Office of the Superintendent of Financial Institutions
Subsection 515(1) of the Insurance Companies Act (ICA) requires Federally Regulated Property and Casualty Insurance Companies (property and casualty companies) to maintain adequate capital. Under the provisions of the ICA, mortgage insurance companies (insurers) are considered to be property and casualty companies. The Mortgage Insurer Capital Adequacy Test (MICAT) Guideline is not made pursuant to subsections 515(2) of the ICA. However, the minimum and supervisory target capital standards set out in this guideline provide the framework within which the Superintendent assesses whether an insurer maintains adequate capital pursuant to subsection 515(1). Notwithstanding that an insurer may meet these standards, the Superintendent may direct the insurer to increase its capital under subsection 515(3).
This guideline outlines the capital framework, using a risk-based formula, for target and minimum capital required, and defines the capital that is available to meet the minimum standard. The MICAT determines the minimum capital required and not the level of capital required at which insurers must operate.
The Mortgage Insurer Capital Adequacy Test (MICAT) Guideline applies to Canadian mortgage insurance companies (insurers).
This chapter provides an overview of the MICAT Guideline, sets out general requirements, and specifies the transitional arrangements for insurance and operational risks. More detailed information on specific components of the capital test is contained under subsequent chapters.
Further guidance concerning some of the requirements of the MICAT Guideline may be found in other guidelines and advisories available on OSFI's website.
Insurers' capital requirements are set at a supervisory target level that, based on expert judgment, aims to align with a conditional tail expectation (CTE) of 99% over a one-year time horizon including a terminal provision.
The formulas and risk factors defined in this guideline are used to compute capital requirements at the supervisory target level. The capital requirements at the supervisory target level are divided by 1.5 to derive the minimum capital requirements. The capital ratio is expressed as the capital available over the minimum capital required.
Insurers are required to meet the MICAT capital requirements at all times. The definition of capital available to be used for this purpose is described in chapter 2 and includes qualifying criteria for capital instruments, capital composition limits, and regulatory adjustments and deductions. The definition encompasses capital available within all subsidiaries that are consolidated for the purpose of calculating the capital ratio.
Insurers' minimum capital requirements are calculated on a consolidated basis and determined as the sum of the capital requirements at the supervisory target level for each risk component, divided by 1.5.
The capital requirements at the supervisory target level are calculated as follows:
The capital adequacy requirements apply on a consolidated basis. The consolidated entity includes the insurer and all of its directly or indirectly held subsidiaries, which carry on business that the parent could carry on directly in accordance with the Insurance Companies Act (ICA), including holding companies. It therefore excludes:
Whether a subsidiary should be consolidated is determined by the nature of the subsidiary's business (i.e. whether it carries on business related to mortgage insurance), not the location where the subsidiary conducts its business. All other interests in subsidiaries are considered "non-qualifying" for capital purposes and are excluded from capital available and capital required calculations.
The MICAT is a standardized measure of capital adequacy of an insurer. It is one of several indicators that OSFI uses to assess an insurer's financial condition and should not be used in isolation for ranking and rating insurers.
The MICAT ratio is expressed as a percentage and is calculated by dividing the insurer's capital available by minimum capital required, which is derived from capital required calculated at the target level for specific risks.
Federally regulated insurers are required, at a minimum, to maintain a MICAT ratio of 100%. OSFI has established an industry-wide supervisory target capital ratio (supervisory target) of 150% that provides a cushion above the minimum requirement and facilitates OSFI's early intervention process. The supervisory target provides additional capacity to absorb unexpected losses and addresses capital needs through on-going market access.
OSFI expects each insurer to establish an internal target capital ratio (internal target) per Guideline A-4 Regulatory Capital and Internal Capital Targets, and maintain on-going capital, above this target. However, the Superintendent may, on a case-by-case basis, establish an alternative supervisory target (in consultation with an insurer) based upon the insurer's individual risk profile.
Insurers are required to inform OSFI immediately if they anticipate falling below their internal target and to lay out their plans, for OSFI's supervisory approval, to return to their internal target. OSFI will consider any unusual conditions in the market environment when evaluating insurers' performance against their internal targets.
Insurers are expected to maintain their MICAT ratios at or above their established internal targets on a continuous basis. Questions about an individual insurer's target ratio should be addressed to the Lead Supervisor at OSFI.
Insurers are required to engage their auditor appointed pursuant to section 337 of the ICA to report annually on the MICAT prepared as at fiscal year-end, in accordance with the relevant standards for such assurance engagements, as promulgated by the Canadian Auditing and Assurance Standards Board (AASB).
The annual audit report of the MICAT must be prepared separately from the audit report for the financial statements, and is to be filed no later than 90 days after the insurers' fiscal year-end. The annual audit opinion provided must be with respect to the current fiscal year-end, for page 10.10 of the insurers' quarterly return.
The capital required for premium liabilities associated with residential exposures is determined using the formula for required capital stated in chapter 3, subsection 3.1.1 in the following way.
The total of premium liabilities and capital, T, is equal to the sum of:
Insurers should continue to phase-in the impact that the insurance risk requirements of the 2017 capital advisoryFootnote 2 (Advisory) had on their capital requirements for operational risk as at December 31, 2016. The phase-in of the original amount will continue in 2019 on a straight-line basis, over the remaining four quarters of the original twelve-quarter phase-in period.
The phase-in capital required for operational risk is determined using the following formula:
Phased-in Capital Required for operational risk = Capital Required for operational risk under this guideline - n/12 x (Capital Required for operational risk under the Advisory at December 31, 2016 – Capital Required for operational risk as filed with OSFI for regulatory compliance purposes as at December 31, 2016)
Where n declines from 11 in the first quarter 2017 to 0 in the fourth quarter 2019.
This chapter establishes requirements for the adequacy and appropriateness of capital resources used to meet capital requirements, having regard to their ability to meet insurers' obligations to policyholders and creditors and to absorb losses in periods of stress. This includes the determination of the criteria for assessing the quality of capital components for inclusion in capital available and the composition of capital available for regulatory purposes, focussing on the predominance of highest quality capital.
The four primary considerations for defining the capital available of a company for the purpose of measuring capital adequacy are:
Regulatory capital available will consist of the sum of the following components: common equity or category A capital, category B capital, and category C capital.
Retained earnings and accumulated other comprehensive income include interim profit or loss. Dividends are removed from capital available in accordance with applicable accounting standards.
For an instrument to be included in capital available under category A, it must meet all of the following criteria:
For an instrument to be included in capital available under category B, it must meet all of the following criteria:
Purchase for cancellation of Category B capital instruments is permitted at any time with the prior approval of the Superintendent. For further clarity, a purchase for cancellation does not constitute a call option as described in the above Category B qualifying criteria.
Tax and regulatory event calls are permitted during an instrument's life subject to the prior approval of the Superintendent and provided the insurer was not in a position to anticipate such an event at the time of issuance.
Dividend stopper arrangements that stop payments on common shares or Category B instruments are permissible provided the stopper does not impede the full discretion the insurer must have at all times to cancel distributions or dividends on the Category B instrument, nor must it act in a way that could hinder the recapitalization of the institution pursuant to criterion number 13 above. For example, it would not be permitted for a stopper on a Category B instrument to:
A dividend stopper may also act to prohibit actions that are equivalent to the payment of a dividend, such as the insurer undertaking discretionary share buybacks.
Where an amendment or variance of a Category B instrument's terms and conditions affects its recognition as regulatory capital, such amendment or variance will only be permitted with the prior approval of the Superintendent.Footnote 13
Insurers are permitted to "re-open" offerings of capital instruments to increase the principal amount of the original issuance provided that call options will only be exercised, with the prior approval of the Superintendent, on or after the fifth anniversary of the closing date of the latest re-opened tranche of securities.
Defeasance options may only be exercised on or after the fifth anniversary of the closing date with the prior approval of the Superintendent.
For an instrument to be included in capital available under category C, it must meet all of the following criteria:
Category C capital instruments must not contain restrictive covenants or default clauses that would allow the holder to trigger acceleration of repayment in circumstances other than the insolvency, bankruptcy or winding-up of the issuer.
Purchase for cancellation of category C instruments is permitted at any time with the prior approval of the Superintendent. For further clarity, a purchase for cancellation does not constitute a call option as described in the above Category C criteria.
Where an amendment or variance of a Category C instrument's terms and conditions affects its recognition as regulatory capital, such amendment or variance will only be permitted with the prior approval of the SuperintendentFootnote 18.
Institutions are permitted to "re-open" offerings of capital instruments to increase the principal amount of the original issuance provided that call options will only be exercised, with the prior approval of the Superintendent, on or after the fifth anniversary of the closing date of the latest re-opened tranche of securities.
