Office of the Superintendent of Financial Institutions
Market risk arises from potential changes in rates or prices in various markets such as those for bonds, foreign currency, equities and commodities. Exposure to this risk stems from investment and other business activities that create on- and off-balance sheet positions. Market risk in the LICAT includes interest rate, equity, real estate, and currency risks. A reduction in required capital for the potential risk-mitigating effect of dividend reductions or contractual adjustability is calculated separately for participating and adjustable products (q.v. Chapter 9).
Risks associated with segregated fund guarantees are covered in Chapter 7. Consequently, with the exception of the requirements for hedges in sections 5.2.3 and 5.2.4, liabilities for segregated fund guarantees, assets backing these liabilities under CALM (including hedges), and assets held in segregated funds by an insurer’s policyholders (and the corresponding liabilities) are not subject to the requirements of this chapter.
Sections 5.2, 5.3 and 5.4 relate to market risks associated with particular assets. These sections do not apply to assets backing index-linked products that are included in the correlation factor calculation in section 5.5. Investment income due and accrued on assets subject to market risk is reported with, and receives the same factor as, the asset to which it relates.
A commitment to purchase a traded asset that is subject to market risk should be treated as a sold put option under section 188.8.131.52. The capital requirement for a commitment to purchase a non-traded asset is equal to the product of the applicable credit conversion factor from section 4.4, the applicable market risk factor, and the amount of the commitment.
Assets held in composite insurance subsidiaries may be subject to the market risk requirements of either the LICAT guideline or the MCT guidelineFootnote Chapter 3; the interest rate risk and currency risk requirements for a composite subsidiary are determined using the same guideline as used for assets that do not back CALM liabilities. If MCT requirements are used for interest rate risk and currency risk, they are calculated at the MCT target level, and are not divided by 1.5.
Interest rate risk is the risk of economic loss resulting from market changes in interest rates. The most significant aspect of this risk is the net effect of potential changes in interest rates on the values of interest-sensitive assets and liabilities whose cash flows may be mismatched.
A projected cash flow methodology is used to measure the economic impact of sudden interest rate shocks. Required capital for interest rate risk is calculated as the maximum loss under four different prescribed stress scenarios. For each scenario, the loss is defined as the decrease in the insurer’s net position after revaluing asset and liability cash flows by changing the discount rates from those of the initial scenario to those of the stress scenario. The net position used to measure the loss in each scenario is equal to the difference between the present values of asset cash flows (including assets backing capital or surplus) and liability cash flows. Required capital for interest rate risk is calculated for each geographic region (Canada, the United States, the United Kingdom, Europe other than the United Kingdom, Japan, and other locations).
Initial Scenario Discount Rates are defined in terms of risk-free interest rates plus a spread, with the sum grading to an ultimate interest rate (UIR) plus an ultimate spread. Initial Scenario Discount Rates are prescribed for Canada, the United States, the United Kingdom, Europe other than the United Kingdom, and Japan. The Initial Scenario Discount Rates for other locations are the same as for the United States.
Risk-free interest rates are based on the following:
The UIR for Canada, the United States, and the United Kingdom is a spot rate of 4.5%. The UIRs for Europe other than the United Kingdom and for Japan are 2.8% and 1.0%, respectively.
The risk-free spot interest rates used in the initial scenario are determined as follows:
The spread is defined as follows:
The market average spreads between years 0 and 20 are determined using market spreads at the valuation date based on a recognized investment-grade corporate bond index chosen by the insurer. The index used must be published by a reliable information provider, should be used consistently from period to period, and should be disclosed in the LICAT memorandum. In order to be recognized, an investment-grade corporate bond index must meet the following criteria:
The following illustrates the calculation of risk-free spot rates and market spreads for both par and non-par blocks of business.
Risk-free spot rates
Step 1: Gather ParFootnote 2 Risk-Free Yields
Insurers would first collect par risk-free (semi-annual) yields. These yields are available from several sources, including but not limited to the following:
The series codes for the relevant maturities are:
For example, Canadian sovereign par yields could be obtained by:
Although yields obtained above are tied to a specific currency, it is assumed that they are appropriate for use for all business within a geographic region (e.g., Euro yields are used for all business within Europe).
Step 2: Convert Par Yields to Spot Rates
The following formulas would be used to convert par semi-annual yields to spot rates (zero coupon yields):
Risk-free par yields that are not obtained directly can be inferred using linear interpolation (i.e. for durations 4, 6, etc.). The resulting quantities Yield zero coupon,t for t = 1, 2, ... , 20 as determined above would constitute the risk-free spot rate curve.
Step 1: Select an Investment-Grade Corporate Bond Index
The following are examples of indices that could be found to meet the criteria for recognition as an investment-grade corporate bond index:
Step 2: Gather Par Investment-Grade Corporate Bond Yields
Similar to the process described above for gathering par risk-free yields, investment-grade corporate bond yields should be collected from the appropriate source for the relevant maturities (i.e. 3 months, 6 months, 1 year, 2 years, etc.). Insurers would use as many maturities as are available, and would only use fewer if constrained by the data source.
As an example, United States corporate bond par yields could be obtained in Bloomberg by:
There are a number of jurisdictions (e.g. Canada, United Kingdom and Japan) for which an insurer may not be able to find pre-constructed investment-grade corporate bond curves that provide the necessary information. For these jurisdictions, an insurer could use a curve building tool to collect the required bond yields. More generally, an insurer could extract the data for each constituent of an index and construct the curve by applying appropriate filters and using an appropriate curve fitting model. For example, a Canadian investment-grade corporate bond curve could be constructed using Bloomberg’s curve building tool and the following procedures:
Other appropriate filters could apply depending on the nature of the corporate bond market in a particular jurisdiction. For instance, inflation-linked corporate bonds are quite common in the United Kingdom and will distort the corporate bond curve. They would therefore be excluded.
Aside from Bloomberg, insurers who subscribe to a data feed from an index provider may receive the “Mid-YTM” at key maturities for the index as a whole. In some cases, individual bond data for all bonds in the index are provided. If so, an insurer would apply the appropriate filters (similar to the ones above) and use an appropriate curve fitting model.
There are many methods by which par yields could be extracted from an index. An insurer would choose an appropriate method based on the data that it has available (for example, an insurer would use underlying bond data if available, and would only use summary data, such as Mid-YTM for a subset of key maturities, if more detailed data were not readily available). In accordance with this guideline, the methodology used would be consistent from period-to-period and disclosed in the LICAT memorandum.
