Government of Canada
Symbol of the Government of Canada

Federally Regulated
Financial Institutions

Risk Assessment and Intervention

OSFI supervises federally regulated financial institutions (FRFIs), monitors the financial and economic environment to identify issues that may have a negative impact on these institutions, and intervenes in a timely manner to protect depositors and policyholders from loss. In doing so, OSFI recognizes that management and boards of directors of FRFIs are ultimately responsible and that those institutions can fail.

In 2014-2015, high levels of domestic household indebtedness, exceptionally low interest rates, falling oil prices and ongoing global financial uncertainty continued to be seen as sources of potential systemic vulnerability. OSFI took action to address the possible impact of these challenges and achieve its strategic priorities by communicating its expectations for risk management to FRFIs and conducting significant reviews in several areas, including stress testing, cyber security, risk data aggregation, outsourcing, and internal audit. We continued to develop supporting guidance for OSFI’s Supervisory Framework and initiated a review of our supervisory processes and tools.

Review by Sector

Deposit-Taking Institutions

The Canadian banking industry is comprised of six large domestic banks designated as domestic systemically important banks (D-SIBs) and many smaller deposit-taking institutions (DTIs). The six largest banks account for approximately 90% of total assets among Canada’s federally regulated DTIs. Their diversified business lines extend beyond traditional deposit-taking and lending activities into trading, investment banking, wealth management and insurance. In addition to their primary domestic focus, these large banks also have operations in many countries across the globe.

The remaining 10% of Canadian banking assets are held by smaller institutions with niche market and business strategies, such as mortgage lending, commercial real estate or credit cards.

Overall, return on equity for the industry was roughly unchanged in 2014 from 2013, remaining around 16%. The main contributing factors were higher revenues, offset by higher non-interest expenses, and a stable credit environment that drove solid profitability. While loan loss provisions for corporate and retail lending (mortgages, auto loans, credit cards) remained low, vulnerabilities continue related to lower oil and gas prices and other economic risks, as well as high household debt levels.

OSFI fully implemented the Basel III capital rules, and banks began reporting the new Common Equity Tier 1 (CET1) capital adequacy ratios in 2013. Canadian bank capital ratios remain above the target level of 7% for CET1; and the six large domestic banks remain above their higher (8%) capital requirements. OSFI implemented a new liquidity adequacy framework – which includes the Basel III Liquidity Coverage Ratio (LCR) requirement – that came into effect in January 2015. At the same time, the Basel III leverage framework and associated minimum 3% Leverage Ratio (LR) requirement replaced the Assets to Capital Multiple (ACM) leverage constraint. Canadian banks that have reported first quarter results (e.g. D-SIBs, and other banks with October year-ends) show ratios well above the minimum requirements.

Photo: James Lain, Senior Supervisor, Vancouver Regional Office, Supervision Sector; Winnie Lee, Senior Supervisor, Vancouver Regional Office, Supervision Sector
Staff image James Lain
Senior Supervisor
Vancouver Regional Office
Supervision Sector
Staff image Winnie Lee
Senior Supervisor
Vancouver Regional Office
Supervision Sector

Life Insurance

The capital metric used to assess capital adequacy for supervisory purposes is the Minimum Continuing Capital and Surplus Requirement (MCCSR) for federally regulated Canadian life insurance companies, and the Test of Adequacy of Assets and Margin (TAAM) for branches of foreign companies operating in Canada. The requirements for calculating the metrics are updated each year.

In January 2015, OSFI released a policy paper outlining a new standard approach for the life insurance regulatory capital framework. This framework considers recent developments in financial reporting, actuarial methodology, economic capital and financial theory. The framework is intended to provide an improved assessment of solvency risk, and promote improved risk management and business decisions. Industry input is being sought on the policy paper. In addition, quantitative impact studies are being conducted to assess the potential effect of the changes on the life insurance industry. This new regulatory capital framework will be implemented in January 2018.

The aggregate capital ratio for the life insurance industry at year-end 2014 was 239% compared to 242% for 2013. The aggregate level has been well above OSFI’s minimum requirements for the last several years as a result of improvement and stability in capital and equity markets, decreasing product guarantees, and product re-pricing. While low long-term interest rates present a continuing strain on profitability, companies have strengthened their balance sheets and persisting low long-term interest rates will not affect solvency.

Return on equity for the industry was 11% and net income was $10.8 billion in 2014, compared to 10% and $8.1 billion respectively in 2013. Approximately 75% of the industry net income is attributable to the three large conglomerates. Net income benefitted from improving equity markets and re-pricing of products to reflect changed market conditions. Challenges remain with persistently low interest rates, which make asset/ liability management more difficult and strain in-force product profitability as many of these products cannot be re-priced due to contractual provisions. There is also the potential for future adverse equity market changes due to instability in the global economy. However, those companies with large exposure to products with market guarantees have adequate capital to withstand a substantial decline in the equity markets.

Property and Casualty Insurance (excluding mortgage insurance)

The financial performance of the property and casualty (P&C) industry in Canada in 2014 improved over that of the previous year, which had been undermined by large insurance claims arising from the Calgary flood and the Toronto rain storm in 2013. Lower claims in 2014 increased underwriting profitability to $732 million from $109 million in 2013. Net income for the P&C industry of $4.0 billion increased 60% over the previous year’s net income, bolstered by underwriting profits for the industry as well as investment returns at a few select FRFIs.

