Office of the Superintendent of Financial Institutions
The purpose of this study is to gather information to evaluate a number of potential methods for determining the capital requirements related to market, credit, insurance and operational risk.
QIS#5 general instructions are similar to QIS#4 completed by insurers in the fall of 2012, except for the following changes:
The basic information required for this study is to be entered in the attached Excel workbook. In addition to supplying the requested information, we would appreciate receiving your written comments on the results of QIS#5. A worksheet is included titled “Questions and Comments” for insurers to provide supplemental information and any questions or comments you might have.
The instructions set out below provide explanations to assist insurers in completing the calculations and the Excel worksheets.
All information is to be calculated as of December 31, 2012, using 2012 year-end data. For insurers with a fiscal year end other than December 31, the insurer will use their fiscal year-end data. All amounts are in thousands of dollars. When it is not possible to use 2012 year-end data, the insurer may use more recent data and make approximations to determine the December 31, 2012 values. This should only be considered for some limited values and specified in the “Questions and Comments” worksheet.
Any item not explicitly mentioned in the instructions (market, credit, insurance and general) should follow current Minimum Continuing Capital and Surplus Requirements (MCCSR) rules for the QIS. Approximations are allowed where appropriate. Please provide a detailed explanation of the approximations in the “Questions and Comments” worksheet.
Information is broken down for Canada, United States, United Kingdom, Europe, Japan and other geographies (Other) based on where the business and capital are located. Discount rates by geography are used in the present value calculations in the worksheets. For this QIS, any geography not specified (i.e. the “Other” category) will use United States discount rates. Likewise, business sold in a geography will use the discount rates of that geography even if the business is denominated in another currency. Discount rates used in the calculation are those described in the market risk instructions. Insurers wishing to discuss the discount rates should contact their regulator.
The “Summary Page” contains four separate sets of information.
The first set is the solvency buffers for each of the components of market, credit, insurance and operational risk. These are sourced from each “Summary Page” of the QIS Excel workbooks for market, credit and insurance risk. Operational risk is sourced from the summary workbook provided with these instructions.
The second set is the existing MCCSR and Provisions for Adverse Deviations (PfADs). The components should equal the amounts reported in your December 31, 2012 MCCSR returnFootnote 1
or Report of the Appointed Actuary, as applicable.
The third set of information is used to calculate the potential credit for diversification as described below.
The fourth set of information is used to calculate the potential credit for participating and adjustable products under the new capital standards as described below.
Companies are also reminded to enter their company name at the top of the “Summary Page”.
Insurers are requested to provide detailed MCCSR capital requirements, PfADs and statement value of asset information by product line and geography in the “MCCSR”, “PfADs” and “Assets” worksheets respectively. The components should equal the amount reported in the December 31, 2012 MCCSR return and the December 31, 2012 Report of the Appointed Actuary. Approximations should be described in the “Questions and Comments” worksheet.
The summary workbook also includes the following worksheets:
A high level summary and example of how the solvency buffer is calculated is included in Appendices I and II respectively.
This QIS reflects the aggregation of risk and provides a credit for diversification. The aggregation of risks is based on the sum of the risks components reduced by a risk diversification factor determined from a correlation matrix for diversification across risks. Four levels of diversification were considered.
The “within risk” diversification is included in the insurance risk instructions, as it applies directly to each risk. The risk components should be aggregated as the sum of level and trend plus the square root of the sum of the squares for volatility and catastrophe risk. A summary of the “within risk” diversification is included in the “Diversification Credit” worksheet.