Step 3: Convert Par Investment-Grade Corporate Bond Yields to Spot Rates
The formulas and considerations specified in Step 2 of Risk-free spot rates would be used to perform this conversion.
The present value of all asset and liability cash flows is determined under four prescribed stress scenarios by discounting them to time zero using stressed discount rates. The stress scenario used to determine required capital is the one that produces the lowest net present value (i.e., the difference between the present values of assets and liabilities) for the cash flows after taking account of recoveries through reductions in participating dividends. The stress scenario that determines required capital may vary by geographic region.
For each stress scenario, the annualized stressed discount rates are calculated as follows:
The four stress scenarios are described below, relative to the initial scenario:
The interest rate shocks (T, S, B and C) to be used are the following linear functions of the square roots of the current risk-free interest rates r floored at 0.5%:
where r0.25 is the current 90-day risk-free interest rate, r20 is the current 20-year risk-free interest, and all interest rates are expressed as decimals (for example five percent corresponds to 0.05).
The interpolated interest rate shocks under the four stress scenarios can be expressed as:
where rt is the time t risk-free interest rate, and t is between 90 days and 20 years.
Initial and stress scenario interest rates are not floored at zero, and no adjustments are made if an interest rate is negative.
The shock L applied to the UIR, which is a decrease in the first two scenarios and an increase in the last two scenarios, is 40 basis points for Canada, the United States, the United Kingdom, and other locations, 25 basis points for Europe other than the United Kingdom, and 20 basis points for Japan.
For the purpose of determining the most adverse stress scenario that is used to calculate required capital, an insurer's loss under a stress scenario (LSS) within each geographic region should be calculated as:
par npt gross,
The most adverse scenario used to calculate required capital for interest rate risk in geographic regions outside Canada and the United States is the scenario that produces the highest value of LSS as defined above. For Canada and the United States, the same adverse scenario is used to calculate required capital for interest rate risk in both regions, and is the scenario for which the value of:
max(LSSCanada, 0) + max(LSSUS, 0)
Once an insurer has determined the most adverse scenario for each geographic region, the interest rate risk requirement for non-participating business within the region is equal to:
IRRnon-par = max(IRRnon-par gross,0)
under this scenario. The interest rate risk requirement for each block of participating business within the region before reflecting the effect of participating dividends is equal to:
IRRi par = max(IRRi par gross ,0)
under the most adverse scenario.Footnote 4 The interest rate risk requirement for the non-pass through portion of a block of participating business, which is used to calculate the par requirement floor (q.v. section 9.1.2) is equal to:
IRRi par npt = max(IRRi par npt gross ,0)
Although the same scenario is used for Canada and the United States, the interest rate risk requirements for these regions are calculated separately, under the assumption that gains in one region do not offset losses in the other.
The interest rate risk requirement for each participating block is used in the calculation of the standalone requirement for the block (q.v. section 11.2) and the participating credit for the block (q.v. section 9.1.2). The quantities Cstress used to determine the most adverse scenario must be consistent with the quantities Cadverse and Kfloor used to determine the participating credit for a block in section 9.1.2.
Example: Interest Rate Risk
The most adverse stress scenario for interest rate risk is determined based on the gain or loss in a geographic region's non-par block under each scenario (IRRnon-par gross), the gain or loss in the region's par blocks (IRRpar gross and IRRpar npt gross), and the amount of dividends available to pass through any interest rate losses in the par block (Cstress). The quantities IRRnon-par gross, IRRpar gross, IRRpar npt gross are the gross capital requirements for the non-par and par blocks without any floors. They will consequently be positive if there is a loss in the block under a scenario, and negative if there is a gain in the block under a scenario.
The premises underlying the scenario loss measure LSS are that any gains in a par block will ultimately be passed on to policyholders (and hence cannot be used to offset non-par losses), and that losses in the par block under a scenario should not be counted if they can be passed onto policyholders via dividends.
In the situation in which all interest rate risk is passed through to policyholders and an insurer has ample dividends available to absorb losses in its par blocks, the most adverse stress scenario will be determined solely by the gains or losses in the non-par block under each scenario, since the terms max (IRRpar gross - Cstress, IRRpar npt gross, 0) will be zero in all scenarios.
For example, if there is only one par block in a geographic region with no non-pass through elements, and the values of IRRnon-par gross, IRRpar gross and Cstress under each scenario are as follows:
then the most adverse stress scenario is scenario 2. Based on this scenario, the insurer will use a value of IRRnon-par = 1,400 for the interest rate risk requirement in the calculation of Knon-par, a value of IRRpar = 0 for interest rate risk in the calculation of K, Kfloor and Kreduced interest for the par block, and a value of Cadverse = 5,500 in the calculation of the credit for the par block.
If the amount of par dividends available is low, or dividends cannot be used to pass through interest rate risk, then losses in the par block could affect the determination of the most adverse stress scenario. For example, if Cstress under the scenarios changes as follows:
then the most adverse stress scenario is scenario 3. Based on this scenario, the insurer will use a value of IRRnon-par = 0 for the interest rate risk requirement in the calculation of Knon-par, a value of IRRpar = 2,500 for interest rate risk in the calculation of K, Kfloor and Kreduced interest for the par block, and a value of Cadverse = 80 in the calculation of the credit for the par block. However, in this situation it will likely be to the insurer's advantage to treat the par block as non-participating for interest rate risk. If it does so, it will use an interest rate risk requirement of IRRnon-par = 1,900 in the calculation of Knon-par, and an interest rate risk requirement of IRRpar = 0 in the calculation of K, Kfloor and Kreduced interest for the par block, with Cadverse still equal to 80.
Note that if an insurer has dividends available but uses a value of 0 for Cstress in all scenarios to determine the most adverse stress scenario because it is unable to pass through interest rate risk, it should use 100% of the par interest rate risk requirement in the calculation of Kfloor.
Cash flows are determined at the reporting date, and are projected net of all reinsurance (i.e., if all or a portion of an insurance liability corresponds to an on-balance sheet reinsurance asset, then the matching liability and asset are excluded from projected cash flows)Footnote 5. No reinvestment of any asset cash flows should be assumed. Liability cash flows should incorporate insurance MfADs projected under CALM. Projected asset and liability cash flows (except for participating, adjustable, index-linked pass-through liability, and future income tax cash flows) that are interest sensitive should be changed to be consistent with the interest rate scenario.
