OSFI MCT

• MCT ratio = capital available / min capital required (= sum of capital req'ts at CTE 99% over a 1-year horizon for each risk, less diversification credit, divided by 1.5), incl:
  1. insurance risk
     1. Capital required for unpaid claims and premium liabilities
     2. CAT reserves;
     3. Margin required for reinsurance ceded to unregistered reinsurers.
  2. market risk, interest rate risk, foreign exchange risk, equity risk, real estate risk, other market risk exposures.
  3. credit risk; (Counterparty default risk for)
     1. on and off-BS exposures
     2. Collateral held for unregistered reinsurance and SIR
  4. operational risk
• Less:
  5. Diversification credit
• Divided by 1.5.

1. Min:
   • cover risks in capital tests
   • if MCT ratio < 100%, OSFI will be very concerned about ongoing viability and risk to p.h. and creditors.
2. Supervisory target:
   • cover risks in capital tests plus margin for other risks not in capital tests (e.g.reputation, legal)
   • require >= 150% to build a cushion above min to facilitate OSFI’s early intervention
3. Internal target:
   • cover all risks based on insurer’s own risk profile and risk appetite (from ORSA);
   • > supervisory
   • should maintain capital > internal target. If anticipates falling below need to:
     • Notify OSFI immediately
     • Provide OSFI with plans on correction actions to return to Internal Target level within a reasonable period

• Min and Supervisory: based on simplifying assumptions applicable industry-wide, not individualized
• Internal: ORSA to determine own capital needs and establish Internal Targets

• Exposure to risks not captured in supervisory target (absorb unexpected losses)
• Trigger mgt actions before regulators actions

• Common equity / category A capital
• Category B capital
• Category C capital

• Availability: extent that capital element is fully paid in and available to absorb losses;
• Permanence: period for, extent that, capital element is available;
• Absence of mandatory servicing fees: extent that capital element is free from mandatory fees
• Subordination: extent that capital element is subordinated to rights of p.h.'s and creditors in insolvency

• Common shares:
  • Share issued and paid
  • contributed surplus
  • Retained earnings;
  • reserves (EQ, nuclear and general contingency)
  • AOCI
• Dividends are removed from capital available

• (B+C) <= 40% of total capital available excl AOCI
• C <= 7% of total capital available excl AOCI.
• B and C exceeding limits will be subject to:
  • If either B or C > limits, excess will be excluded
  • If B and C both > limits, max of two excesses will be excluded (1st fully exclude excess under C, then excess under B)

1. Interests in and loans to non-qualifying subsidiaries, associates, joint ventures with > 10% ownership
2. Unsecured unregistered reinsurance and SIRs
   • Amounts receivable and recoverable to extent not covered by deposits or LOC;
   • lack of collateral on SIRs that require collateral to ensure collectability of recoverables
3. EPR not used as part of financial resources to cover EQ risk exposure
4. DPAE with A&S business
5. AOCI on CF hedges
6. Accumulated impact of shadow accounting
7. Goodwill and other intangible assets
8. Deferred tax assets
9. G and L due to changes in own credit risk
10. DB fund assets and liabilities
11. Investments in own instruments (treasury stock)

• reverse from retained earnings,
  • unrealized AT FV G/L for owner-occupied property with value based on FV
  • Accumulated net AT revaluation losses in excess of G
• reversed from AOCI: Net AT revaluation G

f.s.'s of subsidiaries consolidated and included in parent’s capital available, their A and L are subject to risk factors and liability margins in parent’s MCT.

• Excluded
  • Common or preferred shares
  • Ownership > 10% joint venture
  • Loans or other debt instruments considered as capital
• Included
  • Ownership ≤ 10% joint venture
  • Loans or other debt instruments not considered as capital
  • Receivables

• Common Shares
• + Contributed Surplus
• + Retained Earnings
• – Accumulated net after‐tax fair value gains (losses) from changes in company’s own credit risk
• + AOCI
• + Earthquake reserves
• – EPR not used as part of financial resources to cover exposure
• + Category B instruments
• + Category C instruments
• – Interests in joint ventures with > 10% ownership
• – Loans considered as capital to associates
• – Intangible assets (net of eligible deferred tax liability)
• – Deduction for unregistered reinsurance receivables in excess of acceptable collateral

• potential for claims or payouts to be made to p.h.'s
• exposure from PV of losses > original estimate
• uncertainties around:
  1. Ultimate amount of net CFs from premiums, commissions, claims, and LAE
  2. Timing of these CFs

1. Unpaid claims (reserving risk from variation in claims provisions);
2. Premium liabilities (UW risk incl CATs);
3. CATs
4. Margin required for reinsurance ceded to unregistered reinsurers (recoverables)

• premium liabilities by LOB = max [net premium liabilities (net of reinsurance) - PfAD, 30% of NWP for past 12 months] * risk factor
• claim liabilities by LOB = [net claims liabilities (net of reinsurance, S&S, SIRs) - PfAD] * risk factor
• CATs = margin for EQ (EQ reserves) /Nuclear
• unregistered reinsurers = 15% * ceded policy liabilities, reduced by max [0, (collateral + payables) - (ceded policy liabilities + receivables)], with LOC capped at 30% * Ceded policy liabilities