The “across risk” diversification is included in the worksheet titled “Diversification Credit”. The correlation matrix calculation is sourced from the solvency buffer for each of the components of market, credit and insurance risk. These are sourced from the summary pages of the completed components of the QIS Excel files. The correlation matrix is applied using the following formula:
The diversification credit percentage is calculated as the difference between the sum of the individual solvency buffers for each risk before diversification and the solvency buffer calculated on an aggregated basis after diversification. For clarity, the diversification credit percentage equals 1 – (aggregate solvency buffer after diversification divided by aggregate solvency buffer before diversification). A gradual haircut will be applied for credits in excess of 5% such that the maximum diversification credit is 15%. The following formula depicts the calculation of the adjusted diversification credit:
The diversification credit percentage is applied to the capital requirements, before credit for participating and adjustable products. The capital requirements are defined as the solvency buffer minus an estimate of the insurance risk margin for the liability. For this QIS, the risk margin is defined as 50% of the level and trend insurance risk solvency buffersFootnote 2. As an additional test, the
diversification credit will also be calculated based on the diversification credit percentage applied to the solvency buffer only.
The across risk credit for diversification also includes a test to ensure that the total solvency buffer is not reduced below the highest single risk solvency buffer included in the correlation matrix.
The “across entities” diversification is included in the relevant QIS instructions. Each risk will be aggregated across entities within the same geography using the consolidated approach.
Additional calculations to measure potential “across geographies” diversification for mortality level and volatility risk is included in the insurance risk instructions.
The potential credit for participating and adjustable products is calculated in aggregate for all risks - market, credit, insurance and operational.
Business that is contractually adjustable at the sole discretion of management meets the definition of adjustable products. Please use the following criteria / considerations in determining the credit:
The credit for participating and adjustable products can only be applied if the participating policies meet the criteria in MCCSR 1.2.6 and the adjustable features of the adjustable products meet the “reasonable flexibility” described in MCCSR.
Insurers should calculate the credit for participating and adjustable products by major blocks of business and separately by geography. For example, the credit for participating products will apply by participating fund. Geographies with more than one participating fund should add together the separate participating credits to apply the overall limit by geography.
In this QIS, the credit for participating and adjustable products is based on the “value” of the discretionary benefits, i.e. the level of dividends and contractual adjustability in the best estimate scenario. This results in a total asset requirement (before the credit for participating and adjustable products) that is comparable with the total asset requirements on a non-participating, non-adjustable basis since the best estimate dividends and contractual adjustability are included in the best estimate liability. As a minimum, the participating and adjustable total asset requirements should be comparable to the equivalent non-participating, non-adjustable total asset requirements assuming no future discretionary benefit cash flows and assuming similar product design, risk profile and investment strategy.
The total credit will be limited based on the solvency buffer for participating products and the insurance risk solvency buffer for adjustable products. The limit will be applied by geography and before operational risk and credit for diversification. See Appendix III for an example of this calculation. The credit for discretionary features is calculated as follows.
A credit for participating products is calculated if there are projected dividend cash flows. The credit is calculated as 60% of the present value of the dividends using the QIS base scenario dividends (i.e. consistent with CALM base scenario but with QIS forward rates as investment return assumptions). The cash flows are discounted using base scenario interest rates described in the market risk instructions. The CALM base scenario dividends can be used as an approximation to QIS base scenario dividends if the difference is not material. The percentage assumed for the credit (60%) is based on the amount of adjustment to participating dividends that could reasonably be made to offset significant adverse experience considering anti-selective lapsation, market pressures and other factors influencing the ability to adjust participating dividends. The percentage also reflects that the credit is based on best estimate dividends and does not reflect the impact of the shocked environment. The dividend cash flows are to be included in the worksheet titled “Par Dividends”.
The amount of the credit is limited so that the participating solvency buffer before credit for diversification is not reduced below a floor. The floor is calculated as the maximum of a) the sum of the participating interest rate risk solvency buffer based on the alternative calculation using 50% of the QIS base scenario dividend cash flows as described in the market risk instructions plus all other risk solvency buffers (excluding operational risk) calculated using QIS base dividend cash flows and b) 50% of all other risk solvency buffers (excluding interest rate risk and operational risk) calculated using QIS base dividend cash flows. The limit by geography ensures a minimum level of solvency buffer for participating products.
