OSFI’s Quantitative Impact Study of the Proposed Changes to the Regulatory Capital Framework for Federally Regulated Property and Casualty Insurers
Instructions
Thank you for participating in this quantitative impact study (QIS). The purpose of the study is to assist the Office of the Superintendent of Financial Institutions Canada (OSFI) in assessing the impact of the proposed changes to the Minimum Capital Test (MCT) and the Branch Adequacy of Assets Test (BAAT), and provide an opportunity for the Canadian property and casualty insurance companies and branches of foreign property and casualty insurance companies (P&C insurers) to estimate the capital impact on their individual companies. All P&C insurers, except for mortgage insurers, are requested to participate in the QIS, with the results to be completed and submitted to Judith Roberge at [email protected] no later than July 31, 2013.
The study is to be completed by providing the requested information in the attached Excel
workbook. The instructions set out below provide explanations to assist insurers in completing the Excel file. All information is to be entered using year-end 2012 data. Companies with a fiscal year end other than December 31 should use their most recent fiscal year-end data. In cases where some requested data points are not available, companies may estimate the December 31, 2012 values with explanations provided in the General Information worksheet of the QIS. All amounts are in thousands of dollars unless otherwise noted. The QIS results should be reported for
federally regulated consolidated entities as well as their federally regulated P&C subsidiaries, similar to the MCT results filed with OSFI.
In completing the QIS, P&C insurers should refer to the accompanying discussion paper and the MCT Guideline for more details on items not explicitly mentioned and/or not explained in detail in the instructions. Approximations are allowed where appropriate on a best effort basis with details explained in the General Information section of the QIS.
There are two QIS Excel files posted on OSFI’s website – one to be completed by Canadian companies and the other one to be completed by branches of foreign insurance companies. The order of the instructions follows the order of the QIS Excel worksheets. Unless otherwise noted, the instructions apply to both Canadian companies and branches. As in the MCT Guideline, the instructions use generic expressions that are meant to apply to both Canadian companies and branches, e.g. capital required refers to margin of assets required for BAAT purposes etc.
Insurers are requested to enter data in all unshaded cells. Cells shaded with a grey background colour will be populated automatically as they contain imbedded formulas calculating values based on the data points provided elsewhere in the worksheets. Cells filled with a dotted pattern are not meant to contain numbers and should be left blank.
The following is a suggested order of completion of the QIS worksheets:
1. Definition of capital available or Definition of net assets available
2. Definition of capital available: assets 100% deducted from capital (Canadian companies only)
3. Capital/margin required for balance sheet assets
4. Capital/margin required for invested assets based on external credit ratings 5. Interest rate risk margin
6. Foreign exchange risk margin
7. Insurance risk: capital/margin required for premium liabilities 8. Insurance risk: capital/margin required for unpaid claims 9. Insurance risk margin
10. Capital/margin required for reinsurance ceded to unregistered insurers – current 11. Capital/margin required for derivatives, structured settlements and other exposures 12. Capital/margin required for non-owned deposits and letters of credit
13. Operational risk margin
14. Branch adequacy of assets test ratio (branches) 15. General information
Upon the completion of the above listed worksheets, values will populate automatically in the following worksheets:
1. Minimum Capital Test Ratio (Canadian companies)
2. Capital/margin required for reinsurance ceded to unregistered insurers – proposed 3. Capital/Margin Required for Non-Owned Deposits and Letters of Credit less Excess
Collateral
General Information
Please provide the name of your company in the designated box in this worksheet. Please also include the name of your company and OSFI assigned unique institution code (e.g. A001 or D001) in the Excel file name that you will be submitting to OSFI. For those entities also completing the QIS on a consolidated basis, please list all the subsidiaries that are included in the consolidated results. If an entity owns less than 100% of an entity which is accounted for in the MCT, provide the percent ownership.
Please provide your technical comments with respect to the QIS and the use of approximations in the Comments box of this worksheet.
Minimum Capital Test Ratio and Branch Adequacy of Assets Test Ratio
The worksheet entitled Minimum Capital Test Ratio can be found in the QIS for Canadian P&C insurers whereas the Branch Adequacy of Assets Test Ratio worksheet can be found in the QIS for branches.
The numbers in the worksheet Minimum Capital Test Ratio will populate automatically once the remaining QIS worksheets are completed.
Most of the numbers in the worksheet Branch Adequacy of Assets Test Ratio will populate automatically except for catastrophes, where branches are asked to enter in column 01 of line 09 asset requirements as reported in the year-end 2012 P&C-2 returns. The values for catastrophes in columns 02 and 03 will populate automatically.
Capital required values populated in column 02 will be at the target level, which can be associated with OSFI’s Supervisory target of 150% MCT. Capital required values populated in columns 01 and 03 will be at the minimum level, associated with a 100% MCT ratio.