Category C capital instruments are subject to straight-line amortization in the final five years prior to maturity. Hence, as these instruments approach maturity, redemption or retraction, such outstanding balances are to be amortized based on the following schedule:
For instruments issued prior to January 1, 2015, where the terms of the instrument include a redemption option that is not subject to prior approval of the Superintendent and/or holders' retraction rights, amortization should begin five years prior to the effective dates governing such options. For example, a 20-year debenture that can be redeemed at the insurer's option at any time on or after the first 10 years would be subject to amortization commencing in year 5. Further, where a subordinated debt was redeemable at the insurer`s option at any time without the prior approval of the Superintendent, the instrument would be subject to amortization from the date of issuance. For greater certainty, this would not apply when redemption requires the Superintendent's approval as is required for all instruments issued pursuant to the above criteria in section 184.108.40.206.
Amortization should be computed at the end of each fiscal quarter based on the "years to maturity" schedule above. Thus, amortization would begin during the first quarter that ends within five calendar years to maturity. For example, if an instrument matures on October 15, 2020, 20% amortization of the issue would occur on October 16, 2015 and be reflected in the December 31, 2015 regulatory return. An additional 20% amortization would be reflected in each subsequent December 31 return.
Insurers are permitted to include, in capital available, non-controlling interests in operating consolidated subsidiaries, provided:
If a subsidiary issues capital instruments for the funding of the insurer, or that are substantially in excess of its own requirements, the terms and conditions of the issue, as well as the intercompany transfer, must ensure that investors are placed in the same position as if the instrument were issued by the insurer directly in order for it to qualify as capital available upon consolidation. This can only be achieved by the subsidiary using the proceeds of the issue to purchase a similar instrument from the parent. Since subsidiaries cannot buy shares of the parent insurance company, it is likely that this treatment will only be applicable to the subordinated debt. In addition, to qualify as capital for the consolidated entity, the debt held by third parties cannot effectively be secured by other assets, such as cash, held by the subsidiary.
The inclusion of capital instruments qualifying under category B and category C criteria is subject to the following limits:
Category B and category C capital exceeding the allowable limits will be subject to the following treatment for regulatory capital purposes:
Items that are deducted from capital available will be subject to a 0% risk factor for capital required purposes.
Adjustments to owner-occupied property valuationsFootnote 22 :
The equity method of accounting is used for all interests in non-qualifying subsidiaries, associates and joint venturesFootnote 23. These interests remain unconsolidated for MICAT purposes.
The financial statements of the subsidiaries are fully consolidated and the net value is included in the parent's capital available. The assets and liabilities of these subsidiaries are therefore subject to risk factors and liability margins in the parent's MICAT.
Interests in non-qualifying subsidiaries are excluded from capital available. Loans or other forms of lending provided to a non-qualifying subsidiary, if they are reported as equity on the financial statements of the non-qualifying subsidiary, are also excluded from capital available of the insurer. Loans or other forms of lending provided to a non-qualifying subsidiary that are not reported as equity are subject to a risk factor of 45%. Receivables from non-qualifying subsidiaries will attract a risk factor of 5% or 10% depending on how long the balances are outstanding (reference section 4.1).
An enterprise is an associate of another enterprise if:
Interests in associates are excluded from capital available. Loans or other forms of lending provided to associates, if they are reported as equity in the financial statements of the associates, are also excluded from capital available of the insurer. Loans or other forms of lending provided to associates that are not reported as equity are subject to a risk factor of 45%. Receivables from associates will attract a risk factor of 5% or 10% depending on how long the balances are outstanding (reference section 4.1).
Where an insurer holds less than or equal to 10% ownership in a joint venture, the investment is included in capital available. The investment is reported under capital required for equity risk, and is subject to the risk factor applicable to investments in common shares (reference section 5.3).
Interests in joint ventures with more than 10% ownership are excluded from capital available. Loans or other forms of lending provided to a joint venture with more than a 10% ownership interest, if they are reported as equity on the financial statements of the joint venture with more than a 10% ownership interest, are also excluded from capital available of the insurer. Loans or other forms of lending provided to a joint venture with more than a 10% ownership interest that are not reported as equity are subject to a risk factor of 45%. Receivables from joint ventures with more than a 10% ownership interest will attract a risk factor of 5% or 10% depending on how long the balances are outstanding (reference section 4.1).
Where companies participate in an intra-group investment arrangement, and the arrangement has been approved by OSFI pursuant to the requirements of the ICA, companies are not required to deduct from capital available their ownership interest. A "look-through" approach should be used for intra-group investments, similar to that for mutual funds (reference section 4.1).
Types of exposures an insurer might have with non-qualifying subsidiaries, associates, and joint ventures:
Common or preferred shares (non-qualifying subsidiaries and associates) including share of accumulated earnings/losses less dividends received based on equity accounting
Excluded from capital available
Ownership interests > 10% joint venture
Ownership interests ≤ 10% joint venture
Included in capital available with a risk factor of 30% applied to the ownership interest
Loans or other forms of lending (bonds, debentures, mortgages, etc.) reported as equity
Loans or other forms of lending (bonds, debentures, mortgages, etc.) not reported as equity
Included in capital available with a risk factor of 45%
Included in capital available with a risk factor of 5% or 10% depending on how long the balances are outstanding
Appendix 2-A: Information Requirements for Capital Confirmations
Given the potential impact of the disqualification of a capital instrument, insurers are encouraged to seek confirmations of capital quality from OSFI prior to issuing instrumentsFootnote 24. In conjunction with such requests, the insurer is expected to provide the following information to the Capital Division:
Insurance risk is the risk that the provisions that an insurer holds to cover its obligations under the insurance contracts it has written are insufficient under a severe but plausible scenario.
The capital requirement for insurance risk consists of:
For the purposes of this Guideline, a residential mortgage is a mortgage on a property that is designed for occupancy by not more than four family units or is a single-family unit of a condominium. A mortgage that is not considered to be a residential mortgage according to this definition will be referred to as a commercial mortgage.
Section 3.1 describes the calculation of the capital requirement for residential exposures while section 3.2 describes the calculation for commercial exposures. Section 3.3 describes the calculation of the additional policy provision. For residential exposures, the additional policy provision is an allocation of the requirement determined in section 3.1; for commercial exposures, it is an amount that is held in addition to the requirement determined in section 3.2.
Premium liabilities are the liabilities that an insurer holds to cover future losses, i.e., losses associated with defaults that occur after the reporting date.
The capital required for premium liabilities associated with residential exposures is defined as
max(T - L,F)
220.127.116.11. Total requirement
The total amount T required for residential exposures is the sum of the total amounts required for individual residential mortgages, whether insured individually or as part of a portfolio, that are in-force as of the reporting date and for which there is no claim outstandingFootnote 28. The total amount required for an individual mortgage loan is the sum of the base total requirement for the mortgage loan and, if applicable, a supplementary capital requirement.
The formula for calculating the base total requirement for an individual mortgage loan is provided in subsection 18.104.22.168. The formula for calculating the supplementary capital requirement is provided in subsection 22.214.171.124. The following data inputs are used in the calculation of the base total requirement and the supplementary capital requirement for an individual mortgage loan:
126.96.36.199. Base total requirement for an individual mortgage loan
The base total requirement for an individual mortgage loan that is in-force on the reporting date and for which there is no claim outstanding is determined by the formula
TB = αB + βB × outstanding loan balance
where the outstanding loan balance is the loan balance as of the reporting date in units of $100,000 and
αB = 1.05 × m × A
βB = 1.05 × m × B
where m is the adjustment factor for credit quality defined in subsection 188.8.131.52, and where the quantities A and B are defined as follows.
i) Formula for A
where LTV represents the loan-to-value ratioFootnote 29 for the mortgage loan as defined in subsection 184.108.40.206 and μ1, μ2, σ1, σ2, C1, C2 are defined as follows:
If the remaining term of insurance for the mortgage loan as of the reporting date is five years or less then
where T* represents the remaining amortization for the mortgage loan as of the reporting date and is measured in yearsFootnote 30.
ii) Formula for B
where LTV represents the loan-to-value ratio for the mortgage loan as defined in subsection 220.127.116.11 and in this case μ1, μ2, σ1, σ2, C1, C2 are defined as follows:
where T* represents remaining amortization for the mortgage loan as of the reporting date and is measured in years.
18.104.22.168. Supplementary capital requirement for an individual mortgage loan
If a mortgage loan originated after December 31, 2016 corresponds to a property that is located in one of the 11 metropolitan areas listed in Appendix 3-A and if the value of the supplementary capital requirement indicator (SCRI) for this metropolitan area is greater than the threshold value for this metropolitan area then a supplementary capital requirement must be determined for this mortgage loan and added to the base total requirement for this mortgage loan to determine the total amount for this loan.
The calculation of the SCRI is described in Appendix 3-A.
If a supplementary capital requirement must be determined for a particular mortgage loan, it is calculated using the following formula:
S = r × TB
where TB is as defined in subsection 22.214.171.124 and where the quantity r is defined as follows.
r = a + b × exp(-0.1·T*)
where a and b are defined as follows:
Note that for a given mortgage loan, LTV and T* have the same values as in the calculation of the base total requirement in subsection 126.96.36.199.
188.8.131.52. Adjustment factor for credit quality of an individual mortgage loan
The adjustment factor for credit quality, m, used in the formulas for αB and βB to determine the base total requirement for an individual mortgage loan depends on the credit score(s) of the borrower(s) associated with the mortgage loan as of origination.
