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 2015-2016, high levels of domestic household indebtedness, low interest rates, sustained low 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 corporate and commercial lending, retail lending, outsourcing, cyber-risk, risk management, and compliance. 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 deposit-taking 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 approximately 10% of Canadian deposit-taking assets are held by smaller and mid-sized institutions with various market and business strategies, such as mortgage lending, commercial real estate lending or credit cards.

Overall, return on equity for the industry was about 15% in 2015, similar to 2014. The main contributing factors were continued solid net income generation and a stable credit environment. While loan loss provisions for corporate and retail lending (mortgages, auto loans, credit cards) remained low, banks began to report that some portfolio metrics were showing signs of the impacts of low oil prices.

OSFI fully implemented the Basel III capital rules in 2013, at which time banks began reporting new Common Equity Tier 1 (CET1) capital adequacy ratios. Smaller Canadian banks’ CET1 capital ratios remain above the target level of 7%; while the six D-SIBs remain above the higher 8% capital requirement (reflecting the 1% capital surcharge). OSFI’s liquidity adequacy framework—which includes the Basel III Liquidity Coverage Ratio (LCR) requirement—came into effect in January 2015. Also, 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 continue to report ratios above the minimum requirements established for these metrics.

Staff image Lachmi Asnani-Ma
Manager, Supervision
Vancouver office
Supervision Sector
Staff image Graham Taylor
Director, Supervision,
Vancouver office
Supervision Sector

Life Insurance

The life insurance industry consists of three conglomerates and over 70 domestic companies and foreign branches. The conglomerates account for over 90% of the assets for the sector and have operations in Canada, the U.S., Europe and Asia. The conglomerates offer a broad range of wealth management as well as life and health insurance products through a range of distribution channels. The non-conglomerates tend to be more restricted in product breadth and distribution.

The key metric used to assess capital adequacy for Canadian supervisory purposes is the Minimum Continuing Capital and Surplus Requirement (MCCSR). This metric is to be replaced by the Life Insurance Capital Adequacy Test (LICAT) effective January 2018.

LICAT represents an evolution in OSFI's regulatory capital expectations and is designed to take account of significant changes in the nature and management of risk within the insurance industry. It improves the overall measurement of the quality of Available Capital and better aligns measures of risks with today’s economic realities for life insurers. The draft guideline was released in March, 2016, for public consultation. Industry responses will be considered in issuing the final guideline in the fall of 2016 and sensitivity tests are planned prior to the effective date to ensure a smooth transition.

The macro-economic environment continues to be a challenge for the life insurers, as it has since the 2008 financial crisis. Life insurers have ceased selling products with high-risk market guarantees, de-risked and re-priced product offerings, increased their hedging of product risks, divested themselves of high risk blocks of business, and strengthened their governance and risk management practices. As a result, life insurers have significantly decreased their sensitivity to interest rate and equity fluctuations.

Market volatility and persistently low interest rates have had an effect on in-force product profitability as investment yields have declined below anticipated yields when these products were originally priced. However, companies have set-up additional balance sheet provisions so they will be able to meet their future obligations to policyholders.

The aggregate capital ratio for the life insurance industry at year-end 2015 was 237% compared to 239% for 2014. The aggregate level has been well above OSFI’s minimum requirements for the last several years as companies conserve capital in response to market volatility.

Return on equity for the industry was 9% and net income was $8.8 billion in 2015, compared to 11% and $10.8 billion respectively in 2014. Approximately 75% of the industry’s net income is attributable to the three large conglomerates. The decline in return on equity is an industry-wide issue due to persistent low interest rates. The decline in net income is largely due to the impact of low commodity prices, particularly oil and gas. Challenges remain as persistently low interest rates make asset/liability management more difficult and strain in-force product profitability as many products cannot be re-priced due to contractual provisions. OSFI is reviewing adherence to accepted actuarial practice when companies price new products, and is monitoring changes in risk policies to ensure companies adopt appropriate mitigation practices and controls if they move up the risk curve.

