minimal on YRT
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Solvency II
Solvency II is not officially planned to be adopted by OSFI
•However, for those companies with European parents, Solvency II could be used
as a capital base in IRR calculations
Expected Foreign Insurer/Reinsurer Effect
Reserves
None
Capital
Increase on long-tailed business
Price Pressure
Increase on long-tailed business
Comments
•Pro-cyclicality an issue
•Given reinsurers write primarily YRT business, the
discounting effect is not as significant as coinsurance
•Solvency II seen as a ‘catch-up’ to MCCSR – level
international playing field?
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Reinsurance Response Paper
The following changes are expected to be implemented in 2010:
•Repeal 25% unregistered reinsurance limit (P&C Only)
•Repeal 75% fronting limit (P&C Only)
•Reinsurance Governance (Guideline on Corp Governance, B-3, B13  “New B-3”
Guideline on Sound Reinsurance Practices and Procedures)
Expected Insurer/Reinsurer Effect
Reserves
None (unless B-3 not followed!)
Capital
None (unless B-3 not followed!)
Price Pressure
None
Comments
•B-3 must be followed to receive credit
•B-3 to be released in 2010
•Increased due diligence on reinsurance usage
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Reinsurance Capacity Speculation
Increased Reinsurance Capacity
Decreased Reinsurance Capacity
IFRS II implementation may lead to more
capital infused into Canada through
reinsurance
Increased price pressure may reduce
reinsurance demand
Solvency II may entice other reinsurers to
enter Canada
Increased risk management may reduce
reinsurance demand
Difficult to say – many moving pieces!
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Reinsurance Pricing Summary
Mortality
Improvement
Neutral Price
Impact
Reinsurance
Counter Party
Charge
Minimal
Increased Price
Impact
IFRS I
Neutral Price
Impact
IFRS II
Minimal
Increased Price
Impact (YRT)
Solvency II
Potential
Increase
Overall, minimal reinsurance
pricing impact for YRT deals.
IFRS II potentially resulting in
higher coinsurance terms
2012+ is key due to IFRS II and
OSFI’s view on Mortality
Improvement in MCCSR
B-3 Implementation is key!
Reinsurance
Paper
Neutral Price
Impact
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