Office of the Superintendent of Financial Institutions
This Advisory applies to all federally regulated life insurance companies and societies, holding companies and companies operating in Canada on a branch basis, and updates and complements Guideline A: Life Insurance Capital Adequacy Test (LICAT). It implements a smoothing mechanism for the calculation of interest rate risk for participating blocks of insurance, and clarifies the capital treatment of certain participating insurance liabilities.
This Advisory will remain in effect until January 1, 2023, at which time the guidance contained herein will be incorporated into the LICAT guideline.
For the purpose of this Advisory, the term "DSR" means a dividend stabilization reserve or other similar experience levelling mechanism that is reported as a liability on the financial statements. This term encompasses additional reserves or other similar experience levelling mechanisms referred to in section 9.1.1 of the LICAT.
OSFI is implementing a smoothing mechanism to reduce unwarranted volatility that could occur in the interest risk requirements for participating blocks of insurance. The smoothing will be effected by substituting rolling average amounts for certain components of the LICAT Base Solvency Buffer calculation, as specified below.
For each separate participating block within an insurer’s LICAT calculation, the following new quantities are defined:
All of the rolling averages above should be calculated as the simple average over the current quarter and the previous five quarters. Once these averages have been determined, they should be substituted for the current quarter amounts in the formulas occurring in the following places in the LICAT:
All other components of the LICAT interest rate risk requirement calculation, including the determination of the most adverse scenario for a geographic region, and the calculation of the requirements for non-participating business, should follow the methodology specified in LICAT without modification.
For new participating blocks, no averaging should be used for the first quarter a block is reported. For the second quarter, all averaged quantities should be calculated using half of the sum of the first quarter and second quarter amounts. For the third quarter, the averages are one third of the sum of the first, second, and third quarter amounts. The averaging continues in this manner until the block is reported for six quarters.
Any participating block that is divested should be excluded completely from the LICAT calculation, and should not have a requirement reported for it.
If an entire participating block is coinsured by a reinsurer, the cedant should treat the transaction as a divesture, and the reinsurer should treat the assumed block as a new participating block. If only a portion of a participating block is coinsured, then:
If a DSR is negative, then it is not available to absorb experience shortfalls within a participating block, and if it is material, it is itself an experience shortfall that must be recovered through dividend reductions. The recovery of negative DSRs will be subject to the same requirements as for recovery of other experience shortfalls (i.e. dividend reductions to effect recovery of a material negative DSR must be made within two years from when the negative reserve becomes material). In addition, irrespective of materiality, all negative DSRs should be deducted from Tier 1 Available Capital, with no corresponding add-back to Tier 2.
For the purpose of determining whether a negative DSR must be recovered, materiality should be assessed taking into consideration the insurer’s internal management policies for participating insurance, and all relevant OSFI guidance related to participating insurance.
The DSRs contemplated in the LICAT guideline are those relating to actual experience. However, in applying the above guidance, an insurer may elect to use either DSRs resulting from actual experience within each participating block, or the total DSR reported on the financial statements for each participating block. Once this choice has been made, it should be applied consistently throughout the LICAT guideline and in subsequent quarters, and should be used consistently for all of the participating blocks of an insurer.
Advisories describe how OSFI administers and interprets provisions of existing legislation, regulations or guidelines, or provide OSFI’s position regarding certain policy issues. Advisories are not law; readers should refer to the relevant provisions of the legislation, regulation or guideline, including any amendments that came into effect subsequent to the Advisory’s publication, when considering the relevancy of the Advisory.