The final credit is calculated in the worksheet titled “Summary - Credit Par & Adj Prod”.
A sensitivity test for the participating solvency buffer limit based on worst scenario dividends is described in the market risk instructions.
A non-trivial reduction in dividends may result in other adverse impacts (ripple effects) due to lapses, anti-selection, unit expense increases or even actions by policyholders. Insurers are requested to disclose estimated significant ripple effects of reducing dividends by the amount used in the calculation of the participating credit in the “Questions and Comments” worksheet. The ripple effects impacts should not be reflected in the cash flows for the calculation of participating credit.
A credit for adjustable products is calculated if there are contractually adjustable liability cash flows at the sole discretion of management. The credit is calculated as 60% of the present value of the best estimate liability cash flows before contractual adjustments, i.e. current best estimate, less the present value of the best estimate liability cash flows after contractual adjustments, i.e. 60% x (before adjustments - after adjustments). An illustrative example is as follows:
Benefits and expenses = 90
Premiums = 100
Net liability cash flow = -10
After adjustment (premium increase example)
Benefits and expenses = 90
Premiums = 110
Net liability cash flow = -20
Credit is 60% x 10 = 6 = 60% of premium increase before any limit is applied
For products with contractually adjustable liability cash flows at the discretion of management but that require regulatory approval, the credit is calculated as 40% of the present value of the best estimate liability cash flows before contractual adjustments, i.e. current best estimate, less the present value of the best estimate liability cash flows after contractual adjustments, i.e. 40% x (before adjustments - after adjustments).
The cash flows are discounted using base scenario interest rates described in the market risk instructions. The percentage is based on the amount of adjustment that could reasonably be made to offset significant adverse experience considering anti-selective lapsation, market pressures and other factors influencing the contractual adjustability. The percentage also reflects that the credit is based on best estimate liability cash flows and does not reflect the impact of the shocked environment. The adjustable liability cash flows are to be included in the worksheet titled “Contractual Adjustability”.
Although this may not be permitted in a future capital test, insurers could use, as an approximation, the expected management actions which would be taken rather than the maximum contractual adjustability if the latter is not available for this QIS and if management actions would result in a higher solvency buffer than that calculated using maximum contractual adjustability. Approximations should be described in the “Questions and Comments” worksheet.
The amount of the credit is limited to 50% of the insurance risk solvency buffer for adjustable products. The credit is calculated in aggregate for adjustable products that require regulatory approval and for those that do not require regulatory approval. The limit by geography ensures a minimum level of solvency buffer for adjustable products.
The percentage credit for adjustable products is less than that for participating products. Adjustable products are different in their nature and adjustability and therefore less credit will be given compared to products with discretionary liability cash flows such as participating dividends.
The final credit is calculated in the worksheet titled “Summary - Credit Par & Adj Prod”.
The calculation of the credit on adjustable products is needed to evaluate the level of discretionary liability cash flows. We are aware that this may require significant work for some insurers. If this information is not available or insufficiently complete/reliable from our analysis of QIS#5 results, the level of the credit may be reduced to reflect the uncertainty or the implementation of the credit may be delayed to provide insurers with the time to gather and provide the required information.
Insurers are requested to provide a summary of the types of adjustable products in the “Questions and Comments” worksheet. Products that are considered adjustable but where a credit has not been calculated should be included. In those cases, insurers should disclose why the credit was not taken.
The QIS solvency buffer is calculated net of reinsurance. Similar to the MCCSR guideline, the solvency buffer and best estimate liability should not be reduced below zero for unregistered reinsurance even when there are excess assets in trust.
Insurers are requested to provide information on unregistered reinsurance, as considered in the MCCSR, in the “Unregistered Reins” worksheet. The solvency buffer should be calculated for the reinsurance ceded to unregistered reinsurers in order to calculate the assets in trust (collateral) and to compare to the MCCSR guideline requirements.