Ceding maintains a valid security interest in the assets of an unregistered reinsurer

• Receivables and recoverables are deducted to extent not covered by collateral and payable.
• For each unregistered reinsurer, deduction required if A+B+C-D-E-F > 0
  1. UEP ceded;
  2. O/S losses recoverable;
  3. receivables;
  4. payables
  5. non-owned deposits held as security
  6. acceptable LOC held as security

• materially reduce credit risk of reinsurer
• available for period >= remaining term of ceded liabilities as credit for unregistered reinsurance

1. capital available: deduction to extent receivable and recoverable not covered by collateral
2. insurance risk: increased due to margin required
3. credit risk: increased by higher counterparty default risk, which is decreased by excess collateral
4. operational risk:
   • from impact on credit risk and insurance risk
   • Impacts amount of premium ceded

• EQ Reserves = (EPR + ERC) x 1.25 (added to total capital req'ts)
• ERC = EQ Risk Exposure - Financial Resources ≥ 0 (to cover EQ risk not covered by financial resources)
• EQ Risk Exposure = CW PML500 x (Year - 2014)/8 + MAX [East PML420, West PML420] x (2022 - Year)/8
• Financial Resources =
  • 10% of capital and surplus
  • + reinsurance coverage (collectible in an EQ event)
  • + capital market financing
  • + EPR
• EPR is voluntarily accumulated. if financial resources sufficient to cover EQ risk without it, EPR can be deducted from capital available (instead of added to total capital req'ts)

• EQ PML is $ threshold of losses beyond major EQ losses unlikely.
• Gross PML (after ded before CAT / other reinsurance protection) is used for calculating EQ risk exposure for regulatory purposes.
• PML incl adjustments for data quality, non-modelled exposures and model uncertainty, and corresponds to worldwide exposure for Canadian insurers and Canadian exposure for branches of foreign insurers

• Material exposure must use models to estimate PML, incl:
  • Commercial models, in-house or run by TP
  • Internal estimation technique / model to OSFI’s satisfaction
• OSFI requires progressing to 500 year PML by 2022
  • CW PML500 = (East PML500^1.5 + West PML500^1.5)^(1/1.5)
  • 99.8th percentile of exceedance probability curve + adj'ts for data quality, model uncertainty, non-modelled business
  • CW PML (Year) = CW PML500 x (Year – 2014)/8 + MAX [East PML420, West PML420] x (2022 – Year)/8
  • Year = current reporting year

CW PML = Max (East PTIV - ded, West PTIV - ded), if:

• insurer does not use EQ model for PML, or
• OSFI not satisfied with its EQ risk estimation technique
• PTIV for EQ risk exposure incl building, contents, outbuildings, additional living expenses and BI

1. Capital and Surplus: up to 10% to cover EQ risk exposure
   • Canadian insurers: up to 10% of total equity
   • Canadian branch: up to 10% of worldwide; but after an event, must still have >=10% of worldwide to meet Canadian obligations
2. EPR: voluntary accumulation of EQ premiums (must <= CW PML500)
3. Reinsurance Coverage: based on reinsurance in force day after end of financial reporting period and should = amount of reinsurance collectable for a loss of PML size, net of retention
4. Capital Market Financing: require OSFI approval before recognizing as a financial resource for EQ

• if EQ implicitly included in policy premium (CAT reinsurance not specific to EQ risk), need to demonstrate premium allocated to EQ is reasonable
• EQ premium contributed to EPR must remain in EPR unless material decrease in exposure.
• Should EQ occur, establish unpaid claims and LAE, and EPR would be reduced by claims reserves, ERC would be reduced after EPR by claims reserves.
• reduction in EPR or ERC should be brought back into unappropriated surplus immediately.
• EPR and ERC are reported in reserves on BS

Changes in rates or prices in markets for interest rates, forex rates, equities, real estate.

From market changes in interest rates and impact on interest rate sensitive assets and liabilities.

• FV will change with movements in interest rates:
• Interest rate sensitive assets:
  • Term deposits and other ST securities (excl cash)
  • Bonds and debentures
  • Commercial paper
  • Loans, mortgages
  • Preferred shares
  • Interest rate derivatives held for other than hedging purposes.
• Interest rate sensitive liabilities:
  • Net unpaid claims and LAE (incl PfADs, net of reinsurance, S&S and SIRs),
  • Net premium liabilities (incl PfADs, after reinsurance recoverables)

• CFs depend on future interest rates, used to hedge interest rate risk.
• Underlying hedges must decrease interest rate risk and addition of such derivatives does not increase overall risk

Effective duration appropriate when assets or liabilities have embedded options.

• Weighted average of the duration of the assets or liabilities with weight = FV of security/FV of portfolio
• w1D1 + w2D2 + w3D3 + … + wkDK
• wi = FV of security i / FV of portfolio
• Di = duration of security i
• K = # of securities in the portfolio.