The credit score used to determine the value of m for a particular mortgage loan should come from a reputable credit bureau and should also be used as part of the insurer’s business and risk management processes. It should not be acquired for the sole purpose of determining regulatory capital requirements.
In cases where an insurer obtains credit scores from more than one credit bureau, the insurer should select the bureau whose scores the insurer primarily uses in the management of its business, and use the scores of this credit bureau consistently for all mortgage loans and from one reporting period to the next. The only exception is if there is no credit score available for a particular mortgage loan from the credit bureau whose scores the insurer primarily uses to manage its business; in this situation, the insurer may use the credit score from another reputable credit bureau until such time that a credit score becomes available from the bureau whose scores the insurer primarily uses.
For mortgage loans with more than one borrower, the credit score used to determine the value of m is the maximum of the credit scores of the individual borrowers. In cases where the credit scores of the individual borrowers are from different credit bureaus, the maximum is calculated using only the credit scores from the bureau whose scores the insurer primarily uses to manage its business. In cases where none of the credit scores of the individual borrowers is from the credit bureau whose scores the insurer primarily uses to manage its business, the maximum is calculated using the available scores.
The value assigned to the adjustment factor for credit quality, m, for an individual mortgage loan is given by the following table:
The value assigned to the adjustment factor for credit quality, m, of a mortgage loan with no credit score is 1.3 unless more than 5% of an insurer’s mortgage loans considered residential exposures have no credit score, in which case the value assigned to the adjustment factor for credit quality, m, of a mortgage loan with no credit score is 3.0.
184.108.40.206. Loan-to-value ratio for an individual mortgage loan
This subsection describes the calculation of the LTV input for the formulas given in subsections 220.127.116.11 and 18.104.22.168. Note that if the value of LTV determined in this subsection is greater than 100% then an LTV input of 100% should be used in the formulas in subsections 22.214.171.124 and 126.96.36.199.
The value of the LTV input for the formulas in subsections 188.8.131.52 and 184.108.40.206 depends on the origination date of the mortgage.
i) Mortgages originated after December 31, 2015
For mortgages originated after December 31, 2015, the LTV input is calculated by dividing the outstanding loan balance on the reporting date by the property value on the origination date or the date of the most recent appraisal, provided that the appraisal was commissioned by an independent third party entity other than an insurer.
ii) Mortgages originated after December 31, 2004 but on or before December 31, 2015
For mortgages originated after December 31, 2004 but on or before December 31, 2015, the LTV input is calculated by dividing the outstanding loan balance on the reporting date by the property value that is determined as follows.
1. If the property is located in one of the 11 Census Metropolitan Areas specified in Appendix 3-A and defined by Statistics Canada then the property value used to calculate the LTV input is
Property Value at Origination
Teranet index value as of December 2015
Teranet index value as of origination month and year
where “Teranet index value” refers to the value of the Teranet-National Bank House Price Index for the particular metropolitan area as of the end of the indicated month. If the property is located in one of these metropolitan areas but the mortgage was originated in December 2015 or later then the property value used to calculate the LTV input is the property value on the origination date.
2. If the property is not located in one of these metropolitan areas then the property value used to calculate the LTV input is
Property Value at Origination
Teranet composite index value as of December 2015
Teranet composite index value as of origination month and year
where “Teranet composite index value” refers to the value of the Teranet-National Bank National Composite House Price Index for the particular metropolitan area as of the end of the indicated month.
iii) Mortgages originated prior to 2005
For mortgages originated prior to 2005, the LTV input is calculated by dividing the outstanding loan balance on the reporting date by the property value that is determined as follows.
Property Value at Origination
Teranet index value as of December 2015
Teranet index value as of December 2004
where “Teranet index value” refers to the value of the Teranet-National Bank House Price Index for the particular metropolitan area as of the end of the indicated month.
Property Value at Origination
Teranet composite index value as of December 2015
Teranet composite index value as of December 2004
Claim liabilities are the liabilities that an insurer holds to cover losses that have already occurred and for which settlement is not yet complete. This includes mortgage loans that are currently delinquent or in arrears. The capital required for unpaid claims associated with residential exposures is calculated by multiplying the claim liabilities associated with residential exposures by 20%.
The capital required for premium deficiencies associated with residential exposures is calculated by multiplying the provision for premium deficiencies associated with residential exposures by 10%.
The capital required for premium liabilities associated with commercial exposures is the sum of the capital requirements for individual commercial exposures, where the sum is calculated over all commercial mortgage loans that were expected to be in-force on the reporting date based on the mortgage’s amortization schedule at the time of mortgage origination. Unlike the situation for residential exposures, an amount must be calculated and held for all commercial mortgages that were expected to be in-force on the reporting date based on the mortgage’s original amortization schedule, regardless of whether the mortgage is still in-force on the reporting date.
The capital required for an individual mortgage loan is determined by the formula
220.127.116.11. Calculation of F1
The value of F1 for an individual mortgage loan depends on the number of years that have elapsed since the mortgage loan was issued and is defined by the following table.
The values for fractional ages can be determined by interpolation.
18.104.22.168. Calculation of F2
The value of F2 for an individual mortgage loan depends on whether the mortgage’s loan-to-value ratio at origination is greater or less than 80% and whether the underlying mortgage is a first or second mortgage, and is defined by the following table.
22.214.171.124. Calculation of F3
The value of F3 for an individual mortgage loan depends on the settlement option stated in the master policy and the mortgage’s loan-to-value ratio at origination.
If the maximum amount payable on an individual mortgage loan after all recoveries is 100% or more of the mortgage balance at origination then the value of F3 is as defined in the following table.
If the maximum amount payable on an individual mortgage loan after all recoveries is less than 100% of the mortgage balance at origination then the value of F3 is as defined in the following table.
If the amount payable on an individual mortgage loan is a fixed percentage of the lender’s loss net of recoveries then the value of F3 is determined by multiplying this fixed percentage by the value of F3 in the case where the maximum amount payable is 100% of the mortgage balance at origination. For example, if the master policy provides coverage for 50% of the lender’s loss net of recoveries and the loan-to-value ratio at origination is 85% then the value of F3 would be 55% (= 50% × 110%).
The capital required for unpaid claims associated with commercial exposures is calculated by multiplying the claim liabilities associated with commercial exposures by 20%.
The capital required for premium deficiencies associated with commercial exposures is calculated by multiplying the provision for premium deficiencies associated with commercial exposures by 10%.
This section describes the calculation of the additional policy provision for residential and commercial exposures.
An additional policy provision must be determined for every mortgage that was expected to be in-force on the reporting date based on the mortgage’s original amortization schedule, regardless of whether the mortgage is still in-force on the reporting date.
When calculating the capital required at the supervisory target, the total of the additional policy provisions for residential mortgages is to be deducted from the capital required for premium liabilities that is determined in section 3.1.1 and then added to the capital required for catastrophes, and the total of the additional policy provisions for commercial exposures is to be multiplied by 1.25 and simply added to the capital required for catastrophes.
The additional policy provision for an individual mortgage loan is given by the following table.
This appendix describes how insurers are to calculate the supplementary capital requirement indicators (SCRIs) for the purpose of determining whether a supplementary capital requirement is applied to a given residential mortgage loan.
The data sources necessary to calculate the SCRIs are outlined in Section 1 of this appendix. The Teranet – National Bank National Composite House Price Index (“Teranet index”)Footnote 32 is used to measure house prices and Statistics Canada household disposable income and population data are used to measure per capita income.
An SCRI is to be determined for 11 metropolitan areas in the Teranet index. For each metropolitan area, an SCRI is calculated on a quarterly basis and is determined as follows:
OSFI will review the use of the 11 metropolitan areas and may decide to expand the calculation of SCRIs outside of these 11 metropolitan areas in the future.
The SCRI for a metropolitan area is compared to a threshold value for that particular area as defined in Section 5. If the SCRI exceeds the threshold value for that metropolitan area, then supplementary capital requirements will apply at the beginning of an insurer’s next quarterly fiscal reporting period, according to the schedule presented in Section 6, for the life of the loan for newly originated mortgages in that metropolitan areaFootnote 33.
An example illustrating how to calculate SCRIs is provided in Section 7.
Insurers need to access the following data sources to calculate the SCRIs:
The SCRIs are to be determined using as of dates of March 31, June 30, September 30 and December 31. As the income data in CANSIM table 380-0072 is the last item to be released, approximately two months after the calendar quarter ends, its release date determines when the SCRIs can be calculated.
The Teranet index values are available on a monthly basis for the following 11 metropolitan areas:
The Teranet indices for the metropolitan areas as published are not seasonally adjusted. Given the seasonal nature of the housing market, the indices need to be smoothed to ensure the stability of the SCRIs. Without smoothing there is a risk that an index could exhibit short-term fluctuations above and below its threshold, which would not be a desirable outcome. Therefore, a simplified approach is used to determine the smoothed Teranet indices for use in the SCRIs; an average of the last 12 months of each Teranet Index’s monthly metropolitan area values must be calculated.
