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54th Annual Canadian Reinsurance Conference
Breakout Session #5
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Session DescriptionThere is a global “tsunami” of change in regulation and supervisory frameworks and standards for all financial institutions that will greatly influence future capital standards for the Canadian life insurance industry. Many driving forces are contributing to a new paradigm of dramatically increasing challenges in capital planning and pricing for capital requirements. The panel will outline emerging developments in regulation and supervision affecting future capital standards in Canada as well as internationally, give a regulator's view for the necessity for and benefits of this revolution and give a reinsurer's view on how this revolution will impact capital planning and reinsurance pricing and capacity.
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Driving Forces & Emerging Developments
Regulator’s View of Necessity & Benefits of this REvolution
Reinsurer’s View of Impact on Capital Planning, Pricing & Capacity
Questions
Agenda Item Panel
Steven W. EassonCLHIA
Bernard DupontOSFI
Bernard NaumannMunich Re
All
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Steven W. EassonCLHIA
Driving Forces & Emerging Developments
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Driving Forces
Member of G20
Member of FSB
International Convergence
Financial Crisis G20 / Finance Ministers /Financial Stability Board (FSB)
Global comparability
G20 / Finance Ministers / FSB
Trend to more risk-based/principles based standards
Global Convergence (a la Basel) Territories and Sectors
IAIS Adherence/Cooperation
Advances in actuarial and capital theory; increased complexity and globalization of products
Improve risk sensitivity
FinancialReporting
Capital
International Canada
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Emerging Developments
IFRS mandated in April 2008 Adopted pre-crisis
“Phase 1”: 2011
“Phase 2”: 2013+
International Financial Reporting Standards (“IFRS”)
IASB/FASB joint project
IAIS Papers
Solvency II
NAIC
Basel “III”
Life Insurer Solvency AssessmentFramework (next generation to replace MCCSR)
“Solo”/“Holdco” capital, Stress Tests “Reinsurance Response Paper”
FinancialReporting
Capital
International Canada
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International – Financial Reporting 2008 Financial Crisis – G20 meetings
Washington, London, Pittsburgh, Toronto (June 2010) Washington Declaration: Finance Ministers to implement principles for reform
Create high quality accounting standards Basis of loan loss provisions to improve
IASB’s International Financial Reporting Standards Insurance Contracts – IASB committed to finalize June 2011 Other Standards of interest
Financial Instruments (IFRS 9); IAS37; Credit Risk; Fair Value
IASB/FASB joint project Commitment to achieve convergence, but the Boards at times disagree on standards and will convergence happen “on plan”?
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International - Capital International Association of Insurance Supervisors (“IAIS”) Papers
Insurance Core Principles Standards Guidance Papers Target date for revised ICP’s – October 2011
Group Supervision – “Supervisory Colleges” Group vs. Solo Capital requirements Common Assessment Framework (“ComFrame”) for Internationally Active
Insurance Groups
Solvency II Total Minimum and Target Capital Requirement “Market consistent” valuation of assets and liabilities Not just better risk based Capital Standards – Supervision just as important “Third Country Equivalence” – Reinsurance Supervision
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International – Capital (continued) NAIC
Solvency Modernization Initiative (“SMI”) Reinsurance Regulatory Modernization Act of 2009
FSB “Basel III” (Dec ’09 Draft)
Revisions to definitions of “Tier” capital and liquidity standards Tier 1 – emphasis on common equity and retained earnings
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Canadian – Financial Reporting AcSB declared adoption of IFRS in April 2008
i.e. pre-crisis and pre-G20 declaration.
“Phase I”: 2011 Canadian Asset Liability Method (“CALM”) continues to qualify under IFRS4 “Gross” Accounting for Reinsurance
“Phase II” : 2013 or Later Insurance Contracts Exposure Draft – will be released in June 2010? Discount Rate - Huge Issue
Basis still uncertain “De-linking” of asset and liability valuations Insurance Contract Policy liabilities – potential dramatic increases Earnings volatility – potential dramatic increases
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Canadian - Capital “ Life Insurer Solvency Assessment”
More risk based than MCCSR Total Minimum and Target Asset Requirement Standard Factor Approach; Internal Models Approach TBSR = “IFRS liabilities” plus Solvency Buffer
Solo/Holdco capital standards; Stress Tests
Reinsurance Response Paper More “principles” based “Expanded and reinstituted” Guideline B3 – to be released soon
Consolidation of Revoked Guideline B3 (Unregistered Reinsurance) Draft Guideline B3 (Sound Reinsurance Practices and Procedures) Draft Guideline B13 (Reinsurance Agreements)
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Bernard DupontOSFI
Regulator’s View of Necessity & Benefits of this REvolution
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Overview
• Pressure from everywhere to redesign capital requirements
• Vision of Future Framework: allowing the use of internal models for determining regulatory capital
• MCCSR standardized approach: redesign the test to use more risk-based techniques
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Driving Forces
Financial crisis• Lessons learned:
– Capital requirements do not always react as expected
– Lack of willingness to test and report on difficult situations
– Events are linked together more than we think
• Lower the guard in the long run?