A key measure of the industry’s core profitability is the ‘combined ratio’, which measures the revenue from premiums relative to the sum of claims plus expenses. A combined ratio under 100% indicates that premium income exceeds claims and expenses, and that an underwriting profit has been earned. In 2014, the combined ratio was 98.7%, an improvement over 2013’s break-even combined ratio of 100.2%.

For the P&C industry, investment income before realized gains of $3.2 billion in 2014 was approximately a 25% improvement over 2013, and driven by a few insurers holding their investments at fair value. Most insurers continued to record low investment yields in 2014, reflecting the lower yields available as the portfolio is reinvested and highlighting the importance of core underwriting to achieve and sustain financial results.

The Minimum Capital Test (MCT) is the capital metric for Canadian P&C companies while the Branch Adequacy of Assets Test (BAAT) is used for foreign-owned P&C operations in Canada. Capital ratios for the P&C industry in 2014 improved over 2013, increasing to 269% from a 257% industry-weighted MCT/BAAT ratio – well above OSFI’s supervisory target of 150%.

With nearly half of the Canadian P&C insurance industry (by premium volume) being foreign owned (ultimate parents are typically located in the United States or Europe), market conditions in the home jurisdiction can affect Canadian operations; consequently, OSFI continues to monitor parent company conditions.

Domestically, personal auto insurance continued to be the major underwriting challenge, as the auto insurance loss ratio continues to deteriorate. While anticipated impacts of the 2010 Ontario auto insurance reforms have been realized, pressure on Ontario loss ratios is expected to continue with 7% of the targeted 15% reduction slated for August 2015 taking effect in 2015. In Alberta and some Atlantic provinces, auto insurance loss ratios also increased in 2014.

Mortgage Insurance

The private mortgage insurance industry in Canada experienced stable financial results during 2014. The net income of federally regulated private mortgage insurers in Canada rose 7% to $454 million, reflecting higher underwriting income that offset a modest decline in investment returns. The MCT capital ratio also remained largely stable, rising one (1) point to 221%, and above OSFI’s supervisory requirement of 150%. Notwithstanding the currently favourable financial results, mortgage insurance remains vulnerable to both consumer debt levels and the potential impact of sustained low oil prices in certain Canadian regions.

Supervisory Tools

Managing Risk Effectively

In 2014-2015, OSFI continued updating internal guidance to support its risk-based Supervisory Framework, which considers an institution’s inherent business risks, risk management practices (including corporate governance) and financial condition.

OSFI again held annual risk management seminars in 2014-2015 for the industries it regulates (DTIs, life insurance, and P&C insurance) to reinforce the need for strong risk management and to share lessons learned. The goal is to communicate OSFI’s expectations related to key risk management areas based on detailed work OSFI has undertaken during the year, and to share information on issues being discussed internationally by regulators. The seminars also provide participants with the opportunity to ask questions of OSFI’s senior supervisory and regulatory teams.

Continuing the practice of organizing Colleges of Supervisors, in 2014-2015 OSFI hosted a college for each of Canada’s five largest banks. In line with Financial Stability Board recommendations, the colleges brought together executives from each bank with supervisors from jurisdictions where they do business. OSFI also hosted a supervisory college for a large life insurance company. Crisis management and industry information sessions were again held for the seven largest deposit-taking institutions, in conjunction with Canada Deposit Insurance Corporation.

Composite Risk Ratings

The Composite Risk Rating (CRR) represents OSFI’s overall assessment of an institution’s safety and soundness. Beginning in 2013-2014, a Branch Risk Rating (BRR) was assigned to Foreign Bank Branches (FBBs) operating in Canada, rather than a CRR, reflecting OSFI’s limited access to the information needed to assess the FBB’s safety and soundness.

There are four possible risk ratings: ‘low’, ‘moderate’, ‘above average’ and ‘high’. The CRR is reported to most institutions at least once a year (certain inactive or voluntary wind-up institutions may not be rated). The Supervisory Information Regulations for both banks and insurance companies prohibit institutions (or OSFI) from publicly disclosing their rating. As at the end of March 2015, OSFI had assigned CRR ratings of low or moderate to 91% and above average or high to 9% of all CRR-rated institutions. These percentages are unchanged from the previous year.

Intervention Ratings

Financial institutions are also assigned an intervention (stage) rating, as described in OSFI’s guides to intervention for FRFIs, which determines the degree of supervisory attention they receive. Broadly, these ratings are categorized as: normal; early warning (stage 1); risk to financial viability or solvency (stage 2); future financial viability in serious doubt (stage 3); and non-viable/insolvency imminent (stage 4). As at March 31, 2015, there were 23 staged institutions. With a few exceptions, most of the staged institutions were in the early warning (stage 1) category.

Photo: Trenton Haggard, Manager, Property and Casualty Insurance Group, Supervision Sector; Shelina Visram, Manager, MFC Team, Supervision Sector
Staff image Trenton Haggard
Property and Casualty Insurance Group
Supervision Sector
Staff image Shelina Visram
MFC Team
Supervision Sector