For participating, adjustable, index-linked risk pass through (RPT) and non-interest sensitive products, the same liability cash flows are used for all interest scenarios. For participating products, restated dividend cash flows should be projected using the methodology described in section 184.108.40.206, and all other cash flows should be projected based on Best Estimate Assumptions with the addition of insurance risk MfADs. Adjustments to cash flows should not be made for anticipated reductions or increases in dividends that may result from increases or decreases in interest rates under each scenario. A reduction in required capital for the potential risk-mitigating effect of dividend reductions is calculated separately for participating and adjustable products (q.v. Chapter 9).
The treatment for specific asset and liability cash flows is described next.
A fixed cash flow is one that is contractually guaranteed for a definite amount, and not contingent on future market prices or interest rates. A cash flow is considered contractually guaranteed if it is payable regardless of the condition of the obligor (for example, it is not contingent on the obligor meeting its target level of profitability), and if failure to pay the guaranteed cash flow would be considered an event of default. For assets having fixed cash flows, insurers should project the same cash flows as those used in the balance sheet valuation. Asset cash flows that are included in the valuation of CALM liabilities should be projected net of investment expenses, and all other asset cash flows should be projected gross of investment expenses.
Projected cash flows should not reflect the impact of CALM C-1 expected losses, CALM C-1 MfADs, or balance sheet loss provisions reported under IFRS 9 (i.e., asset cash flows should not be reduced by any amount on account of these three items, nor should liability cash flows be increased by any amount on account of these items).
Liability cash flows should be projected reflecting the impact of CALM insurance risk MfADs (i.e., all insurance assumptions used to project liability cash flows should be set equal to the best estimate assumption plus the CALM insurance risk MfAD used for the insurer's financial statements).
All cash flows should be projected without reflecting the impact of CALM C-3 and currency risk provisions.
The dividend cash flows used in the initial scenario are different from those projected under CALM. For the initial scenario, CALM dividend cash flows should be re-projected to produce restated dividend cash flows by making a level adjustment (e.g., determined using an iterative process) to the dividend scale so that the participating block balance sheet surplus is maintained under LICAT Initial Scenario Discount Rates. In other words, the net present value of assets over liabilities discounted using Initial Scenario Discount Rates is equal to the balance sheet surplus.
If some portion of dividends under CALM is projected to be distributed in the form of paid-up additions, the same portion of restated dividends should be projected to be distributed as paid-up additions.Footnote 3
In re-projecting the dividend scale, insurers should only include asset and liability cash flows, whose returns are passed through to policyholders through dividends. If investment returns on surplus and PfADs (including ancillary funds) are not elements that are passed through to policyholders, these cash flows should be excluded. If the assets to be excluded are comingled with other par assets, the insurer should remove them by assuming that they are supported by a proportionate share of the total (in practice, this could be a fixed percentage reduction of assets at each duration).
The restated dividend cash flows projected for the initial scenario remain unchanged under all stress scenarios.
Example: Participating liability dividend restatement
An insurer has a block of participating policies with underlying total cash flows (including surplus assets from non-pass through and pass-through components) as illustrated in (A). The insurer uses CALM discount rates to determine the total net present value of these cash flows for the participating policies, calculating a CALM balance sheet surplus of $445 in (B). In certain situations under LICAT, asset cash flows (e.g. NFI) are projected differently than under CALM (C). The balance sheet surplus resulting from those cash flows and LICAT Initial Scenario Discount Rates is $338 (D), which is different from the CALM surplus. Under LICAT, the insurer (using an iterative process (E), (F)) applies a level adjustment to the dividend scale so that the adjusted liability cash flows (G) discounted using the LICAT Initial Scenario Discount Rates generate a total net present value (H) equal to the balance sheet surplus of $445 (B) initially calculated under CALM.
Preferred shares and innovative instruments that do not constitute substantial investments are treated in the same manner as assets having fixed cash flows. Projected cash flows under the initial and stress scenarios should include all expected dividends and proceeds at maturity.
Insurers should include as a time zero cash flow the balance sheet value of the real estate less the present value of fixed cash flows calculated using Initial Scenario Discount Rates. Where no fixed cash flows are projected, the real estate's entire balance sheet value should be included as a cash flow at time zero. The cash flow amount at time zero remains the same under all interest rate scenarios.
Fixed cash flows on leases in force should be included in the period in which they are contractually expected to be received. No contract or lease renewals should be assumed. Prepaid rent should be treated as a time zero cash flow. The cash flows should exclude projected reimbursements for operating expenses that are paid by the lessor (e.g., property taxes and utilities). Cash flows from lease agreements with a rent-free period followed by a rent-paying period are included in the present value of lease cash flows.
The market value of a floating rate bond, note, or other investment should be reported as a cash flow at time zero.
The cash flows associated with a callable bond or preferred share under the initial and stress scenarios should be projected to the redemption date (i.e., one of the call dates or the maturity date) for which the present value of the cash flows, discounted at the scenario's rates, is lowest. For a puttable bond or preferred share, the cash flows under the initial and stress scenarios should be projected to the date for which the present value of the cash flows, discounted at the scenario's rates, is highest.
For a bond or preferred share that is both callable and puttable, the cash flows under the initial and stress scenarios are projected to the date determined by the following algorithm: if the dates in chronological order on which the investment can be put or called are t1, ... , tN, and tN+1 is the investment's final maturity date, then for 1 ≤ i ≤ N+1, the quantity PVi is defined to be the present value at time zero of the investment's cash flows under the scenario if it is called, put, or matures at time ti. The quantities Wi are solved backwards recursively from:
WN+1 = PVN+1
The cash flows for the investment under the scenario are projected to the earliest time ti for which W1 = PVi. If the investment can be called or put over a continuous time period, the point ti for the period should be defined as the time during the period at which PVi takes its highest or lowest value, respectively. For the purpose of projecting scenario cash flows for perpetual preferred shares that are callable and puttable, the shares may be assumed to mature at any time after which there is no material difference among any of the scenario present values PVi.
Example: Redeemable retractable preferred share
A Canadian perpetual preferred share with par value 100 pays a 7% dividend at the end of each year. At the end of years 3, 5 and 8, the holder of the share is entitled to put the share back to the issuer for prices of 100, 102, and 99 respectively, while at the end of years 5 and 7, the issuer of the share is entitled to call the share for 103 and 100, respectively. At the end of year 10 and all year-ends thereafter, the issuer is entitled to call the share at par. All options are exercisable only after the annual dividend has been paid.