Currently, the assets in trust covering unregistered reinsurance are 100% of the CALM liabilities plus 150% of the MCCSR required capital (with the exception mentioned in MCCSR 10.5.3Footnote 3) on the reinsured business. Companies ceding significant business to unregistered reinsurers should
calculate the solvency buffer for the ceded business to unregistered reinsurers to make an appropriate comparison with the MCCSR guideline requirements for the assets in trust. This calculation should be done in accordance with the QIS shocks for the net business. To simplify the work, and if the reinsurance ceded is on a proportional basis, an insurer can simply use a portion of the results of the buffer for the net business to measure the impact on the assets in trust.
Since the solvency buffer does not include operational risk, the 150% of the MCCSR is reduced to 125%. The table should read as follows:
Assets in trust according to MCCSR guideline to cover the current CALM liabilities
Assets in trust according to MCCSR guideline to cover current required capital at 125%
Assets in trust according to QIS solvency buffer (at 100%) before diversification credit
Assets in trust according to QIS best estimate liabilities (at 100%)
Excess assets in trust under QIS
The operational risk solvency buffer calculation is included in the “Operational Risk” worksheet. A summary of the components of operational risk solvency buffer is included in Appendix IV.
Direct premiums do not include mutual fund deposits, GICs, segregated fund deposits or premium equivalents for administrative service only/investment management services. Segregated funds with no guarantees should use the factor for mutual funds.
Total amounts for premiums and account values should reconcile to relevant values reported in Life-1 or Life-2.
Entities deducted from capital (i.e. shaved subsidiaries) are excluded from the business volume operational risk charges.
In the case of an acquisition, the premiums for a prior reporting period (before the acquisition) will be the sum of the premiums written by the two separate entities, i.e. a sum of the acquiring and the acquired company’s premiums written. For example, assume in 2012 Company A with premiums of $100 for year-end 2011 acquired Company B with premiums of $50 for year-end 2011. The merged company reported a total of $225 in premiums for year-end 2012. The operational risk capital charge associated with rapid growth in premiums would be calculated as: 3% x [225 – (100 + 50) x 1.2)] = 3% x $45 = $1.35.
The risk charge on the solvency buffer is considered a non-diversifiable risk and is calculated on the solvency buffer net of credit for participating and adjustable products and before credit for diversification between risks.
A comparison of the QIS based TAR and the existing capital and accounting frameworks is included in the “TAR Comparison” worksheet. The components of this comparison are sourced from the completed QIS Excel files as well as other inputs by the insurer e.g. liabilities not tested in QIS.
The QIS based TAR is the sum of the best estimate liability plus the solvency buffer. Since we use the CALM best estimate liability in the calculation of the QIS based TAR, we include the difference between the QIS based best estimate liability and the CALM best estimate liability as an additional solvency buffer; this additional amount is referred to as the “discount rate basis buffer”. The existing TAR is the sum of the CALM liabilities plus 150% of MCCSR.
Best estimate liabilities and PfADs that are not used in QIS testing should nonetheless be included in both the QIS and current best estimate liabilities and PfADs. This includes other liabilities such as segregated fund guarantees and bulk liabilities. Any liabilities that are specific to CALM should not be included in the QIS TAR. The purpose of the worksheet is to perform a complete comparison of the potential new solvency framework to the existing capital and accounting frameworks. Insurers should therefore ensure that the QIS based TAR is consistent with the current existing TAR and that the comparison is valid. The insurer should describe the approach used in the “Questions and Comments” worksheet.
Information in the “Solvency Measures” worksheet will be used to test potential solvency measures. The components are sourced from the completed QIS Excel files including the separate QIS on available capital as well as other inputs by the insurer e.g. CALM liabilities.