The per capita income for use in the SCRI is determined as:
Per capita income
Household disposable income
To determine the “Per capita income” on a quarterly basis, the “Population” data series must be converted from a monthly basis to a quarterly basis by calculating a three month average of the data series.
The quarterly SCRI before scaling for each metropolitan area is determined as:
SCRI before scaling
Smoothed quarter-end Teranet house price index for a metropolitan area
Per capita income
The SCRI for a metropolitan area needs to be scaled before being compared to the threshold values to determine whether the mortgages originated in that area are subject to a supplementary capital requirement. The SCRIs are determined by multiplying the ratio of the smoothed Teranet index for a metropolitan area over the per capita income by the scaling factors in the following table.
Each metropolitan area has its own threshold value that has been determined by OSFI using an algorithm that ensured consistency across metropolitan areasFootnote 34. Threshold values will remain stable over time but are subject to periodic review.
The following table shows the threshold values for each metropolitan area used to determine whether a newly originated mortgage in a given area is subject to a supplementary capital requirement. For each metropolitan area, if the calculated SCRI has breached its threshold value then effective the beginning of the next quarterly fiscal reporting period, any mortgage loan originated in that area is subject to the supplementary capital requirement for the life of the loan.
Exposures in those areas remain subject to the supplementary capital requirements until the SCRI for a metropolitan area falls below the threshold value. In this case, the supplementary capital requirement would no longer be required for mortgage loans originated in the next quarterly fiscal reporting period.
The following table provides a summary of the timing for performing the SCRI calculation and determining when the supplementary capital requirement applies.
This example illustrates how to calculate the SCRIs for Q4 2015 for the 11 metropolitan areas in the Teranet index.
Step 1: Calculation of metropolitan area smoothed Teranet indices
The following table provides the monthly Teranet values for the 11 metropolitan areas for 2015 as well as the December 2015 smoothed values (determined as the 12-month average of the January through December 2015 values).
Step 2: Calculation of per capita income
Given the following values for the data series “Household disposable income” (CANSIM table 380-0072) and “Population” data series (CANSIM table 282-0087), the per capita income for Q4 2015 is determined as follows. The average population has to be rounded to the first decimal.
Then the per capita income for Q4 2015 is:
The per capita income value has to be rounded to the first decimal.
Step 3: Calculation of metropolitan area SCRIs
Using the December 2015 smoothed Teranet values for the 11 metropolitan areas and the per capita income for Q4 2015, the SCRIS before and after scaling as at Q4 2015 are as follows. The SCRI before scaling has to be rounded to the fifth decimal, while the final SCRI has to be rounded to the second decimal.
Where for example the Calgary Q4 2015 SCRI before scaling
is determined as:
And the SCRI would be calculated as:
0.00478 × 2,500 = 11.95
As the threshold value is set at 10.0 for Calgary, had this Guideline been in effect in Q2-2016, the supplementary capital requirements would therefore have applied for the life of a mortgage loan originated in the Calgary metropolitan area during that reporting quarter.
In the context of this guideline, credit risk refers to any default risk as defined in this chapter other than the borrower default risk associated with mortgage insurance which is covered in chapter 3, Insurance Risk.
Credit risk is the risk of loss arising from a counterparty's potential inability or unwillingness to fully meet its contractual obligations due to an insurer. Exposure to this risk occurs any time funds are extended, committed, or invested through actual or implied contractual agreements. Components of credit risk include loan loss/principal risk, pre-settlement/replacement risk and settlement risk. Counterparties include issuers, debtors, borrowers, brokers, policyholders, reinsurers and guarantors.
All on- and off-balance sheet exposures are subject to a specific risk factor that either: 1) corresponds to the external credit rating of the counterparty or issuer or 2) represents a prescribed factor determined by OSFI. To determine the capital requirements for balance sheet assets, factors are applied to the balance sheet values or other specified values of these assets. To determine the capital requirements for off-balance sheet exposures, factors are applied to the exposure amounts determined according to the section 4.2. Collateral and other forms of credit risk mitigators may be used to reduce the exposure.No risk factors are applied to assets deducted from capital available (reference section 2.3). The resulting amounts are summed to arrive at the credit risk capital requirements.
In respect of invested assets, insurers must comply with OSFI's Guideline B-2 Investment Concentration Limit for Property and Casualty Insurance Companies.
For the purpose of calculating the capital requirements for credit risk, balance sheet assets should be valued at their balance sheet carrying amounts, with the following exceptions:
Many of the risk factors in this chapter depend on the external credit rating assigned to an asset or an obligor. In order to use a factor that is based on a rating, an insurer must meet all of the conditions specified in this section. For MICAT purposes, insurers may recognize credit ratings from the following rating agencies:
An insurer must choose the rating agencies it intends to rely on and then use their ratings for MICAT purposes consistently for each type of asset or obligation. Companies should not select the assessments provided by different rating agencies with the sole intent to reduce their capital requirements (i.e. "cherry picking" is not permitted).
Any rating used to determine a factor must be publicly available, i.e. the rating must be published in an accessible form and included in the rating agency's transition matrix. Ratings that are made available only to the parties to a transaction do not satisfy this requirement.
If an insurer is relying on multiple rating agencies and there is only one assessment for a particular asset or obligor, that assessment should be used to determine the capital requirements. If there are two assessments from the rating agencies used by an insurer and these assessments differ, the insurer should apply the risk factor corresponding to the lower of the two ratings. If there are three or more assessments for an asset or obligor from an insurer's chosen rating agencies, the insurer should exclude one of the ratings that corresponds to the lowest capital requirement, and then use the rating that corresponds to the lowest capital requirement of those that remain (i.e. the insurer should use the second-highest rating from those available, allowing for multiple occurrences of the highest rating).
Where an insurer holds a particular securities issue that carries one or more issue-specific assessments, the capital requirements for the asset or obligor will be based on these assessments. Where an insurer's asset is not an investment in a specifically rated security, the following principles apply:
The following additional conditions apply to the use of ratings:
Various risk factors are applied to invested assets depending on the external credit rating and the remaining term to maturity as outlined below.
Investments in mutual funds or other similar assets must be broken down by type of investment (bonds, preferred shares, etc.) and assigned the appropriate risk factor relating to the investment. If these investments are not reported on a prorated basis, then the factor of the riskiest asset held in the fund, is assigned to the entire investment.
Long-term obligations, including term deposits, bonds, debentures, and loans that are not eligible for a 0% risk factor attract risk factors according to the following table. Long-term obligations generally have an original term to maturity at issue of 1 year or more.
where CFt denotes the cash flows (principal, interest payments and fees) contractually payable by the borrower in period t.
Short-term obligations, including commercial paper, that are not eligible for a 0% risk factor have risk factors assigned according to the following table. Short-term obligations generally have an original term to maturity at issue of no more than 365 days.
The category of asset-backed securities encompasses all securitizations, including collateralized mortgage obligations and mortgage-backed securities, as well as other exposures that result from stratifying or tranching an underlying credit exposure. For exposures that arise as a result of asset securitization transactions, insurers should refer to Guideline B-5: Asset Securitization to determine whether there are functions provided (e.g., credit enhancement and liquidity facilities) that require capital for credit risk.
National Housing Act (NHA) mortgage-backed securities:
NHA mortgage-backed securities that are guaranteed by Canada Mortgage Housing Corporation (CMHC) receive a factor of 0% to recognize the fact that obligations incurred by CMHC are legal obligations of the Government of Canada.
Other asset-backed securities:
The capital requirements for all other asset-backed securities are based on their external ratings. In order for an insurer to use external ratings to determine a capital requirement, the insurer must comply with all of the operational requirements for the use of ratings in Guideline B-5: Asset Securitization.
For asset-backed securities (other than resecuritizations) rated BBB or higher, the capital requirement is the same as the requirement specified in subsection 126.96.36.199 for a long-term obligation having the same rating and maturity as the asset-backed security. If an asset-backed security is rated BB, an insurer may recognize the rating only if it is a third-party investor in the security. The credit risk factor for an asset-backed security (other than a resecuritization) rated BB in which a company is a third-party investor is 300% of the requirement for a long-term obligation rated BB having the same rating and maturity as the security.
The credit risk factors for short-term asset-backed securities (other than resecuritizations) rated A-3 or higher are the same as those in subsection 188.8.131.52 for short-term obligations having the same rating.
The credit risk factor for any resecuritization rated BBB or higher is 200% of the risk factor applicable to an asset-backed security having the same rating and maturity as the resecuritization.
The credit risk factor for securitization exposures classified within the highest risk category of securitization exposures in Guideline B-5: Asset Securitization, is 60%Footnote 36.
The credit risk factor for any asset-backed security that is not mentioned above (including unrated securities and any asset-backed security that is rated lower than BB) is 60%.
Risk factors for preferred shares should be assigned according to the following table:
Other risk factors for balance sheet assets:
Demand deposits, certificates of deposit, drafts, checks, acceptances and similar obligations that have an original maturity of less than three months, and that are drawn on regulated deposit-taking institutions subject to the solvency requirements of the Basel Framework.