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Driving Forces
International Developments
• IAIS – Bring convergence to various jurisdictions’
requirements• But high level requirements only
– Common Assessment Framework for insurers– Will we be forced to adopt these
requirements?
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Driving Forces
• Solvency II– European capital test, greatly improving
supervisory rules
• Basel II– Allows the use of internal ratings for capital
purposes, as they provide an incentive for better management and understanding of the risks
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Driving Forces
• IFRS and CIA standards– Convergence of accounting rules
• Solvency Modernisation Initiative (USA)
• Awareness and more sophisticated valuation techniques available
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Vision of Future Framework
• A minimum capital requirement, based on a standardised approach, will apply to all companies in Canada
• Standardized approach likely to be similar to current MCSSR methodology
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Vision of Future Framework
• For companies meeting minimum criteria set by OSFI, the target capital requirement will be based on internal models (one risk at a time)– Subject to limits on possible annual reduction– Based on a Total Asset Requirement basis
• For others, the target capital requirement will be based on a standardised approach
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Vision of Future Framework
• Companies will need to demonstrate their compliance with OSFI’s requirements– Criteria for the use of models in development– 3 years of parallel runs– No diversification between risks
• Reporting and disclosure requirements will need to be in place
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Vision of Future Framework
• First risks being looked at for life insurers:– Market risk– Credit Risk
• Earliest expected implementation date:– 2014/2015
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Implementation of IFRS
General principles:
- Reduce MCCSR modifications to a minimum until phase II
- When the company is given the option to retain the current accounting methodology, retain current MCCSR treatment.
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Implementation of IFRS
• Allow IFRS valuations using IAS 39 for non-insurance contracts and non-insurance components bifurcated from insurance contracts into capital
• Own-use Property:– Unrealized revaluation gains and losses will not be
included in capital.– Impact at time of adoption of fair value and valuations
changes going forward will both be excluded from regulatory capital.
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Implementation of IFRS
• Investment Property:– OSFI will require that any fair value gains or losses
upon transition and subsequent revaluation gains and losses be recognized in regulatory capital.
• Phase-in period of 2 years for most insurers
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MCCSR Standardized Approach• Standardized Approach Working Group created: participants:
OSFI, AMF, Assuris• Start modifying existing MCCSR elements that will be most
impacted by IFRS Phase II– Market and credit risk: Reserves will no longer contain
provisions to cover potential losses– Market risk: Companies required to remeasure capital
under shocks applied to interest rates and other market risk factors
– Credit risk: More refined factors, derived from Basel IRB model, based on rating and time to maturity
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MCCSR Standardized Approach
• Calibrate the elements once the results from QIS are available
• Recalibrate the elements once the results from modelling are available
• Modifications expected to be in place for 2012 or 2013
• Work on other MCCSR elements after phase II developments if necessary
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Mortality Improvement
• CIA Standard expected to be in place in 2011 allowing mortality improvement to be taken into account
• OSFI will reverse the impact on capital until the capital requirements have been assessed appropriately, likely including a QIS in 2010
• New capital requirement might be in place in 2012
• Overall review of mortality requirements after IFRS Phase II
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Reinsurance Counterparty Risk
• Reinsurance rules being changed to better reflect risks of counterparties and collateral– Need to ensure rules are consistent with those for
other types of credit risk
• Credit risk factors to be applied to reinsurance recoverables from registered reinsurers
• Credit risk charge for collateral used in unregistered reinsurance to be included in ceding company’s capital required
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Implementation Challenges
• Many moving targets being chased at the same time
• Limited amount of resources to deal with these issues
• Increase complexity of products and valuation techniques
• Impact and priorities different for the various stakeholders
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Bernard NaumannMunich Re
Reinsurer’s View of Impact on Capital Planning, Pricing and Capacity
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Required MCCSR Capital (2009)
37%
31%
17%
15%
Insurer Required Capital
Asset Default
Insurance
C-3
Seg Funds
Source: OSFI
14%
86%
Reinsurer Required Capital
Asset Default + C3 + Seg FundsInsurance
How Does Capital Affect Pricing?
