Life Insurance Capital Adequacy Test

Document Properties

  • Type of Publication: Guideline Impact Analysis Statement
  • A: Life Insurance Capital Adequacy Test
  • Date: November 2017

I. Background

OSFI’s Guideline A, Minimum Continuing Capital and Surplus Requirements (MCCSR), along with other OSFI guidelines, provides the framework within which OSFI assesses whether a life insurance company maintains adequate capital and whether a life insurance company operating in Canada on a branch basis maintains an adequate margin of assets in Canada over liabilities in Canada.

II. Problem Identification

The MCCSR has been in place for close to 25 years. It is reviewed annually and updated as needed to reflect developments in the life insurance industry and evolving risk management practices. Despite this, the MCCSR’s use of various and unspecified levels of confidence for each risk and the lack of explicit measures of certain risks currently faced by life insurers could limit the MCCSR’s ability over time to properly account for an evolving environment. These, along with developments in financial reporting standards (IFRS), actuarial standards (CIA), as well as economic and financial practice and international advancements in solvency frameworks, point to the need for a comprehensive review.

III. Objectives

OSFI’s objective is to develop a new capital framework that results in improved overall quality of available capital, greater risk sensitivity, better measurement of certain risks and closer alignment of risk measures with the economics of the life insurance business. In particular, the new framework should:

  • Better reflect the capacity of available capital elements to absorb losses and protect policyholders and creditors during periods when insurers are under stress;
  • Use more advanced and risk-based techniques based on updated and/or more granular data to measure credit, market, insurance and operational risks at a consistent target level of confidence;
  • Introduce an aggregation methodology of risks which recognizes, to a prudent extent, the benefits of diversification;
  • Improve the measure of risks associated with risk sharing products (e.g. participating policies and adjustable products) and the determination of related capital credits;
  • Consider the most recent developments in financial reporting standards, actuarial methodology, economic and financial practice, as wells as advancements in international solvency standards and best practices in other jurisdictions.

IV. Consultations

A new guideline: Life Insurance Capital Adequacy Test (LICAT) was developed, following several years of consultations, including a number of Quantitative Impact Studies (QIS), collaboration with Quebec’s financial services regulator l’Autorité des marchés financiers (AMF) and Assuris (a not-for-profit organization that protects Canadian policyholders should their life insurance company fail).

On September 12, 2016, OSFI issued the LICAT guideline for implementation effective January 2018. OSFI indicated it would launch an implementation exercise in late 2016 with all federally regulated life insurers. The exercise was comprised of three parts: LICAT test run, sensitivity testing, and the development of an implementation plan. This exercise enabled OSFI to assess whether further calibration of the LICAT and/or transition measures were necessary and to test the new regulatory capital return templates. It became apparent that additional clarity on methodology was needed, and that, due to systems limitations, certain calculations would be very difficult to complete on a real time basis. These considerations and supplemental feedback received from participants resulted in a revised version of the guideline, posted for public consultation in June 2017.

The June 2017 consultation period ended on July 28, 2017. All comments were considered and additional changes were made to the guideline, resulting in the updated LICAT 2018 guideline.

V. Recommendation

The updated LICAT guideline addresses key issues with the current MCCSR. For example, the definition of available capital has been revised such that deductions and adjustments are made at the same level as where the losses occur (i.e. Tier 1 capital). Also, items subject to write-downs during periods of stress (e.g. goodwill and intangibles) and deferred tax assets have been re-evaluated and their capital treatment adjusted. The LICAT guideline also reflects more advanced and risk-based techniques to measure credit, market, insurance and operational risks. All risks are measured or estimated, to the extent possible, at a consistent target level of confidence. The LICAT also incorporates risk sensitive measures for determining capital credits for shared risk products as well as credits for risk diversification (within insurance risks and between asset and insurance risks).

The standardized risk measures for segregated fund guarantees are still under development due to the complexity of their calibration and the potential impact of IFRS 17 Insurance Contracts.

It is recommended that the LICAT be effective January 1, 2018. At a later date, OSFI will amend the LICAT standard approach for segregated fund guarantees. In addition, future additional changes will occur as a result of the implementation of IFRS 17.

VI. Implementation

The LICAT guideline would be effective January 1, 2018. Early adoption would not be permitted. As per OSFI’s usual regular update process, OSFI would review the effectiveness of the LICAT guideline and make amendments as required.