Document Properties
- Type of Publication: Guideline
- Category: Prudential Limits and Restrictions
- Date: August 2003
- No: B-2
- Audiences: Life / Fraternals
I.
Introduction
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This Guideline addresses the issue of large credit risk exposures of
life insurance companies and fraternal benefit societies and of
foreign life insurance companies and foreign fraternal benefit
societies in respect of their business in Canada. It sets out OSFI's
policy with respect to limits on these exposures. In this Guideline,
the term "company" means a federally incorporated life insurance
company or a federally incorporated fraternal benefit society; the
term “foreign branch” means a federally regulated foreign life
insurance company or a federally regulated foreign fraternal benefit
society as defined in the Insurance Companies Act. The
Guideline applies individually to each company on a consolidated basis and to individual foreign branches.
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OSFI is concerned about concentrations of credit risk exposure to a
person or to a group of associated persons because, in the event of
default, the financial condition of the company or foreign branch
could be seriously affected.
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Large exposures are subject to limits, notwithstanding the quality of
security that underlies individual transactions. It is extremely
difficult to establish, in all cases, with certainty and over time,
the availability and value of security that underlies an exposure
until the need to call upon it arises.
Please refer to OSFI’s Corporate Governance Guideline for OSFI’s expectations of company Boards of Directors in regards to operational, business, risk and crisis management policies.
II. Limits
on Large Exposures
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In addition to other limits set out by this guideline, all companies
and foreign branches are to set out in writing their internal policies
on large exposures, including exposures to individual customers,
financial institutions, industries and countries. These policies are
also a requirement of the Prudent Person Approach, Guideline B-1. Companies and foreign
branches are also to have in place the management information and
control systems necessary to give effect to their written policies on
large exposures.
(i) Life
Insurance Companies and Fraternal Benefit Societies
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The aggregate exposure of a consolidated company to any entity or to a connection shall not exceed 25 per cent
of total capital. Notwithstanding this limit, it is expected that
companies will establish lower internal limits and that the 25 per
cent regulatory limit will be employed only on an exceptional basis.
“Total capital”, as used in this and subsequent paragraphs, means
total capital as defined in this Guideline.
(ii)
Foreign Branches
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The aggregate exposure of a foreign branch to any entity or to a
connection shall not exceed the limit established by the regulator in
the foreign branch’s home jurisdiction, provided that the following
criteria are met:
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the home office of the foreign branch has established credit exposure
limits and approval procedures for the branch;
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the home office is adequately supervised with regard to accounting
standards, capital adequacy requirements and actuarial practices;
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the home office is, in the opinion of the Superintendent, a continuing
source of financial strength for the foreign branch, and
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there are no legal, regulatory, statutory or fiscal restrictions in
the home office’s home jurisdiction to obtaining funds from the home
office in the event of losses.
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Where these criteria are not met, the aggregate exposure of a foreign
branch to any entity or to a connection shall not exceed five per cent
of net assets available. “Net assets available”, as used in this and
subsequent paragraphs, means net assets available as defined in this
Guideline. In addition, OSFI expects that a foreign branch will
comply, at all times and on a consolidated basis, with any large
exposure limits established by the regulator in its home jurisdiction.
(iii)
Canadian Life Insurance Company Subsidiaries in Canada
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The aggregate exposure of a consolidate Canadian life insurance company that is the subsidiary of an operating
life insurance company or of an operating fraternal benefit society
may have an exposure to any entity or to any connection that is no
greater than 100 per cent of the total capital of the subsidiary.
Notwithstanding this limit, it is expected that subsidiary companies
will establish lower internal limits and that the 100 per cent
regulatory limit will be employed only on an exceptional basis.
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These subsidiaries must notify the Superintendent of any exposure to
one entity or connection that exceeds 50 per cent of their total
capital no later than 10 working days after the exposure has been
incurred. Exposures that increase to an amount greater than 50 per
cent of capital because of changes in exchange rates need not be
reported but may be reviewed as part of the OSFI examination process.
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The 100 per cent of the total capital limit is contingent upon the
following criteria being met:
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the parent company is made aware of and has sanctioned exposures
greater than 50 per cent of the total capital of the life insurance or
fraternal benefit society subsidiary;
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the parent and the subsidiary are adequately supervised with regard to
accounting standards, capital adequacy requirements and actuarial
practices;
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the parent is subject to a consolidated large exposure limit;
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the parent company is, in the opinion of the Superintendent, a
continuing source of financial strength for the subsidiary; and
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there are no legal, regulatory, statutory or fiscal restrictions in
the parent's home jurisdiction to obtaining capital from the parent in
the event of losses.