Property and Casualty Insurance (excluding mortgage insurance)

Nearly half of the Canadian Property and Casualty (P&C) insurance industry (by premium volume) is foreign owned (parent companies are typically located in the United States or Europe). As market conditions in the home jurisdiction can affect Canadian operations, OSFI monitors both domestic and parent company conditions.

The P&C insurance industry in Canada reported $5.1 billion of net income in 2015, an increase of 13% over the previous year, mainly driven by strong underwriting results.

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 underwriting profits where premium income exceeds claims and expenses. The P&C industry aggregated combined ratio improved to 96% in 2015 from 99% in the previous year, driven by fewer severe weather and catastrophe events.

Net investment income declined 10% from last year due to the low interest rate environment and a few large institutions holding their investments at fair value. Most insurers continued to record low investment yields in 2015, 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 branch operations in Canada. The capital framework was substantially revised, effective Jan 1, 2015, with a more robust risk-based approach. The industry was well positioned to meet the revised requirements and the industry’s capital ratio remained relatively stable at 270% at the end of the year. All institutions maintained capital ratios above the OSFI’s supervisory target of 150%.

OSFI observed that some institutions are adopting a business model of insuring risks in Canada and reinsuring a significant portion of the risk offshore to affiliates reinsurers. While this is not an industry wide phenomenon, these business models introduce concentrated counterparty credit risk and operation risk in distressed situations. During the year, OSFI reviewed a number of reinsurance programs and the related risk management practices, and conducted a standard stress test focused on reinsurance to further identify concerns. OSFI has begun discussing potential remedial actions with individual companies and this work is expected to continue over the next year. Related OSFI guidelines are also being reviewed and will be revised, as appropriate.

Mortgage Insurance

The mortgage insurance industry in Canada is composed of three main players, two insurers regulated by OSFI, and the Canada Mortgage and Housing Corporation. Private mortgage insurers continued to display improving financial performance during 2015, with net income of federally regulated private mortgage insurers in Canada rising 8% to $489 million, reflecting stronger underwriting income and higher investment returns. The average MCT capital ratio rose by 12 points to 233%, which is above OSFI’s supervisory requirement of 150%. Despite the currently favourable financial results, the mortgage insurers remain vulnerable to both rising consumer debt levels and the potential impact of sustained low oil prices in certain Canadian regions.

Supervisory Tools

Managing Risk Effectively

OSFI maintains internal assessment guidance to support its risk-based Supervisory Framework, which consider an institution’s inherent business risks, risk management practices (including corporate governance) and financial condition.

OSFI again held annual risk management seminars in 2015-2016 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 of these seminars is to communicate OSFI’s expectations in 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 holding Colleges of Supervisors, in 2015-2016 OSFI hosted a college for three of Canada’s five largest banks, with colleges planned for the other two in 2016-2017. In line with Financial Stability Board recommendations, the colleges bring together executives from the banks with supervisors from jurisdictions where they do business. OSFI also hosted a supervisory college for a large life insurance company. In conjunction with Canada Deposit Insurance Corporation, Crisis Management Groups (CMGs) and Outreach Panels were again held for the six largest deposit-taking institutions.

Composite Risk Ratings

The Composite Risk Rating (CRR) represents OSFI’s overall assessment of an institution'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 deposit-taking and insurance companies prohibit institutions (or OSFI) from publicly disclosing their rating. As at the end of March 2016, OSFI had assigned CRR ratings of low or moderate to 94% and above average or high to 6% of all CRR-rated institutions.

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 (stage 0); 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, 2016, there were 24 staged institutions, most falling in the early warning (stage 1) category.

Staff image Sheila Catahan
Executive Assistant,
Insurance Supervision Sector
Staff image Susan Missio
Property and Casualty Insurance Group,
Insurance Supervision Sector