Definition of Capital Available (Canadian P&C Insurers)
For column 01, please enter the dollar amount, in thousands, for common shares, preferred shares – equity, subordinated debt, and preferred shares – other (lines 01, 02, 20 and 21) that qualify under the 2012 MCT chapter 2 Definition of Capital. For column 02, please enter the amounts for common shares, preferred shares – equity, preferred shares – other, and subordinated debt, which meet the proposed qualifying criteria as outlined in appendix B of the discussion paper.
In column 01, line 07, report the amount of accumulated net after-tax fair value gains and losses arising from changes in a P&C insurer’s own credit risk on the insurer’s financial liabilities
classified as held for trading. In column 02 of line 07, enter the amount of accumulated net after- tax fair value gains (losses) from changes in own credit risk on all fair valued liabilities.
In line 14, enter accumulated net after-tax fair value gains and losses on derivatives held as cash flow hedges relating to the hedging of items that are not fair valued on the balance sheet (e.g.
loans, debt obligations, etc.) reported in AOCI.
Values in columns 01 and 02, line 29 will populate upon the completion of Assets 100% Deducted from Capital worksheet.
AOCI values requested in lines 33 to 43 are for information purposes only and would enable OSFI to perform additional analysis if necessary. In lines 42 and 43, please enter the value of
remeasurements of defined benefit pension plans and other defined benefits as your entity plans to report for the first quarter of 2013 P&C regulatory returns. Refer to chapter 2 of the 2013 MCT Guideline for more details.
Assets 100% Deducted from Capital (Canadian P&C Insurers)
The value requested for deferred tax assets (DTAs) in line 09 is relevant as per the current MCT requirements, while the values in lines 10, 11 and 12 are for the proposed MCT. Gross DTAs in line 10 can be netted with associated deferred tax liabilities (DTLs) only if the DTAs and DTLs relate to taxes levied by the same taxation authority and offsetting is permitted by the relevant taxation authority. DTLs permitted to be netted against DTAs should be reported in line 11 and must exclude amounts that have been netted against the deduction of goodwill and intangibles assets (including computer software) and must be allocated on a pro-rata basis between DTAs that are to be deducted in full and DTAs subject to a risk factor.
In line 18, column 02, please enter the value of net defined benefit pension plan asset as your entity intends to report for the first quarter of 2013. Refer to chapter 2 of the 2013 MCT Guideline for more details.
Definition of Net Assets Available (Branches of Foreign P&C Insurers)
In line 07 of column 01, please enter 65% of the net of deferred commissions and unearned commissions (if positive) as per the current MCT requirements. In line 07 of column 02, enter 100% of the non-negative value of the net of deferred commissions and unearned commissions.
Capital/Margin Required for Balance Sheet Assets
This worksheet is adapted from pages 30.71 and 30.81 of P&C-1 and P&C-2 regulatory returns respectively, and is intended to capture current and proposed capital/margin requirements for credit risk, equity risk, real estate risk, and foreign exchange risk (for branches).
Insurers are asked to enter 2012 year-end balance sheet value of assets in column 01, with values in columns 03 and 05 to be populated automatically. Values in lines 04, 05 and 15 for Canadian P&C insurers, and 03, 04 and 13 for branches will be populated upon the completion of
Capital/Margin Required for Invested Assets based on External Credit Ratings worksheet.
In order to assess the capital impact of the proposed changes for loans, P&C insurers are asked to enter values twice, using a different breakdown each time. In the worksheet Capital/Margin Required for Balance Sheet Assets, please enter the value of loans at amortized cost by nature of loans. In the worksheet Capital/Margin Required for Invested Assets based on External Credit Ratings, enter the value of loans at amortized cost based on external credit ratings of
counterparties and term to maturity of loans.
Capital requirements for Deferred Policy Acquisition Expenses (DPAE) for Canadian companies are calculated as part of insurance risk margins on premiums and therefore the values in column 03 should remain blank.
Capital/Margin Required for Invested Assets based on External Credit Ratings
Please enter balance sheet values of assets. For loans, enter values at amortized cost, grouped by external credit ratings and term to maturity. Capital required for each risk bucket will be populated automatically, with the total capital requirements to be populated in line 34.
Interest Rate Risk Margin
To compute the interest rate risk margin, duration and an interest rate shock factor are applied to the fair value of interest rate sensitive assets and liabilities. Only those interest rate sensitive assets and liabilities that are permitted under the current MCT requirements should be included in the calculation of the current and proposed interest rate risk margin. A 0.5% shock factor is used to compute the interest rate risk margin for the current MCT as we are using 2012 data, and a 1.25%
shock factor is used to calculate the interest rate risk margin for the proposed MCT framework.