• Modified and effective duration are related to % FV changes. 
• Interest rate risk requirements depend on determining the adjustment to FV of interest rate sensitive assets and liabilities for $ FV changes.
• $ FV change = duration * $ FV * interest rate change

• Effective duration is the appropriate measure when assets or liabilities have embedded options.
• For portfolios with plain-vanilla interest rate derivatives, use effective $ duration because the insurer is hedging $ interest rate risk exposure.

Effective $ duration of a swap for a fixed-rate payer = effective $ duration of a floating-rate bond – effective $ duration of a fixed rate bond

Eco impact of Δy change in interest rates (1.25%)

1. $ FV change in interest rate sensitive assets for increase of Δy = Duration x Δy x FV
2. $ FV change in interest rate sensitive liabilities for increase of Δy = Duration x Δy x FV
3. Effective $ duration change in allowable interest rate derivatives for increase of Δy = sum of effective $ duration for Δy increase
4. capital requirement for increase of Δy: max(0, A – B + C)
5. Steps A-C are repeated for decrease of Δy and capital requirement = max(0, A – B + C)
6. interest rate risk margin = max (D,E)

Risk of loss resulting from fluctuations in currency exchange rates and is applied to the entire business activity

• Measure exposure in each currency position
• Calculate capital requirement for the portfolio of positions in different currencies.
• Forex risk margin is 10% * max of agg net long and short positions in each currency, adjusted by effective allowable forex rate hedges if any

Risk of economic loss due to fluctuations in the value of common shares and other equity securities

• Common shares and joint ventures:  risk factor to investments where company holds <= 10% ownership interest.
• Futures, forwards, and swaps: risk factor to MV of equity security or index
• Short positions
• Recognition of equity hedges (must demonstrate that hedging strategies decrease overall risk)

• Risk of eco loss due to changes in value of a property or in amount and timing of CFs from investments in real estate
• Risk factors to
  • Owner-occupied properties (excl unrealized FV G/L arising at conversion to IFRS, or subsequent unrealized FV G/L due to revaluation)
  • Real Estate held for investments purposes

Counterparty’s potential inability or unwillingness to fully meet its contractual obligations.

• BS assets: loans carried at FV under FV option, FV hedges, AFS (amortized cost);
• off-BS exposures: structured settlements, LOC or non-owned deposits, derivatives
• collateral and guarantees
• Counterparties: issuers, debtors, borrowers, brokers, p.h.'s, reinsurers and guarantors.

• risk factors either:
  1. based on credit rating of counterparty or
  2. OSFI prescribed factor
• Capital req'ts:
  • BS assets: factors to BS values
  • Off-BS exposures: factors to exposure amounts
  • Collateral may be used to reduce exposure

• Apply risk factors to total amount of collateral from each reinsurer
• Collateral in excess of unregistered reinsurance requirements are considered excess collateral and are not subject to capital requirements.

For each reinsurer,

• Excess Collateral = Max(0; Non‐owned deposits + Letters of credit +Payables ‐ 1.15 * (Unearned premium + Outstanding Losses) – Receivables)
• Excess collateral % = Excess collateral / Total collateral
• Capital required for counterparty default risk for unregistered reinsurance collateral and SIRs = Collateral * risk factor * (1- excess collateral %)

• SIR = portion of a loss payable by the policyholder
• To admit SIRs recoverable for regulatory capital purposes, OSFI may require collateral to ensure collectability. e.g., when there is an excessive concentration of SIRs owed by one policyholder.
• LOCs may be used as collateral for SIRs

• Depending on credit rating and the remaining term to maturity
• LT / ST obligations, preferred shares

• (credit equivalent amount at reporting date (replacement cost for structure settlements)
• - value of collateral or guarantees)
• * factor reflecting nature and maturity (credit conversion factor)
• * factor reflecting counterparty default risk

• from inadequate or failed internal processes, people and systems or from external events (incl legal risk; excl strategic and reputation risk)
• Exposure from
  • day-to-day operations or
  • specific, unanticipated event

• Risk drivers: capital required and premiums, subject to a cap.
• MIN {30% CR0, (8.50% CR0 + 2.50% Pw + 1.75% Pa + 2.50% Pc + 2.50% PΔ) + MAX(0.75% Paig, 0.75% Pcig)}
• CR0 = total capital required, before operational risk margin and diversification credit
• Pw = direct WP in past 12 months
• Pa = assumed WP in past 12 months from TP reinsurance
• Paig = assumed WP in past 12 months from intra-group pooling
• Pc = ceded WP in past 12 months from TP reinsurance
• Pcig = ceded WP in past 12 months from intra-group pooling
• PΔ = GWP growth in past 12 months above 20% (direct+assumed excl assumed from intragroup pooling)
• rapid growth from acquisitions, new LOB or changes to existing products / UW can create pressures on people and systems
• A 30% cap to dampen operational risk margin for companies with high-volume/low-complexity business

• to recognize that risks are not perfectly correlated; very low probability all risks will suffer x percentile loss simultaneously -> reduction to capital. explicit credit for diversification between asset risk and insurance risk so capital required < straight sum
• Diversification credit = A + I − sqrt (A^2 + I^2 + 2*R*A*I)