The current Canadian risk-free rate at all maturities between 1 and 20 years is 5%, and 90% of the market average spread at all maturities between 1 and 20 years is 80 bps. Based on the put and call dates before year 10, the times ti are defined as:
(Note that if a put and call are exercisable simultaneously, the strike price of the put must be lower than the strike price of the call. In such a case, the calculation will not be affected by which option is assumed to be exercisable first).
Since all options in years 10 and later are calls, the date to which the present value of payments is lowest can be treated as a maturity date. If the preferred share remains outstanding to year 10, the issuer will realize the lowest present value of payments under the initial and stress scenarios if it redeems the share at the following year-ends:
With t6 taken to be the optimal calling time for the issuer after year 10, then the present values PVi under the scenarios are as follows:
The values of the Wi are then:
Consequently, in the initial scenario, the share is valued on the assumption that it will be redeemed at the end of year 7, in scenarios 1 and 4 it is valued assuming that it will be redeemed at the end of year 5, in scenario 2 it is valued assuming that it will be retracted at the end of year 5, and in scenario 3 it is valued assuming that it will be retracted at the end of year 3.
Non-fixed income (NFI) investments include any assets that do not have contractually guaranteed cash flows. Examples of such assets include equities and infrastructure investments without contractually fixed cash flows. However, real estate, preferred shares and innovative instruments are excluded from the definition of NFI investments as they are treated separately within the interest rate risk requirement.
In order to approximate the non-interest sensitive component of NFI investment's dividend stream, 33% of the investment's valueFootnote 6 is projected as cash flows occurring beyond time zero, while the remaining 67% of the investment's value is projected as a time zero cash flow. At all integer times t ≥ 1, a cash flow of:
of the investment's value is projected as a cash flow occurring at time t, where Dt is the initial scenario discount factor from time t to time zero.
If the index-linked product risk component is used (q.v. section 5.5), liability cash flows should match asset cash flows in each scenario. However, minimum interest rate guarantees must be reflected if they are higher than the asset cash flows.
If the index-linked product risk component is not used, the liability cash flows should be the same as those used in the balance sheet valuation. If minimum interest guarantees do not apply, the account value should be included as a cash flow at time zero. Cash flows from the portion of investment management fees used to cover investment expenses and other administration costs should be included in both asset and liability cash flows.
Where the account value of a policy is linked to a bond fund but does not vary directly with the fund's value, the cash flows of the fund should be projected so that the value of the fund changes appropriately in response to the change in interest rates under each scenario.
For mutual or pooled funds holding assets that do not have fixed cash flows (e.g., equities and real estate), insurers should treat the funds according to the type of assets that the funds hold. For example, equity funds should be treated as specified in section 220.127.116.11, and real estate funds should be treated as specified in section 18.104.22.168. If such treatment cannot be applied (e.g. if real estate lease cash flows are not known), the balance sheet value of the fund should be included as a cash flow at time zero.
For securitized assets whose cash flows are fixed, insurers should project the underlying fixed cash flows. For securitized assets whose cash flows are not fixed, the balance sheet value should be projected as a cash flow at time zero.
Obligations that the insurer has issued itself and that qualify for recognition in available capital under Chapter 2 (e.g ., preferred shares and subordinated debt) should be excluded from the projection of liability cash flows.
The cash flows projected for interest rate and currency swaps consist of three components:
Interest rate derivatives other than swaps should be included as an asset or liability cash flow at time zero in all scenarios. In each scenario, the time zero cash flow for the derivative is equal to the derivative's fair value under the scenario's risk-free interest rates. Stressed fair values should be calculated assuming no change in underlying interest rate volatility.
Cash flows for reverse mortgages and collateral loans with fixed interest rates are projected using Best Estimate Assumptions, including mortality assumptions. If the assets have variable interest rates then they are shown as time zero cash flows. If an insurer's model used for valuation in its financial statements is able to project variable interest assets accurately then asset cash flows are updated in each interest rate scenario.
Cash flows for policy loans with interest rates that are fixed or subject to guaranteed maximums should be projected using mortality and lapse assumptions that are consistent with those used in the valuation of the related policies. Policy loan amounts for variable rate policy loans that are not subject to guaranteed maximums should be projected as time zero cash flows.
Projected cash flows should include cash flows arising from investment income taxes and tax timing differences that are projected under CALMFootnote 3. No other income tax cash flows should be included in the projection. Cash flows related to tax timing differences should not be re-projected to reflect the interest rate scenario being tested.
If an insurer uses dynamic assumptions (e.g. for lapses) that vary with interest rates to project insurance cash flows under CALM, the liability cash flows projected in the interest rate initial scenario and stress scenarios should reflect these assumptions (i.e ., the assumptions that are set dynamically should vary in each interest rate scenario to be consistent with the scenario).
Cash flows projected for expenses, and for benefit payments that are subject to cost-of-living adjustments should reflect the impact of inflation assumptions that vary consistently with each scenario. Inflation rates should bear the same relation to risk-free interest rates as assumed under the CALM valuation. For example, if an insurer generates inflation rates dynamically under CALM, the same generator should be used to derive inflation rates in the initial scenario and stress scenarios that are consistent with these scenarios.
The cash flows projected for assets replicated synthetically (q.v. section 5.2.3), including non-fixed income assets, should be the same as those of the replicated assets.
The projection of cash flows for liabilities that are classified as investment contracts in the financial statements and that are not covered in a previous section depends on whether the contract holder has an option to redeem the investment. If the contract is not redeemable, the insurer should project the same cash flows as those used in the balance sheet valuation. If the contract is redeemable at the option the holder, the cash flows under the initial and stress scenarios should be projected to the redemption date for which the present value of the cash flows, discounted at the scenario’s rates, is highest. In particular, the balance sheet value of deposit-type liabilities should be treated as a time zero cash flow.
For most products, only contractual cash flows are projected, without assuming reinvestments. Universal life (UL) is an exception as the contract continues after the end of any interest guarantee period inside the investment account. It is therefore necessary to use a reinvestment assumption to generate a credited rate that is used to project best estimate cash flows for premiums, policy charges and benefits and expenses.
Insurers should use Initial and stress Scenario Discount Rates (qq.v. sections 5.1.1 and 5.1.2) for discounting UL cash flows. The credited rate should vary appropriately with the scenario that is being tested, including the initial scenario. The relation between the restated credited rates for LICAT purposes and the LICAT discount rates under each scenario should be consistent and maintain the same relationship as exists between actual credited rates and the implied discount rates that are derived from the assets (both fixed income and non-fixed income) used to support the specific UL product under the CALM base scenario.
