OSFI New Standard Approach to Setting Capital Requirements

On November 6, 2008, the Standardized Approach Working Group (SAWG) published a paper proposing a new standard approach to determine how much capital a Canadian life insurance company should be required to have on hand to be able to meet its obligations. The new framework represents a modernization of the current Minimum Continuing Capital and Surplus Requirements (MCCSR) approach. Impending accounting changes will also make it necessary to update the standard MCCSR approach.

The new standard approach is consistent with the “Canadian Vision for Life Insurer Solvency Assessment,” and will use a target asset requirement approach. This requires the company to hold assets equal to the best estimate of its insurance obligations plus a solvency buffer. The solvency buffer will be calculated to cover all risks that could have a negative financial impact on a life insurance company. The solvency buffer will be calibrated so that a company can withstand adverse conditions over a one-year time horizon with a very high degree of confidence and have enough assets to sell or run off the business after that time (the terminal provision).

The target required capital is defined as the difference between the target asset requirement and the amount of assets required for the IFRS GAAP liability. When available capital is below target required capital, the regulator will require the life insurance company to take corrective action.

First Quantitative Impact Study (QIS) for Market Risk and Credit Risk

On October 22, 2009, the SAWG undertook the first QIS for the new MCCSR standardized approach. This QIS covers the market and credit risk components of the new approach. The main purpose of the QIS is to test the practicality of the methods proposed for the new components as well as to estimate the potential impact of adopting these components.

The new market risk component is determined from the change in the company’s financial position as a result of the applications of shocks to interest rates, equities, and other market variables that affect the valuation of a company’s assets and liabilities. The new credit risk component retains the existing factor-based methodology, but differs from current requirements in that the factors used depend on both the term and credit quality of an obligation.

GGY AXIS Actions with Respect to the New MCCSR Standardized Approach

GGY AXIS staff has reviewed the above-mentioned papers and are assessing what system enhancements might be useful or necessary when the new approach is implemented. Overall, AXIS is well equipped to handle the new standardized approach. The new Required Fund and Book Profit Financials are designed to handle the target asset requirement approach. Please refer to KB article #1075 for more information.

The modeling requirements in the first QIS can be readily handled by the existing functionality in AXIS. Users can make use of their existing AXIS CALM models to project future cash flows for assets and liabilities under each test scenario. The Present Value function in the Summary Report can be used to discount any Calendar Year row at the current risk free rates. The ALM Risk Report in Batch can be used to obtain the present value of asset cash flows excluding the impact of reinvestment. Note that the rate used to discount cash flows beyond 30 years back to year 30 can be specified in the Forward rate extrapolation field in the Scenario Processing screen.

In the near future, GGY AXIS plans to implement additional changes to AXIS related to the new MCCSR standardized approach:

• In Asset and Reinvestment cells, support for a table of required surplus factors that allows the factors to vary by remaining term.
• In Valuation scenario formula tables, support for the determination of the ultimate forward rate during projection.

Should you have questions on how GGY AXIS plans to support the new MCCSR standardized approach, please contact any GGY AXIS client support staff or email us at axis@ggy.com.

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