(Note: where the maturity of the asset is longer than three months, the risk factor related to the credit rating of the regulated deposit-taking institution would apply instead.)
The capital required for off-balance sheet exposures such as structured settlements, letters of credit or non-owned deposits, derivatives and other exposures is calculated in a manner similar to on-balance sheet assets in that the credit risk exposure is multiplied by a counterparty risk factor to arrive at the capital required. However, unlike most assets, the face amount of an off-balance sheet exposure does not necessarily reflect the true credit risk exposure. To approximate this exposure, a credit equivalent amount is calculated for each exposure. This amount, net of any collateral or guarantees, is then multiplied by a credit conversion factor. For letters of credit and non-owned deposits, the credit equivalent amount is the face value. The determination of the counterparty credit risk categories and the approach for determining the eligibility of collateral and guarantees is the same as it is for other assets.
Insurers should also refer to OSFI’s Guideline B-5: Asset Securitization, which outlines the regulatory framework for asset securitization transactions, including transactions that give rise to off-balance sheet exposures.
The risk to an insurer associated with structured settlements, letters of credit, non-owned deposits, derivatives and other exposures and the amount of capital required to be held against this risk is:
The credit equivalent amount related to off-balance sheet exposures varies according to the type of instrument.
The credit equivalent amount for a "Type 1" structured settlement is the current replacement cost of the settlement, which is gross of the coverage provided by Assuris.
"Type 1" structured settlements are not recorded as liabilities on the balance sheet, and have the following characteristics:
Under this type of structured settlement arrangement, the insurer is not required to recognize a liability to the claimant, nor is it required to recognize the annuity as a financial asset. However, the insurer is exposed to some credit risk by guaranteeing the obligation of the annuity underwriter to the claimant and, consequently, must set aside additional capital.
Insurers should refer to Guideline D-5 Accounting for Structured Settlements.
The credit equivalent amount for derivatives is the positive replacement cost (obtained by "marking to market") plus an amount for potential future credit exposure (an "add-on" factor).
Derivatives include forwards, futures, swaps, purchased options, and other similar contracts. Insurers are not exposed to credit risk for the full face value of these contracts (notional principal amount); only to the potential cost of replacing the cash flow (on contracts showing a positive value) if the counterparty defaults. The credit equivalent amounts are assigned the risk factor appropriate to the counterparty in order to calculate the capital requirement.
The credit equivalent amount depends on the maturity of the contract and the volatility of the underlying instrument. It is calculated by adding:
No add-on for potential future exposure is required for credit derivatives. The credit equivalent amount for a credit derivative is equal to the greater of its replacement cost or zero.
A commitment involves an obligation (with or without a material adverse change or similar clause) of the insurer to fund its customer in the normal course of business should the customer seek to draw down the commitment. This includes:
Normally, commitments involve a written contract or agreement and a commitment fee or some other form of consideration.
The maturity of a commitment should be measured from the date when the commitment was accepted by the customer, regardless of whether the commitment is revocable or irrevocable, conditional or unconditional, until the earliest date on which:
Repurchase and reverse repurchase agreements
A securities repurchase (repo) is an agreement whereby a transferor agrees to sell securities at a specified price and repurchase the securities on a specified date and at a specified price. Since the transaction is regarded as a financing transaction for accounting purposes, the securities remain on the balance sheet. Given that these securities are temporarily assigned to another party, the factor accorded to the asset should be the higher of the factor of the security and the factor of the counterparty to the transaction (net of any eligible collateral).
A reverse repo agreement is the opposite of a repo agreement, and involves the purchase and subsequent sale of a security. Reverse repos are treated as collateralized loans, reflecting the economic reality of the transaction. The risk is therefore to be measured as an exposure to the counterparty. Where the asset temporarily acquired is a security that attracts a preferential factor, this would be recognized as collateral and the factor would be reduced accordingly.
Guarantees provided in securities lending
In securities lending, insurers can act as principal to the transaction by lending their own securities or as agent by lending securities on behalf of clients. When the insurer lends its own securities, the risk factor is the higher of:
When the insurer, acting as an agent, lends securities on behalf of a client and guarantees that the securities lent will be returned, or the insurer will reimburse the client for the current market value, the insurer should calculate the capital requirement as if it were the principal to the transaction. The capital requirements are those for an exposure to the borrower of the securities, where the exposure amount may be reduced if the insurer holds eligible collateral (reference section 4.3).
Separate credit conversion factors exist for structured settlements, letters of credit, non-owned deposits, derivatives and other exposures.
For other exposures, the weighted average of the credit conversion factors, described below, for all of these instruments held by the insurer, should be used.
Risk factors for off-balance sheet exposures are assigned a risk factor consistent with section 4.1. All criteria in section 4.1 around the use of ratings are applicable to off-balance sheet exposures.
Risk factors for structured settlements, which are considered long-term exposures, are based on the credit rating of the counterparty from which the annuity is purchased. The risk factors are as follows:
If the structured settlement is not rated by one of the four rating agencies listed in section 4.1.1, an insurer may use a credit rating from another reputable rating agency. The use of an alternative rating agency must comply with all the criteria around the use of ratings specified in section 4.1.1, including a consistent use of the same rating agency in order to assign a risk factor based on the credit rating of the annuity underwriter.
A collateralized transaction is one in which:
Recognition of collateral in reducing the capital requirement is limited to cash or securities rated A- or higher. Any collateral must be held throughout the period for which the exposure exists. Only that portion of an exposure that is covered by eligible collateral will be assigned the risk factor given to the collateral, while the uncovered portion retains the risk factor of the underlying counterparty. Only collateral securities with a lower risk factor than the underlying exposure will lead to reduced capital requirements. All criteria in section 4.1 around the use of ratings are applicable to collateral. Where a rating is not available for the collateral asset, exposure, or counterparty where applicable, no reduction in capital required is permitted.
The effects of collateral may not be double counted. Therefore, insurers may not recognize collateral on claims for which an issue-specific rating is used that already reflects that collateral.
Collateral securities used to reduce capital requirements must materially reduce the risk arising from the credit quality of the underlying exposure. In particular, collateral used may not be related party obligations of the issuer of the underlying exposure (i.e. obligations of the underlying counterparty itself, its parent, or one of its subsidiaries or associates).
Investments (principal and interest) or exposures that have been explicitly, directly, irrevocably and unconditionally guaranteed by a guarantor whose long-term issuer credit rating is A- and higher, may attract the risk factor allocated to a direct claim on the guarantor where the desired effect is to reduce the risk exposure. Thus only guaranteesFootnote 42 issued by entities with a lower risk factor than the underlying counterparty will lead to reduced capital requirements. To be eligible, guarantees must be legally enforceable.
Where the recovery of losses on a loan, financial lease agreement, security or exposure is partially guaranteed, only the part that is guaranteed is to be weighted according to the risk factor of the guarantor (see examples below). The uncovered portion retains the risk factor of the underlying counterparty.
All criteria in section 4.1 around the use of ratings remain applicable to guarantees. Where a rating is not available for the investment, exposure, or guarantor where applicable, no reduction in capital required is permitted.
An insurer may not recognize a guarantee provided by a related party (parent, subsidiary or associate) of the insurer. This treatment follows the principle that guarantees within a corporate group are not a substitute for capital.
The effects of credit protection may not be double counted. Therefore, no capital recognition is given to credit protection on claims for which an issue-specific rating is used that already reflects that protection.
To be eligible, a guarantee must cover the full term of the exposure , i.e. no recognition will be given to a guarantee if there is a maturity mismatchFootnote 43.
The following conditions must be satisfied in order for a guarantee to be recognized:
Example 4-1: Credit risk exposure.
To record a $100,000 bond rated AAA due in 10 years that has a government guarantee of 90%, the insurer would report a balance sheet value of $90,000 ($100,000 x 90%) in the 0% risk weighted category and a balance value of $10,000 ($100,000 - $90,000) in the AAA category under bonds expiring or redeemable in more than five years. The capital required in the 0% risk weighted category is $0 ($90,000 x 0.0%). The capital required in the AAA category is $125 ($10,000 x 1.25%) for a total capital requirement of $125. An example of the calculation, assuming no other assets, is provided in the chart below.
Example 4-2: Type 1 structured settlement.
To record a $300,000 Type 1 structured settlement rated BBB+ to B-, backed by collateral or a guarantee of $200,000 from a counterparty rated A- or higher, the insurer would report a credit equivalent amount of $300,000 and collateral and guarantees of negative $200,000 in the BBB+ to B- category, and collateral and guarantees of $200,000 in the A- and higher category.
The capital required in the BBB+ to B- category is $4,000 (($300,000 - $200,000) x 50% x 8%). The capital required in the A- and higher category is $500 ($200,000 x 50% x 0.5%) for a total capital requirement of $4,500. An example of the calculation, assuming no other exposures, is provided in the table below.
Market risk arises from potential changes in rates or prices in various markets such as for interest rates, foreign exchange rates, equities, real estate, and other market risk exposures. Exposure to this risk results from trading, investing, and other business activities, which create on- and off-balance sheet positions.