The following inputs will be used:
As a test of the sensitivity arising from changes in the QIS discount rates, insurers are requested to provide the results of QIS#5 using QIS#4 discount rates. The solvency buffer should be re-calculated for each risk (insurance, interest rate and operational risk) assuming the QIS#4 base scenario discount rates. The tables with the 2011 interest rates for this test will be provided in the worksheet with the 2012 interest rates. Interest sensitive cash flows and participating dividends should be recalculated for the revised interest rates. If these interest sensitive cash flows are not material, the insurer may leave the cash flows unchanged for the discount rate test. The impact on credit risk and other market risks may be estimated based on the overall change in asset values as described below. The insurer should describe the approach used in the “Questions and Comments” worksheet.
This test of the impact of interest rate changes also requires the recalculation of the 2012 total assets using the test interest rates. As an approximation, insurers may calculate the impact of the discount rate sensitivity on the present value of the asset cash flows used for the interest rate risk calculation. This change in asset value may be added to the 2012 statement value of assets to approximate the change in the 2012 assets. Any other reasonable methodology may be applied to reflect the change in asset values. The insurer should describe the approach used for the assets in the “Questions and Comments” worksheet.
The discount rate test should be run as follows:
BufPar = MtPar + LoPar + MclPar + MtePar + LsePar + LsuPar + ExPar + ArPar
BufPar-Fl = max[IrrPar + MtPar + LoPar + MclPar + MtePar + LsePar + LsuPar + ExPar + OarPar , 0.5 x
[MtPar + LoPar + MclPar + MtePar + LsePar + LsuPar + ExPar + OarPar] ]
Par Crt = min [0.6 Pv Dvd; BufPar – BufPar-Fl ]
IRBuf Adj = Mt Adj + Lo Adj + Mcl Adj + Mte Adj + Lse Adj + Lsu Adj + Ex Adj
AdjC = min [0.6 Pv AdjCF; 0.5 IRBuf Adj]
where 0.6 is replaced by 0.4 for products where adjustment is subject to regulatory approval
CR= Sum [MtAll;LoAll;MclAll; MteAll;LseAll;LsuAll;ExAll;ArAll] – RM
Buf All-Dc = Sum [MtAll;LoAll;MclAll; MteAll;LseAll;LsuAll;ExAll;ArAll] – ADC x CR
Buffer = Buf All-Dc + OpAll – Par Crt – AdjC
The following table outlines the components of the operational risk solvency buffer calculation.
(1) Direct premiums
(2) Ceded reinsurance premiums
(3) Assumed reinsurance premiums
(4) Account values/liabilitiesFootnote 5 for deposit products:
a. Mutual funds
b. Universal life
c. Annuity liabilities – annuities in payment
d. Annuity liabilities – accumulation annuities
e. Segregated funds
Risk charge on change in year-over-year premiums/account values beyond a threshold of 20%
Component of operational risk tied to a company’s total solvency buffer
For Branches of foreign companies, refer to the equivalent lines on the TAAM return, where applicable. For provincial insurance companies, refer to the equivalent lines on the provincial return.
Return to footnote 1 referrer
Solvency buffer includes the total expense risk solvency buffer. This calculation approximates the level of insurance risk margins for the liability under IFRS 4/II.
Return to footnote 2 referrer
MCCSR Section 10.5.3 Asset risk requirements: Consistent with the substitution capital treatment used for collateral and guarantees, companies are required to include, in the MCCSR/TAAM capital or margin requirement, the C-1 and C-3 capital charges (as determined under chapter 3 and section 5.4) for all assets subject to the company’s claim under a perfected security interest, and for all letters of credit, that are used to obtain credit for ceded liability or capital requirements relating to unregistered reinsurance. In addition, such collateral and letters of credit will give rise to a charge for foreign exchange risk under section 9.7 if there is a currency mismatch with the reinsured policy liabilities they support.
Return to footnote 3 referrer
Using round numbers for simplified example.
Return to footnote 4 referrer
Account values and liabilities are gross of reinsurance.
Return to footnote 5 referrer
Applied to the solvency buffer net of credits for participating and adjustable products and before credit for diversification between risks.
Return to footnote 6 referrer