Where the universal life contract has minimum interest guarantees, the effect of these guarantees must be reflected in the scenario that is being tested.
If the performance of a universal life contract inside-account benefit is tied to the performance of specific assets and these assets are held by the insurer, then the cash flows on these assets and liabilities should be included with the cash flows of other index-linked RPT products (q.v. section 5.5). If matching assets are not held, then the cash flows should be projected using assumptions that are consistent with those used in the balance sheet valuation and then adjusted for the scenario being tested.
Equity risk is the risk of economic loss due to potential changes in the prices of equity investments and their derivatives. This includes both the systematic and specific components of equity price fluctuation.
Required capital for all investments classified as common equities (including equity index securities, managed equity portfolios, income trusts, limited partnerships, and interests in joint ventures) is calculated by applying a factor to the market value of the investment. The base factor is 35% for equities in developed markets, and 45% for equities in other markets. The base factor is increased by 5 percentage points (i.e., to 40% or 50%) if:
If an increased factor is used for an equity holding that is a substantial investment, the amount to which the factor is applied should be net of the amount of associated goodwill and intangible assets deducted from Gross Tier 1 capital in section 22.214.171.124.
Developed markets include countries listed as developed markets by at least two of the five following data providers: Dow Jones & Company, FTSE Group, MSCI Inc., Russell Investments and Standard and Poor's.
Substantial investments in mutual fund entities that do not leverage their equity by borrowing in debt markets, and that do not otherwise leverage their investments, do not receive equity risk factors for substantial investments. Instead, a capital charge on the assets of the mutual fund entity will apply based on the requirements of section 5.4. For example, the factors for substantial investments do not apply where the insurer has made a substantial investment in a mutual fund as part of a structured transaction that passes through the unaltered returns (i.e., no guarantee of performance) on the substantial investment to the mutual fund holder.
The treatment of offsetting long and short positions in identical or closely correlated equities is described in section 5.2.4.
Required capital for preferred shares depends on their rating category, and is calculated by applying the factors shown in the table below to their market values:
For investments in capital instruments issued by domestic or foreign financial institutions, other than common or preferred shares, that qualify as capital according to the solvency standards of the financial institution’s home jurisdiction (e.g. subordinated debt), the applicable factor is the higher of:
Refer to appendix 5-A for the correspondence between the rating categories used above and individual agency ratings, and to section 3.1.1 for requirements related to the use of ratings.
This section describes required capital for transactions that increase an insurer’s exposure to market risk and for which the full notional amount of the transaction may not be reported on the balance sheet, such as transactions undertaken through derivatives. Insurers should calculate required capital based on the full exposure amount and underlying risk assumed under these transactions, irrespective of whether they are recognized or how they are reported on the balance sheet.
No additional capital is required under this section for hedges of index-linked liabilities that have been taken into account in the correlation factor calculation under section 5.5.
Where an insurer has entered into transactions (including short equity positions and purchased put options) that:
required capital for the hedges may be reduced to a minimum of zero if the insurer is able to demonstrate, to the satisfaction of the Superintendent, that losses on the hedges under particular scenarios would be offset by decreases in its segregated fund guarantee liabilities. Insurers should contact OSFI for details on the calculation for determining the capital requirement for these hedges.
The requirements in this section are distinct from the requirements for counterparty credit risk arising from off-balance sheet transactions. Transactions referred to in this section remain subject to the requirements for potential replacement cost as described in section 3.1 and Chapter 4.
Required capital for a short position in any equity security or index that does not wholly or partially offset a long equity position is the same as that for a long position of the same magnitude. Positions eligible for offset recognition and the corresponding treatment are described in section 5.2.4.
Required capital for a futures or forward position in any security or index is the same as that for the equivalent spot position, and is reported as if the position were current. Required capital for a swap is the same as that for the series of future or forward transactions that replicates the swap.
Examples: Futures and Swaps
1) An insurer has entered into a futures contract to purchase equity securities on a future date. The insurer reports an equity exposure in an amount equal to the total current market value of the equities underlying the futures contract.
2) An insurer has entered into a one-year swap during which it will pay the total return (coupons and capital gains) on a 10-year Government bond, and receive the return on a notional index of equities that was worth $100 at the time of inception. The index of equities is currently worth $110. The insurer reports an equity risk exposure of $110 for the long position in the index, and liability cash flows in the interest rate risk calculation for the short position in the bond.
The following describes the methodology used to determine the required capital for both equity options that have been purchased and options that have been sold. This methodology may not be applied to equity options embedded in products sold to policyholders. The market risk required capital for policies containing an equity option component is calculated using the methodologies for index-linked RPT products (q.v. section 5.5) or segregated fund guarantees (q.v. Chapter 7), as appropriate.
Required capital for an option (or a combination of options in exactly the same underlying equity) is determined by constructing a two-dimensional matrix of changes in the value of the option position under various market scenarios, using the same valuation model that is used for the financial statements. The first dimension of the matrix requires an insurer to evaluate the price of the option position over a range within the corresponding equity risk charge above and below the current value of the underlying stock or index, with at least seven observations (including the current observation) used to divide the range into equally spaced intervals. The second dimension of the matrix entails a change in the volatility of the underlying stock or index equal to ±25% of its current volatility. Required capital for the option position is then equal to the largest decline in value calculated in the matrix. The application of this method and the precise manner in which the analysis is undertaken must be documented and made available to OSFI upon requestFootnote 8.
As an alternative to constructing a scenario matrix for a purchased option, an insurer may deduct 100% of the carrying amount of the option from its Tier 1 Available Capital.
Example: Options on Equities
An insurer has sold a call option on a publicly listed Canadian stock, with the stock currently having a market value of $100 and volatility of 20%. The first dimension of the matrix ranges from $65 to $135, divided into six intervals of $11.66 each, and the second dimension assumes that volatility stays at 20%, increases to 25% (= 20% + 25% of 20%) or decreases to 15% (=20% - 25% of 20%). If the change in the value of the insurer's option position under the various market scenarios is as below, then the required capital for the option is $25.83.
The balance sheet carrying amount of an equity- or index-linked note is decomposed into the sum of a fixed-income amount, equivalent to the present value of the minimum guaranteed payments under the note, and an amount representing the value of the option embedded within the note. The fixed-income portion of the note is classified as a debt exposure subject to a credit risk charge based on the rating and maturity of the note, and the residual amount is treated as an equity option.