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Failure to meet all the criteria will result in the Superintendent
reducing the limit to not lower than 25 per cent of the total capital
of the company subsidiary.
(iv)
Parent Guarantees
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A company or foreign branch may not use a guarantee from its parent or
from an affiliate to reduce the calculation of an exposure to an
amount within the limits prescribed in this Guideline.
III.
Definitions
(i)
Total Capital
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For the purposes of this Guideline, total capital for a company is the consolidated total available capital of a company as defined for the purpose of calculating the Life Insurance Capital Adequacy Test (LICAT) for Canadian Life Insurance Companies and Fraternal Benefit Societies. Where the following criteria are not met, the investments that have been deducted for capital adequacy purposes must be added back to total capital in order to calculate the large exposure limit:
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the deducted investment is adequately supervised consistent with the
minimum standards for supervision published by the Basel Committee on
Banking Supervision in 1992, or
the entity is adequately supervised with regard to accounting
standards, capital adequacy requirements and actuarial practices and
is subject to a consolidated large exposure limit that is not
materially different from OSFI’s requirements; and
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there are no legal, regulatory, statutory or fiscal restrictions in
the deducted investment’s host jurisdiction for transferring capital
to the company.
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Where a company deducts an investment for capital adequacy purposes
and does not add that investment back to total capital in order to
calculate the large exposure limit and where, in the opinion of the
Superintendent, the above criteria have not been met, the
Superintendent will require that these investments be added back to
total capital for the purpose of calculating the large exposure limit.
(ii) Net
Assets Available
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For the purposes of this Guideline, net assets available for a foreign branch are the net assets available as defined for the purposes of calculating the Life Insurance Margin Adequacy Test (LIMAT).
(iii)
Exposure
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An exposure includes claims on an entity or connection
comprising:
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any draw-downs on arrangements for providing funds or credit
including loans and advances, debt and equity securities, loan
substitute securities, and financial leases;
- all undrawn amounts of authorized irrevocable advised credit
commitments provided by the company or foreign branch, including,
but not limited to:
- standby letters of credit;
- financial guarantees;
- conditional sales contracts;
- repurchase agreements;
- fully underwritten lending commitments;
- note issuance facilities; and
- revolving underwriting facilities;
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the credit equivalent amount of foreign exchange, interest rate, equity and commodity contracts calculated in accordance with the OSFI LICAT and LIMAT, recognizing the net amount where transactions are subject to a legally valid contractual right of set-off; and
- for exposures to units or shares of a mutual fund where the returns
of the mutual fund units or shares are passed through unaltered
(i.e., there is no guarantee of performance) to the holders of
insurance policies (e.g., universal life insurance policies), only
25% of the book value of the exposure is included in the calculation
of the exposure to the mutual fund provided certain criteria are
met. For other exposures to the mutual fund, 100% of the book value
of the exposure must be included in the calculation of the exposure
to the mutual fund. To qualify for the lower exposure multiple, the
following criteria must be met:
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the mutual fund is not sponsored, administered or marketed by the
company;
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there are no restrictions or limitations on the redemption of the
mutual fund units or shares by the company,
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the mutual fund does not have an exposure to any single counterparty
in excess of 10% of the total market value of the mutual fund at the
date of acquisition of the exposure to that counterparty,
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the company holds no more than 10% of the total market asset value of
the mutual fund,
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the mutual fund can be independently valued on a daily basis, and
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the mutual fund has a broad and active secondary market.