• After-Tax Internal Rate of Return (AT IRR) used as Primary Pricing Measure– 10 out of top 10 companies use AT IRR– 6 out of top 10 companies target >=15% AT
IRR– 10 out of top 10 use Canadian CGAAP
Reserves and MCCSR as the capital base in AT IRR calculation
Source: Munich Re’s 2010 Individual Insurance Survey
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Mortality Improvement Assumptions
Expected Insurer / Reinsurer Effect
Reserves Decrease
Capital Increase (set to offset Reserve decrease)
Price Pressure Minimal expected in short term
Comments •After Tax IRR takes into account Capital + Reserves•Net effect on Price Pressure depends how offset is taken into account (tax effected)•OSFI will likely revisit in 2012+
The Actuarial Standards Board has drafted a change to its Standards of Practice to allow mortality improvement assumptions in policy liabilities. This Standard is expected to become effective in 2011.
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Reinsurance Counterparty Risk
Expected Insurer Effect Expected Reinsurer Effect
Reserves No effect No effect
Capital Increase (<1%) Increase (<<1%)
Price Pressure Increase (<<1%) Increase (<<<1%)
Comments •Could solidify a ‘flight to quality’ with the higher rated reinsurers•Minimal effect on reinsurer pricing or capacity
In 2012+, a reinsurance counterparty charge will be implemented for the Life Sector.•The C-1 factor will be applied against ceded reserves and recoverables
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IFRS Phase I Changes
Expected Insurer/Reinsurer Effect
Reserves None
Capital Available capital to decrease e.g. due to increased pension plan liabilities
Price Pressure Minimal
Comments •Despite Gross Accounting of Reinsurance, MCCSR will continue to apply factors on a net basis•Pension plan liabilities increase may be significant
The following changes will be implemented in 2011:•Gross Accounting of Reinsurance•Other (e.g. Full Recognition of Pension Plan Deficits)
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IFRS Phase II Changes
The following changes to be implemented in 2013+:•Removal of CALM – Liabilities and Assets de-linked
Expected Insurer Effect Expected Reinsurer Effect
Reserves Increase Increase; although not as significant as Insurers
Capital Avail capital to decrease Avail capital to decrease
Price Pressure Increase on long-tailed business
Increase on coinsurance business; Minimal on YRT
Comments •Methodology is unknown•Canada is only country where stat res = GAAP res•Expected volatile reserve results = volatile avail cap.•Pressure to move away from long-tailed business
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Solvency II
Expected Foreign Insurer/Reinsurer Effect
Reserves None
Capital Increase on long-tailed business
Price Pressure Increase on long-tailed business
Comments •Pro-cyclicality an issue•Given reinsurers write primarily YRT business, the discounting effect is not as significant as coinsurance•Solvency II seen as a ‘catch-up’ to MCCSR – level international playing field?
Solvency II is not officially planned to be adopted by OSFI•However, for those companies with European parents, Solvency II could be used as a capital base in IRR calculations
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Reinsurance Response Paper
Expected Insurer/Reinsurer Effect
Reserves None (unless B-3 not followed!)
Capital None (unless B-3 not followed!)
Price Pressure None
Comments •B-3 must be followed to receive credit•B-3 to be released in 2010•Increased due diligence on reinsurance usage
The following changes are expected to be implemented in 2010:•Repeal 25% unregistered reinsurance limit (P&C Only)•Repeal 75% fronting limit (P&C Only)•Reinsurance Governance (Guideline on Corp Governance, B-3, B13 “New B-3” Guideline on Sound Reinsurance Practices and Procedures)
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Reinsurance Capacity Speculation
Increased Reinsurance Capacity Decreased Reinsurance Capacity
IFRS II implementation may lead to more capital infused into Canada through reinsurance
Increased price pressure may reduce reinsurance demand
Solvency II may entice other reinsurers to enter Canada
Increased risk management may reduce reinsurance demand
Difficult to say – many moving pieces!
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Reinsurance Pricing Summary
Overall, minimal reinsurance pricing impact for YRT deals.
IFRS II potentially resulting in higher coinsurance terms
2012+ is key due to IFRS II and OSFI’s view on Mortality Improvement in MCCSR
B-3 Implementation is key!
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