Example: Equity-linked Notes
An insurer purchases an A-rated equity-linked note from a Canadian bank for $10,000. The note promises to pay, in two years, the $10,000 purchase price of the note plus the purchase price times 65.7% of the percentage appreciation (if positive) of the S&P 500 over the term of the note. The insurer uses the Black-Scholes option valuation model for financial reporting purposes. The implied volatility of the stock index is 25%, the yield curve is flat, the annual risk-free rate is 5%, and the issuing bank's annual borrowing rate is 6.5%. The total required capital for this note is ($88.17 + $1,118.92 + $17.09 =) $1,224.18, the sum of the following three separate charges:
Required capital for a convertible bond is equal to the credit risk required capital for the bond's fixed-income component, plus the equity option requirement for the bond's embedded warrant. Required capital for the fixed-income component is equal to the bond's credit risk factor (based on its rating and maturity) multiplied by the present value of the minimum guaranteed payments under the bond. The required capital for the embedded warrant is calculated using the scenario table method (q.v. section 126.96.36.199) for options on equities, where the gains and losses are based on either the change in value of the bond's warrant component (if the valuation methodology assigns an explicit value to this component) or the change in value of the whole bond.
As a simplification, an insurer may classify the entire balance sheet value of the convertible bond as an equity exposure and calculate required capital for the bond by applying the market risk factor for equities to the bond's value.
Equity positions backing indexed-linked policyholder liabilities for which a factor is calculated under section 5.5 may not be recognized as an offset to any other positions. Offsetting hedges of an equity position may only be recognized if the party providing the hedge is an eligible guarantor as defined in section 3.3.4.
Identical reference assets
Long and short positions in exactly the same underlying equity security or index may be considered to be offsetting so that an insurer is required to hold required capital only for the net position.
Closely correlated reference assets
Where underlying securities or indices in long and short positions of equal amounts are not exactly the same but are closely correlated (e.g., a broad stock index and a large capitalization sub-index), insurers should apply the correlation factor methodology described in section 5.5.2. The capital requirement for the combined position is equal to the capital factor F multiplied by the amount of the long position. If an insurer has not held a short position over the entire period covered in the correlation factor calculation, but the security or index underlying the short position has quotations that have been published at least weekly for at least the past two years, the insurer may perform the calculation as if it had held the short position over the entire period. However, returns for actively managed short positions may not be inferred for periods in which the positions were not actually held, and mutual funds that are actively managed externally may not be recognized as an offsetting short position in an inexact hedging relationship.
Option hedges of an equity holding may only be recognized if the party providing the hedge is an eligible guarantor as defined in section 3.3.4. Option hedges of segregated fund guarantee risk may not be recognized in the segregated fund guarantee capital requirement without explicit approval from OSFI. The form and amount of any such recognition will be specified by OSFI at the time of approval. Option hedges of segregated fund guarantee risk that receive recognition in the segregated fund guarantee required capital cannot be applied towards other equity risks.
If an option's reference asset is exactly the same as that underlying an equity position held, an insurer may exclude the equity holding in calculating required capital for its equity exposures and instead consider the combined change in value of the equity position with the option in constructing the scenario table (q.v. section 188.8.131.52).
If an option's reference asset is not exactly the same as that underlying an equity position, but is closely correlated with the equity, then the factor for offsetting long and short positions in the option's reference asset and the asset underlying the equity position is calculated as described in section 184.108.40.206. An insurer may then exclude the equity holding from its required capital for equity exposures and instead calculate the combined change in value of the equity position with the option in a scenario table (q.v. section 220.127.116.11). However, the movement in the option's reference asset under each scenario must be assumed to be higher or lower (whichever produces a lower value for the option position) than the movement of the equity, by an amount equal to the required capital for directly offsetting positions. No additional adjustments need be made to the assumed changes in asset volatilities under the scenarios to account for asset mismatch.
Example: Equity Option Hedges
An insurer has a long position in a main equity index in a developed market, and also owns a call option and a put option on different indices that are closely correlated with the main index. The highest factor F over the previous four quarters between the reference index of the call option and the main index, calculated per section 5.5.2, is 3%, and the highest factor F calculated over the previous four quarters between the reference index of the put option and the main index is 1%. The insurer therefore constructs a scenario table in which the price of the main index ranges from 35% below to 35% above its current value, while the index underlying the call option ranges from 38% below to 32% above its current value, and the index underlying the put option ranges from 34% below to 36% above its current value. In the scenarios in the center column of the table, the main index will remain at its current value, while the index underlying the call option will be 3% lower than currently and the index underlying the put option will be 1% higher than currently.
Note that for short option positions, the direction of the adjustment to account for correlation will be opposite to that of a long option position. Thus, if the insurer had sold the call and put options instead of purchasing them, the index underlying the call would range from 32% below to 38% above its current value in the scenario table, and the index underlying the put would range from 36% below to 34% above its current value.
Real estate market risk is the risk of economic loss due to changes in the amount and timing of cash flows from investment property, and holdings of other property, plant and equipment.
The capital requirements for investment property that is leased, or holdings of property, plant and equipment that are leased, are determined in the same manner as the requirements for assets that are owned. The balance sheet value used for leased assets is the associated balance sheet value of the right of use asset, determined in accordance with relevant accounting standards.
The carrying amount of investment property is divided into two components: leases in force and the residual value of the property. For leases in force, required capital is calculated for interest rate risk (section 5.1) and for credit risk (section 18.104.22.168). The exposure amount used to determine the credit risk requirement is the present value of the contractual lease cash flows, including projected reimbursements for operating expenses paid by the lessor, discounted using the Initial Scenario Discount Rates specified in section 5.1.1. The residual value of the investment property is defined as its balance sheet value at the reporting date minus the present value of the fixed cash flows that are contractually expected to be received as determined in section 22.214.171.124, including prepaid rent cash flows. Required capital for the residual value of the property is calculated by applying a factor of 30% to this value.
For owner-occupied propertyFootnote 9, required capital is calculated as the difference, if positive, between either:
and 70% of the property's fair value at the reporting date.
For all other property not having contractually guaranteed cash flows, including oil and gas properties, timberland, and agricultural properties, required capital is calculated as the difference, if positive, between the balance sheet value at the reporting date, and 70% of the property's fair value at the reporting date.
If the fair value of any property is not available then required capital is 30% of the property's balance sheet value. Required capital is determined on a property-by-property basis.
The capital charge for plant and equipment is 30% of the balance sheet value.