- An exposure excludes:
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(any deposits with, and debt obligations (including acceptances)
of, banks, trust and loan companies, life insurance companies and
cooperative credit associations that have a residual maturity of
less than one year;
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any deposits with, and debt obligations of, a federally regulated
Canadian parent bank, trust and loan company or life insurance
company;
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foreign exchange, interest rate, equity and commodity contracts
with banks, life insurance companies, trust and loan companies and
cooperative credit associations with a residual maturity of less
than one year;
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all foreign exchange, interest rate, equity and commodity
contracts with the regulated parent, regulated affiliate bank,
regulated affiliate life insurance company or regulated affiliate
trust and loan company in the normal course of business;
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direct obligations of, and that portion of obligations fully and
unconditionally guaranteed by, the Government of Canada, a
Canadian province, OECD central governments, and bodies designated
as public sector entities for capital adequacy assessment
purposes;
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exposures to an entity that occur while a transaction is in the
course of settlement,
including daylight overdrafts;
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exposures to an entity arising from purchases of Government of
Canada securities, securities issued by a province of Canada or by
an OECD central government, subject to an agreement that the
seller will repurchase at the end of a stated period, provided
that the purchasing company or foreign branch has obtained control
of the securities that are to be repurchased;
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loans of securities made in accordance with OSFI Guidelines on
securities lending and loans made to securities brokers and
dealers that are fully collateralized by securities issued by the
Government of Canada or by a province of Canada;
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commitments pursuant to an underwriting agreement to purchase a
new issue of securities or a secondary issue of securities by a
subsidiary that is a member of the Investment Dealers Association
of Canada or regulated by a provincial securities commission and
that is subject to the capital requirements for such underwriting
agreements; and
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exposures held in trusteed accounts that are not exposures of the
company or foreign branch (e.g., mutual funds and segregated funds).
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Exclusions from the definition of exposure must continue to be
monitored by the company or foreign branch and be subjected to
internal exposure limits established by the company. In addition, any market risks associated
with these exposures should also be incorporated into the company's
and the foreign branch’s overall market risk measurement and control
framework.
(iv)
Exposures to Reinsurers
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This Guideline does not establish quantitative limits for exposures
to reinsurers. However, OSFI expects prudent management of
companies to include reasonable limits on exposure to any single
reinsurer. Assessment of limits on exposure to a reinsurer will take
into account the size of the regulated institution, the nature of its
business, the availability of reinsurance in the market and the credit
worthiness of the particular reinsurer.
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Companies are expected to have in place specific policies relating to
reinsurance. These policies should be consistent with any OSFI
guidance with respect to reinsurance.
(v)
Control of Securities
- Control of securities may be effected by a company or a foreign
branch through the following methods:
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acquiring physical possession of security certificates;
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delivery of either security certificates or book-entry securities
to a third-party custodian designated by the purchasing company or
foreign branch under a written custodial agreement that explicitly
recognizes the purchaser's interest in the securities as superior
to that of any other person;
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appropriate entry on the books of a third-party custodian acting
pursuant to an agreement with the purchasing company or foreign
branch and the seller, thereby ensuring adequate segregation and
identification of either physical or book-entry securities; or
- a substantially equivalent method.
(vi)
Entity
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An entity is a natural person, a body corporate, trust,
partnership, fund, unincorporated association or organization, Her
Majesty in right of Canada or of a province, an agency of Her Majesty
in either of such rights and the government of a foreign country or
any political subdivision thereof and any such agency thereof.
(vii)
Connection
- A connection exists where two or more entities are a common
risk. The exposures to the entities that make up a connection shall be
aggregated for the purpose of applying limits on a company’s or a
foreign branch’s large exposures. In circumstances where there is some
uncertainty as to whether a connection exists, exposures should be
viewed as a common risk for the purposes of this Guideline.
(viii)
Common Risk
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Common risk is to be determined on a case-by-case basis, with
reference to the material facts of the situation. The presence of any
of the following conditions indicates a common risk:
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the expected source of repayment is the same for each entity;
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the entities are part of a corporate group;
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the entities are joined in or by partnerships, joint ventures or
structures that create material “risk sharing” between such
entities; or
- there is material financial interdependence between the entities.
(ix)
Expected Source of Repayment
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The obligations of a partnership or joint venture and the obligations
of each member of a partnership or joint venture shall be deemed to
have the same source of repayment and will be aggregated as
follows:
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the exposure to each member of a general partnership shall include
the obligations of the general partnership; and
- the exposure to each member of a limited partnership or joint
venture shall include their pro rata share of the
obligations of the limited partnership or joint venture.
(x)
Corporate Group
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Corporate group is defined to include an entity and all of
its subsidiaries, whether or not they are owned directly or indirectly and whether or not they are consolidated for financial statement
purposes.
(xi)
Financial Interdependence
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Financial interdependence is to be assessed on a case-by-case
basis taking into consideration inter-company funds movement and
contractual agreements, including common security arrangements,
guarantees and letters of comfort. An example of intercompany funds
movements that indicate financial interdependence would be the
reliance arising from an entity in a corporate group obtaining more
than 50 per cent of its gross receipts for the most recent 12 month
period from another entity in the corporate group. Financial
interdependence could also exist where:
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entities have the same or similar products or markets; or
- entities share operational facilities and systems.