Investments in mutual funds or other similar assets must be broken down by type of investment (bonds, preferred shares, common shares, etc.) and assigned the appropriate risk factor relating to the investment. If these investments are not reported on a prorated basis, then the factor of the riskiest asset held in the fund is assigned to the entire investment.
Interest rate risk represents the risk of economic loss resulting from market changes in interest rates and the impact on interest rate sensitive assets and liabilities. Interest rate risk arises due to the volatility and uncertainty of future interest rates.
Assets and liabilities whose value depends on interest rates are affected. Interest rate sensitive assets include fixed income assets. Interest rate sensitive liabilities include those for which the values are determined using a discount rate.
To compute the interest rate risk margin, a duration and an interest rate shock factor are applied to the fair value of interest rate sensitive assets and liabilities. The interest rate risk margin is the difference between the change in the value of interest rate sensitive assets and the change in the value of interest rate sensitive liabilities, taking into account the change in the value of recognized interest rate derivative contracts, as appropriate.
The components used to calculate the interest rate risk margin are as follows.
The interest rate sensitive assets to be included in the calculation of the interest rate margin are those for which their fair value will change with movements in interest rates. Although certain assets, for example loans and bonds held to maturity, may be reported on the balance sheet on an amortized cost basis, their economic value, and changes in that value, are to be considered for interest rate risk margin purposes. Interest rate sensitive assets include:
Investments in mutual funds and other similar assets should be broken down by type of investment (bond, preferred share, common shares, etc.). The assets in the fund that are interest rate sensitive are to be included in the determination of the fair value of the insurer's total interest rate sensitive assets.
Other assets, such as cash, investment income due and accrued, common shares and investment properties, are not to be included in the determination of the value of interest rate sensitive assets. Such assets are assumed for interest rate risk margin determination purposes to be insensitive to movements in interest rates.
The interest rate sensitive liabilities to be included in the calculation of the interest rate risk margin are those for which their fair value will change with movements in interest rates. The following liabilities are considered sensitive to interest rates and are to be included:
Insurers must obtain OSFI's supervisory approval in order to be able to consider other liabilities in the calculation of interest rate risk margin.
Net unpaid claims and adjustment expenses, which include PfADs, are net of reinsurance, salvage and subrogation, and self-insured retentions. Net premium liabilities, which also include PfADs, are after reinsurance recoverables.
Interest rate derivatives are those for which the cash flows are dependent on future interest rates. They may be used to hedge an insurer's interest rate risk and as such may be recognized in the determination of the margin required for interest rate risk, subject to the conditions below.
Only plain-vanilla interest rate derivatives that clearly serve to offset fair value changes in a company's capital position due to changes in interest rates may be included in the interest rate risk calculation. Plain-vanilla interest rate derivative instruments are limited to the following:
Other interest rate derivatives, including interest rate options, caps and floors are not considered plain-vanilla and may not be recognized in the determination of the interest rate risk margin.
Insurers must understand the interest rate hedging strategies that they have in place and be able to demonstrate to OSFI, upon request, that the underlying hedges decrease interest rate risk exposure and that the addition of such derivatives does not result in overall increased risk. For example, insurers are expected to be able to demonstrate that they have defined the hedging objectives, the class of risk being hedged, the nature of the risk being hedged, the hedge horizon, and have considered other factors, such as the cost and liquidity of the hedging instruments. In addition, the ability to demonstrate an assessment, retrospectively or prospectively, of the performance of the hedge would be appropriate. If the insurer cannot demonstrate that the derivatives result in decreased overall risk, then additional capital may be required, and companies in this situation should contact OSFI for details.
Derivatives used for hedging an insurer's interest rate risk are subject to credit risk requirements. Refer to section 4.2 for further details.
Insurers are required to calculate the duration of the interest rate sensitive assets and liabilities for the purpose of the interest rate risk requirement calculation. The duration of an asset or a liability is a measure of the sensitivity of the value of the asset or liability to changes in interest rates. More precisely, it is the percentage change in an asset or liability value given a change in interest rates.
The calculation of duration for an asset or liability will depend on the duration measure chosen and whether the cash flows of the asset or liability are themselves dependent on interest rates. Modified durationis a duration measure in which it is assumed that interest rate changes do not change the expected cash flows. Effective duration is a duration measure in which recognition is given to the fact that interest rate changes may change the expected cash flows.
An insurer may use either modified duration or effective duration to calculate the duration of its assets and liabilities. However, the duration methodology chosen should apply to all interest rate sensitive assets and liabilities under consideration and the same methodology must be used consistently from year to year (i.e. "cherry-picking" is not permitted).
The cash flows associated with interest rate derivatives are sensitive to changes in interest rates and therefore the duration of an interest rate derivative must be determined using effective duration. In particular, if a company has interest rate derivatives on its balance sheet that lie within the scope of section 184.108.40.206, then it must use effective duration for all of its interest rate sensitive assets and liabilities.
The portfolio duration (modified or effective) can be obtained by calculating the weighted average of the duration of the assets or the liabilities in the portfolio.
The dollar duration of an asset or liability is the change in dollar value of an asset or liability for a given change in interest rates.
Modified duration is defined as the approximate percentage change in the present value of cash flows for a 100 basis point change in the annually compounded yield rate, assuming that expected cash flows do not change when interest rates change.
Modified duration can be written as:
Yield = the annually compounded yield to maturity of the cash flows,
PVCFt = the present value of the cash flow at time t discounted at the yield rate, and
the sum in the numerator is taken over all times t at which a cash flow occurs.
Effective duration is a duration measure in which recognition is given to the fact that interest rate changes may change the expected cash flows. Although modified duration will give the same estimate of the percentage fair value change for an option-free series of cash flows, the more appropriate measure for any series of cash flows with an embedded option is effective duration.
Effective duration is determined as follows:
∆y change in yield in decimal
V0 initial fair value
V- fair value if yields decline by ∆y
V+ fair value if yields increase by ∆y,
then effective duration is as follows:
The duration of a portfolio of interest rate sensitive assets or liabilities is to be determined by calculating the weighted average of the duration of the assets or liabilities in the portfolio. The weight is the proportion of the portfolio that a security comprises. Mathematically, a portfolio's duration is calculated as follows:
w1D1 + w2D2 + w3D3 + … + wkDK
wi fair value of security i/fair value of the portfolio
Di duration of security i
K number of securities in the portfolio.
Modified and effective duration are related to percentage fair value changes. The interest rate risk requirements depend on determining the adjustment to the fair value of interest rate sensitive assets and liabilities for dollar fair value changes. The dollar fair value change can be measured by multiplying duration by the dollar fair value and the number of basis points (in decimal form). In other words,
Dollar fair value change = duration x dollar fair value x interest rate change (in decimal)
Effective duration is the appropriate measure that should be used when assets or liabilities have embedded options. For portfolios with eligible plain-vanilla interest rate derivatives, insurers should be using effective dollar duration because the insurer is hedging the dollar interest rate risk exposure.
Example 5-1: Effective dollar duration of a swap
Assuming an insurer has a longer duration for its interest rate sensitive assets and a shorter duration for its interest rate sensitive liabilities, the current dollar duration position of the insurer, prior to taking into consideration any interest rate derivatives, is effectively as follows:
Insurer's dollar duration = dollar duration of assets – dollar duration of liabilities > 0
The insurer enters into a single-currency interest rate swap in which it pays fixed-rate and receives floating-rate. The dollar duration of a swap for a fixed-rate payer can be broken down as follows:
Assuming the dollar duration of the floating-rate bond is near zero, then
The dollar duration of the swap position is negative; therefore, adding the swap position reduces the company's dollar duration of assets and moves the insurer's overall dollar duration position closer to zero.
The interest rate risk margin is determined by measuring the economic impact on the insurer of a ∆y change in interest rates. The ∆y interest rate shock factor is 1.25% (∆y = 0.0125).
The foreign exchange risk margin is intended to cover the risk of loss resulting from fluctuations in currency exchange rates and is applied to the entire business activity of the insurer.
Two steps are necessary to calculate the foreign exchange risk margin. The first is to measure the exposure in each currency position. The second is to calculate the capital requirement for the portfolio of positions in different currencies.
The foreign exchange risk margin is 10% of the greater of:
where effective allowable foreign exchange rate hedges are limited to plain-vanilla foreign currency derivatives such as futures and forward foreign currency contracts and currency swaps.
Investments in mutual funds and other similar assets should be broken down by type of investment (bond, preferred share, common shares, etc.) for calculating foreign exchange risk margin. The assets in the fund that are denominated in a foreign currency are to be included in the calculation to determine the capital requirement for each currency position. In cases where a claim liability is recorded in Canadian dollars but the settlement of the claim will be made in a foreign currency, the liability must be included in the calculation of the foreign exchange risk margin.