The factor for investments in unleveraged mutual fundsFootnote 10, exchange traded funds, segregated funds and real estate investment trusts is a weighted average of the market and credit risk factors for the assets that the fund is permitted to invest in. The weights and factors are calculated assuming that the fund first invests in the asset class attracting the highest capital requirement, to the maximum extent permitted in its prospectus or Annual Information Form (where more current). It is then assumed that the fund continues allocating investments to asset classes in declining order of capital charge, to the maximum extent permitted, until a total allocation of 100% is reached. The factor for the mutual fund is then the sum of the products of the weights and risk factors for the assumed investment allocation.
In the absence of specific limits to asset classes or if the fund is in violation of the limits stated in the prospectus, the entire fund is subject to the highest risk charge applicable to any security that the fund holds or is permitted to invest in.
Funds that employ leverageFootnote 11 are treated as equity investments, and receive the equity risk factor corresponding to the fund under section 5.2.1.
The credit risk factors in section 3.1 and market risk charges in sections 5.2 to 5.4 do not apply to assets backing index-linked products. All assets backing index-linked products must be segmented and included in the index-linked reporting form, and receive factors based on the historical correlation between weekly asset and liability returns in section 5.5.2.
The correlation factor calculation may be used for index-linked products, such as universal life policies, having the following characteristics:
The following conditions must be adhered to:
The factor F applicable to a particular subgroup of assets is given by:
F = 20 x (C - B + B x √ 2 - 2A)
Note that a factor should be calculated for each asset subgroup.
The historical correlations and standard deviations should be calculated on a weekly basis, covering the previous 52-week period. The returns on asset subgroups should be measured as the increase in their market values net of policyholder cash flows.
The factor F for the previous 52 weeks is required to be calculated each quarter. The charge is then equal to the highest of the four factors calculated over the previous four quarters. This factor is applied to the fair value at quarter-end of the assets in the asset subgroup.
Instead of using policyholder funds in the calculations, an insurer may use cash surrender values or policy liabilities to measure the correlation. The basis used must be consistently applied in all periods.
Credit and market risk factors should be applied to:
As a simplification, insurers may choose to apply the common equity risk factor from section 5.2.1 corresponding to the assets listed above.
When a synthetic index investment strategy is used, there is some credit risk that is not borne directly by policyholders. This may include credit risk associated with fixed income securities and counterparty risk associated with derivatives that are purchased under the synthetic strategy. Insurers should hold credit risk required capital for these risks in addition to the index-linked requirements of this section.
For index-linked insurance policies that have a minimum death benefit guarantee, the requirement for segregated fund mortality guarantees should be applied. This requirement may be obtained using the methodology described in Chapter 7.
Currency risk is the risk of economic loss due to changes in the amount and timing of cash flows arising from changes in currency exchange rates. Three steps are required to calculate required capital for currency risk. The first is to measure the exposure in each currency position. The second is to calculate the required capital for the portfolio of positions in different currencies, which is 30% of the greater of the sum of (i) the net open long positions or (ii) the net open short positions in each currency, plus the net open position in gold, whatever the signFootnote 12. A charge is then added for currency volatility, if applicable. The final step allocates the total currency risk requirement to participating and non-participating blocks in each geographic region.
The net open position for each individual currency (and gold) is calculated by summing:
Example: Currency Risk Offset
Suppose that a life insurer has the following asset and liability positions:
The offset is defined as a short position of up to 120% of the solvency buffer in each currency. In this example, the USD solvency buffer is 37.50, so the maximum permitted offset is 120% x 37.50 = 45 for the USD exposure. A 10 offset for the EUR position is used (100% of $10) to reduce the net EUR exposure to zero. The GBP exposure is negative (short position), so no offset is calculated, as any offset would increase the GBP short position. For other currencies, the maximum permitted offset is 120% x 15 = 18. Note that any percentage, up to 120%, may be used by the insurer to produce the lowest net exposure in each currency:
The following structural positions and related hedges are excluded from the calculation of net open currency positions:
If an insurer has purchased or sold options on a foreign currency, it should perform the scenario table calculation described in section 126.96.36.199, where the changes in value measured are those of the net open position in the currency and the options combined, and where the range of values used for the currency in the table is 30% above and below its current value instead of 35%. The magnitude of the net open position in the currency after adjusting for options is then equal to 3.33 times the largest decline in value that occurs in the middle row of the table. If this decline occurs in a column where the value of the currency decreases then the position is treated as a long position, and if the decline occurs in a column where the value of the currency increases then the position is treated as a short position.
If the largest decline in the entire scenario table is greater than the largest decline in the middle row, then the difference represents the required capital for volatility in the foreign currency, and this amount is added to the capital requirement for currency risk.
Currency risk is assessed on a consolidated basis. It may be technically impractical in the case of immaterial operations to include some currency positions. In such cases, the internal limit in each currency may be used as a proxy for the positions, provided there is adequate ex post monitoring of actual positions complying with such limits. In these circumstances, the limits are added, regardless of sign, to the net open position in each currency.
Forward currency positions are valued at current spot market exchange rates. It is not appropriate to use forward exchange rates since they partly reflect current interest rate differentials. Insurers that base their normal management accounting on net present values are expected to use the net present values of each position, discounted using current interest rates and translated at current spot rates, for measuring their forward currency and gold positions.
Accrued interest, accrued income and accrued expenses are treated as a position if they are subject to currency fluctuations. Unearned but expected future interest, income or expenses may be included, provided the amounts are certain and have been fully hedged by forward foreign exchange contracts. Insurers should be consistent in their treatment of unearned interest, income and expenses and should have written policies covering the treatment. The selection of positions that are only beneficial to reducing the overall position is not permitted.
The nominal amount (or net present value) of the net open position in each foreign currency (and gold) is converted at spot rates into Canadian dollars. Required capital is 30% of the overall net open position, calculated as the sum of:
Required capital is increased by the total of the volatility risk charges for each foreign currency, if any, to arrive at the final required capital.
Example: Currency Risk Requirement for a Portfolio
An insurer has the following net currency positions. These open positions have been converted at spot rates into Canadian dollars, where (+) signifies an asset position and (-) signifies a liability position.
In this example, the insurer has three currencies in which it has long positions, these being the Japanese Yen, the Euro and the British Pound, and two currencies in which it has a short position, the Swiss Franc and the United States Dollar. The middle line of the above chart shows the net open positions in each of the currencies. The sum of the long positions is +300 and the sum of the short positions is -200.
The foreign exchange requirement is calculated using the higher of the summed absolute values of either the net long or short positions, and the absolute value for the position in gold. The factor used is 30%. In this example, the total long position (300) would be added to the gold position (35) to give an aggregate position of 335. The aggregated amount multiplied by 30% results in a capital charge of $100.50.