The interest rate risk margin is the difference between the estimated change, for a given shock in interest rates, of the value of interest rate sensitive assets portfolio and interest rate sensitive liabilities portfolio, offset by recognized interest rate derivative contracts, as appropriate.
Foreign Exchange Risk Margin
The foreign exchange risk margin is 10% of the greater of:
i.) the aggregate net long positions in each currency, adjusted by effective allowable foreign exchange rate hedges if any are used, and
ii.) the aggregate net short positions in each currency adjusted by effective allowable foreign exchange rate hedges if any are used,
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.
Two steps are required to calculate foreign exchange risk margin. The first is to measure the exposure in each currency position. The second is to calculate the margin requirement for the portfolio of positions in different currencies.
Step 1: Measuring the exposure in a single currency
The net open position for each currency is calculated by summing:
the net spot position, defined as all asset items less all liability items denominated in the currency under consideration, including accrued interest and accrued expenses if they are subject to exchange rate fluctuations;
the net forward position (i.e. all net amounts under forward foreign exchange transactions, including currency futures and the principal on currency swaps), valued at current spot market exchange rates or discounted using current interest rates and translated at current spot rates;
guarantees (and similar instruments) that are certain to be called and are likely to be irrecoverable,
net future income/expenses not yet accrued but already fully hedged (at the discretion of the reporting institution), and
any other item representing a profit or loss in foreign currencies.
Adjustments:
For P&C insurers transacting foreign operations, those items that are currently deducted from capital available in calculating the MCT 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
Interests in non-qualifying subsidiaries, associates and joint ventures; and
Non-allowable foreign exchange rate hedges that are not considered in capital available.
Carve-out:
A P&C 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 risk charge is 10%
of the overall net open position, calculated as the greater of:
the sum of the net open long positions and the absolute value of the sum of the net open short positions.
Example
A P&C insurer has $100 of U.S. assets and $50 of U.S. liabilities.
The net spot position, defined as assets less liabilities, is a long position of $50.
The carve-out, using 25% of liabilities, is:
= 25% * 50
= 7.5
Therefore, the foreign exchange risk margin is:
= 10% * MAX1 ((net spot position - carve-out), 0)
= 10% * MAX ((50 – 7.5), 0)
= 10% * 42.5
= 4.25
There is an additional table contained in the worksheet, requesting insurers to enter the value, in Canadian dollars, of assets and liabilities denominated in each currency. This table is for
information purposes only, and will enable OSFI to perform additional analysis if necessary.
1
Insurance Risk Margin
Values in shaded cells will populate upon completion of the next two worksheets – Margin Required for Premium Liabilities and Margin Required for Unpaid Claims. Insurers are asked to enter the amount of capital required for premiums and claims liabilities associated with accident and sickness (A&S) business (lines 03 and 04, column 01) as reported for the year-end 2012.
The value for minimum gross capital/margin level should be calculated in accordance with the current MCT requirements and entered in line 08, column 01. This value should correspond to the value reported in line 96, page 30.70 of the P&C-1 return and line 96, page 30.80 of the P&C-2 return.
Margin Required for Premium Liabilities
Column 05 of the QIS for Canadian P&C insurers (current requirements table) asks for the value of deferred policy acquisition expenses on commissions (DPAE – commissions), net of adjustment for unearned commissions, by line of business. If numbers are not available by line of business, insurers are asked to allocate the total amount of DPAE – commissions by line of business using expert judgement or using a proportion of net unearned premiums by line of business to the total net unearned premiums. Please explain your allocation approach in the General Information worksheet.
P&C insurers are asked to enter the balance sheet value of premium deficiencies in line 21, column 07 for Canadian P&C insurers and column 05 for branches.
Under the proposed MCT, risk factors are applied to the net premium liabilities, which are after deducting reinsurance recoverables and the provision for adverse deviations (PfADs). The total net premium liabilities should be equal to those reported in the Appointed Actuary’s Report (AAR) under the net policy liabilities in connection with the unearned premiums.
Margin Required for Unpaid Claims
Unpaid claims risk margin will continue to be calculated on the net amount of risk (i.e. net of any reinsurance, salvage and subrogation, and self-insured retentions) less the PfADs, using the revised risk factors.
Capital/Margin Required for Reinsurance Ceded to Unregistered Insurers
to preserve current formulas and reference points. If the number of rows provided in the current and proposed worksheets in not sufficient to accommodate for all unregistered reinsurers, please contact OSFI as specified at the end of this document.
Most of the values in the worksheet calculating the proposed requirements will populate automatically.