Step 1: Measuring the exposure in a single currency
The net open position for each currency is calculated by summing:
For insurers with foreign operations, those items that are currently deducted from capital available in calculating the MICAT ratio and are denominated in the corresponding currency may be excluded from the calculation of net open currency positions, to a maximum of zero. For example:
An insurer with a net open long position in a given currency may reduce the amount of the net exposure, to a maximum of zero, by the amount of a carve-out, which is equivalent to a short position of up to 25% of the liabilities denominated in the corresponding currency.
Step 2: Calculating the capital requirement for the portfolio
The nominal amount (or net present value) of the net open position in each foreign currency calculated in step 1 is converted at a spot rate into Canadian dollars. The gross capital requirement is 10% of the overall net open position, calculated as the greater of:
An insurer has $100 of U.S. assets and $50 of U.S. liabilities.
= 25% * 50
= 10% * MAXFootnote 44 ((net spot position - carve-out), 0)
= 10% * MAX ((50 – 12.5), 0)
= 10% * 37.5
Foreign currency derivatives are those for which the cash flows are dependent on future foreign exchange rates. They may be used to hedge an insurer's foreign exchange risk and as such, may be recognized in the determination of the capital requirement for foreign exchange risk, subject to the following requirements.
Only effective hedges that offset the changes in fair value of the hedged item may be included in the foreign exchange risk calculation. The company must be able to demonstrate to OSFI the effectiveness of its foreign exchange hedges.
Companies with foreign currency derivatives on their balance sheet must be able to demonstrate that the addition of such derivatives does not result in increased risk. If the insurer cannot demonstrate that the derivatives do not result in increased risk, then OSFI may require additional capital.
Only plain-vanilla foreign currency derivatives may be recognized in the calculation of the foreign exchange capital requirement. Plain-vanilla foreign currency derivative instruments are limited to the following:
Other foreign currency derivatives, including options on foreign currencies, are not considered plain-vanilla and are not to be recognized in the determination of the foreign exchange risk margin.
Derivatives used for hedging an insurer's foreign exchange risk are subject to credit risk requirements. Refer to section 4.2 for further details.
Forward currency positions should be valued at current spot market exchange rates. It would not be appropriate to use forward exchange rates since they partly reflect current interest rate differentials. Companies 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 positions.
Accrued interest, accrued income and accrued expenses should be treated as a position if they are subject to exchange rate fluctuations. Unearned but expected future interest, income or expenses may be included, provided the amounts are certain and have been fully hedged by allowable forward foreign exchange contracts. Companies must be consistent in their treatment of unearned interest, income and expenses and must have written policies covering the treatment. The selection of positions that are only beneficial to reducing the overall position will not be permitted for capital purposes.
A separate component calculation must be performed for each group of liabilities ceded to an unregistered reinsurer that is backed by a distinct pool of assets, where the defining characteristic of the 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, the assets supporting them, and deposits placed by the reinsurer to cover the capital requirement for the ceded liabilities if the deposits are in a currency different from the currency in which the ceded liabilities are payable to policyholders. If some of the assets supporting the liabilities ceded to an unregistered reinsurer are held by the ceding company (e.g. funds withheld), the company's corresponding liability should be treated as an asset in the calculation of the open positions for the ceded business.
Excess deposits placed by an unregistered reinsurer within a pool of supporting assets may be used to reduce the foreign exchange risk requirement for the corresponding ceded business to a minimum of zero. Any requirements not covered by excess deposits must be added to the ceding company's own requirement.
Equity risk is the risk of economic loss due to fluctuations in the value of common shares and other equity securities.
A 30% risk factor applies to investments in common shares and joint ventures in which a company holds less than or equal to 10% ownership interest.
Equity futures, forwards, and swaps attract a 30% risk factor, which is applied to the market value of the underlying equity security or index. Where a swap exchanges a return on an equity security or index for a return on a different equity security or index, a 30% risk factor applies to the market value of both equity securities or indices for which the returns are being exchanged.
An insurer has entered into a one-year swap during which it will pay the 3-month Canadian Dollar Offered Rate (CDOR) plus fees, and receive the total return on a notional index of equities that was worth 100 at the time of inception. The index of equities is currently worth 110. A 30% equity risk charge will apply to 110 for the long position in the index, but no capital charge will be required on the short position in the bond because such a position is not subject to an equity risk charge.
In addition to the capital requirements set out in this section, futures, forwards, and swaps are subject to credit risk requirements. Refer to section 4.2 for further details.
The capital requirements for short positions in common shares, equity futures, forwards, and swaps that do not wholly or partially offset a long equity position are determined by assuming the instrument is held long and then applying the corresponding risk factor. Common shares, futures, forwards, and swaps eligible for offset recognition and the corresponding capital treatment are described in section 5.3.4.
Equity futures, forwards, and swaps, as well as common shares can be used to wholly or partially hedge an equity exposure. Insurers may recognize qualifying equity hedges in the calculation of the capital requirements in accordance with section 220.127.116.11 and 18.104.22.168.
Insurers must document the equity hedging strategies employed and demonstrate that the hedging strategies decrease the overall risk. The documentation must be available for review, upon request. If the insurer cannot demonstrate, to the satisfaction of the Superintendent, that the hedging strategies result in decreased overall risk, then additional capital above that calculated as per sections 22.214.171.124 and 126.96.36.199 may be required, at the discretion of the SuperintendentFootnote 45.
For hedges to qualify, they must be issued by an entity that:
Long and short positions in exactly the same underlying equity security or index may be considered to be offsetting so that the capital requirements are calculated for the net exposure only. Individual instruments of portfolios that qualify for the capital treatment under section 188.8.131.52 cannot be carved out of the portfolios to receive the capital treatment of section 184.108.40.206.
Only common shares and plain-vanilla equity futures, forwards, and swaps can obtain the capital treatment under this section. Exotic equity derivativesFootnote 46 do not qualify for this treatment.
A portfolio of common shares and equity futures, forwards, and swaps can be used to partially hedge the equity exposure of another portfolio of similar instruments. When the instruments contained in both portfolios are closely linked, instead of following the capital requirements set out in sections 5.3.1, 5.3.2, and 5.3.3, insurers may calculate the capital requirements for the combined portfolios in the following manner:
(1- Correlation Factor) × 1.5 × MIN (market value of the portfolio of hedging instruments, market value of the portfolio of instruments being hedged)
The capital requirements set out above are capped at 60% of the minimum market value of both portfolios.
The difference between the market value of the two portfolios is not considered a hedged position and is subject to a 30% risk factor.
The Correlation Factor is derived by using:
CF = A*(B/C)
A represents the historical correlation between the returns on the portfolio of instruments being hedged and the returns on the portfolio of hedging instruments
B represents the minimum of [standard deviation of returns on the portfolio of instruments being hedged, standard deviation of returns on the portfolio of hedging instruments]
C represents the maximum of [standard deviation of returns on the portfolio of instruments being hedged, standard deviation of returns on the portfolio of hedging instruments]
The historical correlations and standard deviations must be calculated on a weekly basis, covering the previous 52-week period. The returns on each portfolio of hedging instruments used to calculate the components of the CF must be determined by assuming that the portfolio is held long. The returns on each portfolio must be measured net of additional capital injections, and must include the returns on each component of the portfolio. For example, the returns on both the long and short legs of a total return swap included in a portfolio must be reflected in the calculation of the CF.
The CF for the previous 52 weeks is required to be calculated for each of the past four quarters. The Correlation Factor is the lowest of the four CFs calculated and is used to calculate capital requirements.
In order for the portfolios to obtain the capital treatment set out in this section, the following conditions must be met:
Suppose a portfolio of instruments is valued at $200 and is paired with another portfolio of instruments as part of a qualifying equity hedge. Assuming that the second portfolio is worth $190 and that the Correlation Factor between the two portfolios is 0.95, the total capital charge for both portfolios will be 190 × 5% × 1.5 + $10 × 30% = $17.25.
Portfolios that were established less than two years prior to the reporting date attract the following capital treatment:
T × capital requirements for the combined portfolios using the correlation factor approach described in this sectionFootnote 48; and
(1-T) × capital requirements set out in 1 above.
T equals 20%, 40%, 60%, and 80% in the first, second, third, and fourth quarter, respectively, of the second year following the establishment of the portfolios.
Two portfolios (as part of an equity hedge), each equal to 100, are established on April 1, 2016. On March 31, 2017, the capital charge for both portfolios will be 30% × 100 + 30% × 100 = 60. On June 30, 2017, assuming that the Correlation Factor is 0.90, the combined portfolios will be subject to a capital charge of 20% × 10% × 1.5 × 100 + 80% × 60% × 100 = 51.
Real estate risk is the risk of economic loss due to changes in the value of a property or in the amount and timing of cash flows from investments in real estate.
The risk factors are as follows:
For owner-occupied properties, the risk factor is applied to the value using the cost model, excluding any unrealized fair value gains (losses) arising at the conversion to IFRS, or subsequent unrealized fair value gains (losses) due to revaluation.
Other market risk exposures include assets that fall in the category "other assets," for example, equipment, that are exposed to asset value fluctuations that may result in the value realized upon disposal being less than the balance sheet carrying value. A 10% risk factor applies to other assets as part of the total capital requirements for market risk.