After the total currency risk solvency buffer has been calculated in aggregate, it is allocated by geographic region in proportion to the contribution of the region's net long currency positions or net short currency positions (whichever is used to determine the capital requirement) to the aggregate currency risk solvency buffer. Within a geographic region, the buffer is allocated between par and non-par blocks in proportion to the share of the liabilities in the region.
Example: Allocation of the Aggregate Currency Risk Solvency Buffer
Continuing the example from the previous section, the total capital requirement of $100.50 is allocated to Japan, Europe other than the United Kingdom, and the United Kingdom as follows:
Japan: 50 / 300 × $100.50 = $16.75
Europe other than the United Kingdom: 100 / 300 × $100.50 = $33.50
United Kingdom: 150 / 300 × $100.50 = $50.25
Since the aggregate requirement is determined from the long positions rather than the short positions, the short position in CHF does not lead to any additional allocation to Europe other than the United Kingdom, and none of the requirement is allocated to the United States.
If the United Kingdom has two participating blocks and a non-participating block for which liabilities are the following:
Participating block 1: 300
Participating block 2: 400
then, of the requirement of $50.25 allocated to the United Kingdom, $26.80 is allocated to the non-participating block, $10.05 is allocated to the first participating block, and $13.40 is allocated to the second participating block.
A separate component calculation should be performed for each group of liabilities that is backed by a distinct pool of assets under unregistered reinsurance arrangements. The defining characteristic of a pool is that any asset in the pool is available to pay any of the corresponding liabilities. Each calculation should take into consideration the ceded liabilities and the assets supporting the credit available under section 10.4.1, including any excess deposits. If some of the assets supporting the ceded liabilities are held by the ceding insurer (e.g. funds withheld coinsurance), the insurer's corresponding liability should be treated as an asset in the calculation of the open positions for the ceded business. If the ceded liabilities are payable to policyholders in a foreign currency, this currency should be used as the base currency in the component calculation (the Canadian Dollar is then treated as a foreign currency).
The currency risk requirement for each group of ceded liabilities is added to the insurer’s own requirement, without netting open positions between ceded business and the insurer’s retained business, or between different groups of ceded business.
An insurer doing negligible business in foreign currency, and that does not take foreign exchange positions within its own investment portfolio, may be exempted from the requirement for currency risk provided that:
Appendix 5-A Rating Mappings
(Chapter 3) Assets that have been specifically designated as supporting a composite subsidiary’s life insurance liabilities under CALM are subject to the asset risk requirements of the LICAT Guideline. The capital requirements for all other assets in the subsidiary are determined using either the LICAT or the MCT Guideline exclusively, depending on whether the subsidiary has a larger insurance risk capital requirement for life business under LICAT, or for P&C business under MCT. An insurer should use the same guideline from year to year until the relative portion of that guideline’s insurance risk requirement falls below 40%. The capital requirements for assets, based on either the LICAT or the MCT Guideline, are included within A in the calculation of the diversified risk requirement (q.v. section 11.2.2). Asset risk requirements based on MCT are at the MCT target level, and are not divided by 1.5.
Return to footnote 3
A “reliable” index provider would, at a minimum, construct benchmarks that (1) use a transparent and objective process (2) are an accurate representation of the target market segment and (3) use a rebalancing approach that reflects market changes in a timely and orderly fashion.
Return to footnote 1
“Par” in this context refers to yields for securities priced at par with the relevant maturities, and not to participating business.
Return to footnote 2
An approximation may be used under section 1.4.5.
If the gross interest rate risk requirement for a participating block is positive under the most adverse scenario, an insurer may optionally choose to treat the block as non-participating under this scenario. If the insurer does so then:
The gross interest rate risk requirement for the participating block (without any reduction for dividends) is added to the gross interest rate risk requirement for non-participating business before the non-participating requirement is floored at zero, and
The interest rate risk requirement for the participating block used in the calculation of the standalone requirement and participating credit for the block is set to zero.
Return to footnote 4
Liabilities corresponding to business ceded under funds withheld arrangements are excluded from liability cash flows, but liabilities due to reinsurers under funds withheld arrangements are included in liability cash flows. If business ceded under a modified coinsurance arrangement effectively transfers interest rate risk on an insurance liability and a pool of supporting assets to the reinsurer, both the liability and asset cash flows should be excluded from projected cash flows.
Return to footnote 5
For hedged equity positions receiving credit under section 5.2.4, the delta equivalent value of the hedged position should be used as the investment value.
Return to footnote 6
As defined in Section 10 of the Insurance Companies Act.
Return to footnote 7
Insurers should demonstrate an understanding of the details of the valuation model used to construct the scenario matrix, and should objectively review and test the model on an ongoing basis, to the satisfaction of OSFI. Market prices, volatilities and other inputs to the valuation model must be subject to review by an objective and qualified person that is not close to or otherwise involved in the transactions or have related decision making authority. An insurer that does not apply the matrix method to the satisfaction of the Superintendent is required to deduct 100% of the carrying amount of the purchased option from its Tier 1 Available Capital.
Return to footnote 8
If an insurer is leasing a portion of owner-occupied property to an external party, it may treat the lease in the same manner as a lease in force on an investment property.
Return to footnote 9
If an insurer’s balance sheet includes an unleveraged mutual fund entity reported on a consolidated basis and the investment in the entity is not deducted from Available Capital, the requirements of this section apply to the portion of the fund whose returns are retained for the insurer’s own account. The requirements of this section do not apply to the portion of the fund for which the insurer can demonstrate, to the satisfaction of the Superintendent, that: (1) the mutual fund units are owned by policyholders or outside investors; (2) the insurer has a contractual obligation to pass through all returns; and (3) the insurer tracks and distinguishes these units from the units held for its own account. The portion of the fund not subject to the requirements of this section is instead subject to the requirements for index-linked products in section 5.5.
Return to footnote 10
Leveraged funds are those that issue debt/preferred shares, or that use financial derivatives to amplify returns. Funds that employ an insignificant amount of leverage for operational purposes, in a manner not intended to amplify returns may be excluded from this definition.
Return to footnote 11
Gold is treated as a foreign exchange position rather than a commodity because its volatility is more in line with foreign currencies.
Return to footnote 12
Liabilities corresponding to business ceded under funds withheld arrangements are excluded, but liabilities due to reinsurers under funds withheld arrangements are included.
Return to footnote 13