Given the proposed increase from 10% to 20%, in the margin applied to unearned premiums ceded to and outstanding losses recoverable from reinsurers, it is assumed that P&C insurers will
increase collateral holdings (letters of credit and non-owned deposits) in order to reduce the amount of recoverables fully deducted from capital (column 14) and margin required (column 17) to zero. Based on this assumption, we have filled with a dotted pattern the proposed capital/margin required in the worksheets Minimum Capital Test Ratio/Branch Adequacy of Assets Test Ratio and Assets 100% Deducted from Capital, to show a capital neutral impact from the margin increase.
We have also increased the amount of collateral that insurers would need to hold to cover the additional margin, and adjusted capital requirements accordingly (reflected in the worksheet Capital/Margin Required for Non-Owned Deposits and Letters of Credit less Excess Collateral).
Capital/Margin Required for Structured Settlements, Derivatives and Other Exposures The first table of this worksheet (current capital/margin required) asks insurers to sort structured settlements, derivatives, and other exposures into three risk buckets – first with exposures categorized as government grade, second with exposures rated A- and higher, and the third one with exposures rated BBB+ and lower. A similar breakdown is required for collateral and guarantees used for structured settlements, derivatives and other exposures, except that only collateral rated A- and higher is permitted for these exposures consistent with the current MCT requirements.
The second table (proposed capital/margin required) asks companies to identify individual exposures and indicate in column 01 the rating and term to maturity of exposures and collateral associated with those exposures. P&C insurers are asked to make all reasonable efforts to assign an appropriate rating and term to maturity to individual exposures, in order to accurately estimate the capital impact. Please enter the dollar value of possible credit exposure in column 02 and the dollar amount of associated collateral held in column 03.
Other exposures are broken down into two groups, one with a 50% credit conversion factor and another with a 100% credit conversion factor. Chapter 7 of the MCT Guideline provides more details on which credit conversion factor should be applied depending on type of exposure. In column 05, enter the % risk factor associated with a particular exposure, based on external credit ratings and term to maturity as per risk factors table provided at the bottom of the worksheet. Enter
% risk factor for collateral in column 07 based on ratings and term to maturity also using the risk factors table. Similar to the current requirements, only collateral rated A- and higher should be used to reduce capital requirements on structured settlements, derivatives and other exposures.
Capital/Margin Required for Non-Owned Deposits and Letters of Credit
P&C insurers are requested to enter the values of non-owned deposits with the results of the current and proposed requirements to be populated automatically.
The table for calculating capital/margin required for LOCs splits them into three categories – 1) LOCs used as collateral for unregistered reinsurance, 2) LOCs used for self-insured retention, and 3) other LOCs. In the table, please enter LOCs grouped by term to maturity and a credit rating of the bank issuing/confirming the LOCs. For the proposed MCT, in column 04 enter risk factors depending on ratings and term to maturity of exposures based on the table provided below in the worksheet.Please note that according to OSFI’s General Guidelines for Use of Letters of Credit, LOC’s must be for a fixed term of at least one year.
Capital/Margin Required for Non-Owned Deposits and Letters of Credit less Excess Collateral
According to the current MCT requirements, non-owned deposits and letters of credit held as collateral for unregistered reinsurance that are greater than 100% of the unregistered reinsurance requirements are considered excess collateral and are not subject to a risk charge. The previous worksheet, Capital/Margin Required for Non-Owned Deposits and Letters of Credit, calculates total capital/margin required for non-owned deposits and LOCs. This worksheet calculates the pro-rated amount of excess collateral, which is then subtracted from total capital/margin required for LOCs and non-owned deposits to arrive at the final requirements less the excess.
The formulas in the proposed column for non-owned deposits and LOCs and capital/margin required for these exposures are based on the assumption that P&C insurers will increase the amounts of non-owned deposits and LOCs held, as a result of the increase in the unregistered reinsurance margin from 10% to 20%, up to the amount that would reduce their unregistered reinsurance requirements to zero (refer to the Instructions for the worksheet Capital/Margin Required for Reinsurance Ceded to Unregistered Insurers). Therefore, no excess collateral will be populated in the proposed column.
The values in this worksheet should populate automatically upon the completion of Reinsurance Ceded to Unregistered Insurers – Current and Proposed worksheets and Capital/Margin Required
Operational Risk Margin
Operational risk margin should be calculated after the margins for all other risks have been calculated.
Risk charge on premiums
Enter premiums data for the past 12 months from the annual income statement for the years 2011 and 2012. The 2011 premiums data is necessary for calculating premiums growth charge.
For insurers with intra-group reinsurance pooling arrangements, the proposed risk charge on premiums is different and is reported in the second table of the worksheet. The imbedded formula will populate the results automatically if applicable.
Questions concerning the completion of the QIS should be addressed to Anna Beith at [email protected] or by telephone at (613) 949-3961.