Operational risk is the risk of loss due to inadequate or failed internal processes, people and systems, or external events. It includes legal risk but does not include strategic or reputational risk.
The capital required for an insurer's operational risk is calculated using the following formula:
Operational risk capital required = 20% × [TC – SC]
TC is the insurer's total capital required, before the calculation of the requirement for operational risk.
SC is, if applicable, the supplementary capital required for insurance risk (reference subsection 220.127.116.11).
In the context of this guideline credit risk refers to any default risk as defined in chapter 4 other than the borrower default risk associated with mortgage insurance which is covered in chapter 3, Insurance Risk.
Return to footnote 1
Advisory: Capital Requirements for Federally Regulated Mortgage Insurers, January 1, 2017
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Where repayment is subject to Superintendent's approval.
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The criteria also apply to non-joint stock companies, such as mutuals, taking into account their specific constitution and legal structure. The application of the criteria should preserve the quality of the instruments by requiring that they are deemed fully equivalent to common shares in terms of their capital quality as regards loss absorption and do not possess features that could cause the condition of the insurer to be weakened as a going concern during periods of market stress.
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Paid-in capital generally refers to capital that has been received with finality by the institution, is reliably valued, fully under the institution's control and does not directly or indirectly expose the institution to the credit risk of the investor.
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A related entity can include a parent company, a sister company, a subsidiary or any other affiliate. A holding company is a related entity irrespective of whether it forms part of the consolidated insurance group.
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Further, where an institution uses a special purpose vehicle to issue capital to investors and provides support, including overcollateralization, to the vehicle, such support would constitute enhancement in breach of criterion #3 above.
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A step-up is defined as a call option combined with a pre-set increase in the initial credit spread of the instrument at a future date over the initial dividend (or distribution) rate after taking into account any swap spread between the original reference index and the new reference index. Conversion from a fixed rate to a floating rate (or vice versa) in combination with a call option without any increase in credit spread would not constitute a step-up.
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Other incentives to redeem include a call option combined with a requirement or an investor option to convert the instrument into common shares if the call is not exercised.
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Replacement issuances can be concurrent with, but not after, the instrument is called.
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A consequence of full discretion at all times to cancel distributions/payments is that "dividend pushers" are prohibited. An instrument with a dividend pusher obliges the issuing insurer to make a dividend/coupon payment on the instrument if it has made a payment on another (typically more junior) capital instrument or share. This obligation is inconsistent with the requirement for full discretion at all times. Furthermore, the term "cancel distributions/payments" means to forever extinguish these payments. It does not permit features that require the insurer to make distributions/payments in kind at any time.
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Institutions may use a broad index as a reference rate in which the issuing institution is a reference entity; however, the reference rate should not exhibit significant correlation with the institution's credit standing. If an institution plans to issue capital instruments where the margin is linked to a broad index in which the institution is a reference entity, the institution should ensure that the dividend/coupon is not credit-sensitive.
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Any modification of, addition to, or renewal or extension of an instrument issued to a related party is subject to the legislative requirement that transactions with a related party be at terms and conditions that are at least as favourable to the institution as market terms and conditions.
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An option to call the instrument after five years but prior to the start of the amortisation period will not be viewed as an incentive to redeem as long as the insurer does not do anything that creates an expectation that the call will be exercised at this point.
Return to footnote 15
Replacement issuances can be concurrent with but not after the instrument is called.
Return to footnote 16
Insurers may use a broad index as a reference rate in which the issuing insurer is a reference entity; however, the reference rate should not exhibit significant correlation with the insurer's credit standing. If an insurer plans to issue capital instruments where the margin is linked to a broad index in which the insurer is a reference entity, the insurer should ensure that the dividend/coupon is not credit-sensitive.
Return to footnote 17
Any modification of, addition to, or renewal or extension of an instrument issued to a related party is subject to the legislative requirement that transactions with a related party be at terms and conditions that are at least as favourable to the institution as market terms and conditions.
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This includes computer software intangibles.
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This does not permit offsetting of DTAs across provinces.
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To obtain OSFI supervisory approval, an insurer must demonstrate, to OSFI's satisfaction, that it has clear entitlement to the surplus and that it has unrestricted and unfettered access to the surplus pension assets. Evidence required by OSFI may include, among other things, an acceptable independent legal opinion and the prior authorization from the pension plan members and the pension regulator.
Return to footnote 21
No adjustments are required for "investment properties" as fair value gains (losses) are allowed for capital purposes.
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Interests in limited partnerships that are reported using the equity method of accounting are subject to the same capital treatment as joint ventures.
Return to footnote 23
If an insurer fails to obtain a capital confirmation (or obtains a capital confirmation without disclosing all relevant material facts to OSFI), OSFI may, at its discretion and at any time determine that such capital does not comply with these principles and is to be excluded from the insurer's capital available.
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OSFI reserves the right to require a Canada Revenue Agency advance tax ruling to confirm such tax opinion if the tax consequences are subject to material uncertainty.
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OSFI reserves the right to require such accounting opinion to be an external opinion of a firm acceptable to OSFI if the accounting consequences are subject to material uncertainty.
Return to footnote 26
For the purposes of this calculation, includes liability amounts for incurred but not reported (IBNR) claims.
Return to footnote 27
Mortgages that are in arrears or default are excluded from this calculation provided that a specific provision for such mortgages is included in the unpaid claim reserve; otherwise, they should be included.
Return to footnote 28
Throughout this Guideline, the loan-to-value ratio used for a residential exposure is a hybrid ratio in the sense that the loan balance in the ratio is the outstanding loan balance on the reporting date while the property value in the ratio is the property value on some earlier fixed date, possibly with adjustments. Details of the calculation are provided in subsection 18.104.22.168. The loan-to-value ratio used for commercial exposures is described in the section on commercial exposures.
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If a mortgage is split into tranches, then the remaining amortization used in this and subsequent formulas is the maximum of the remaining amortizations of all tranches.
Return to footnote 30
For second mortgages, is the total amount of outstanding loan balance for both the first and second mortgage as of the date of loan issue.
Return to footnote 31
In the future, OSFI may consider using equivalent house price indices with the same geographic coverage.
Return to footnote 32
The metropolitan areas geographical limits are determined using Statistics Canada definition of Census Metropolitan Areas.
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In particular, the threshold value for a particular metropolitan area is given by the formula:
Threshold = Average SCRI + K, where
K = α × Average SCRI + β × Standard Deviation,
and where the quantities α and β are the same for all metropolitan areas and are assumed to be non-negative. The average and standard deviation are specific to each metropolitan area and are determined based on the experience over historical periods that are not considered to be outside the tail of the distribution.
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The dates presented are approximate; they may vary according to the CANSIM table 380-0072 release date.
Return to footnote 35
OSFI plans to define the term “highest risk category of securitization exposures”, or a similar category, in a revised B-5 guideline – Asset Securitization. We plan to publish the updated guideline in the fall of 2018.
Return to footnote 36
Includes securities, loans and accounts receivable.
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Sovereign obligations rated lower than AA- may not receive a factor of 0%, and are instead subject to the factor requirements in section 4.1.2.
Return to footnote 38
Includes receivables for assumed business from unregistered insurers.
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1) Alternatively, assets classified as held for sale may be re-consolidated (look-through approach) at the option of the insurer. If this method is selected, any write-down made as a result of re-measuring the assets classified as held for sale at the lower of carrying amount and fair value less costs to sell should be reflected in the MICAT after re-consolidation. Any asset within a consolidated group that is deducted from capital available for MICAT purposes should continue to be deducted from capital when it becomes an asset held for sale.
2) If the insurer has elected to apply a 20% risk factor to assets held for sale instead of using the look-through approach, associated liabilities held for sale should be subject to the usual MICAT treatment of liabilities.
Return to footnote 41
Letters of credit for which a company is the beneficiary are included within the definition of guarantees, and receive the same capital treatment.
Return to footnote 42
A maturity mismatch occurs when the residual maturity of the credit protection is less than that of the underlying exposure.
Return to footnote 43
The carve-out can be used to reduce the net open long currency position to a minimum of zero.
Return to footnote 44
An insurer may contact OSFI to discuss the adequacy of its documentation and/or risk assessment to assess the likelihood or amount of potential additional capital that may be required.
Return to footnote 45
An example of an exotic derivative would be one that has a discontinuous payoff structure.
Return to footnote 46
For the purposes of this section, the hedging strategy and active management strategy together are deemed to be unchanged if the ex-ante equity risk profile of the combined portfolios is maintained. For example, the ex-ante equity risk profile is maintained if the combined beta is continuously targeted to be 0 (the hedging strategy), and if instrument selection is continuously based on the price-earnings ratio (the active management strategy).
Return to footnote 47
For the purposes of this calculation, the Correlation Factor must be determined based on actual portfolio returns (i.e. portfolio returns up to the reporting date). Projected (simulated) returns cannot be used. The Correlation Factor must be determined as the lowest of available 52 week Correlation Factors given the actual history of portfolio returns. During the second year, the number of available 52 week Correlation Factors will increase from one to four as time elapses.
Return to footnote 48