­­A key yardstick for measuring the risk that a lifeco won’t have enough money to pay claims is about to change. While it’s too early to predict how the change will affect balance sheets, the federal solvency regulator is trying to avoid major changes to key lifeco solvency metrics.

The Office of the Superintendent of Financial Institutions (OSFI) has modified the life insurance capital adequacy test (LICAT) to help OSFI understand how companies perform under International Financial Reporting Standard (IFRS) 17, EY Canada insurance leader Janice Deganis said. The LICAT change, which OSFI released on July 21, has “been in the works for three years now,” Deganis said.

IFRS 17 replaces IFRS 4 as of Jan. 1, 2023, and the revised LICAT — a 217-page document — takes effect the same day.

The new LICAT won’t change the financial health of a life insurer, said Steve Prince, head of RSM Canada’s stochastic modeling unit and president-elect of the Canadian Institute of Actuaries.

“It’s about as neutral as you could get under the new accounting rules with the corresponding changes in the capital rules,” Prince said. Life insurers will still issue the same policies and still pay the same claims, he added.

But until the new LICAT is actually in place, “nobody knows for sure” whether it will significantly change the way a life insurer is valued, Prince said.

“A lot of work has gone into making sure it hasn’t changed anything. OSFI has added the caveat that under new rules, we will see how things shake down. Maybe companies will adjust their operating strategies a bit because of the new accounting rules and therefore, possibly, LICAT rules should also be reviewed in a year or two,” Prince said.

One previously released part of IFRS 17 is the contractual service margin (CSM), which essentially means that profits from a multi-year contract should be booked over the contract’s length, not in the year in which the contract is initially signed.

CSM is one of the most significant changes resulting from IFRS 17, Prince said.

“Life insurance accounting in Canada used to allow you to front-end profits to some extent. And under the new rules with the CSM, you can’t. You set up a CSM and then you release that over the life insurance policy. So the timing of profits can be significantly different with these new accounting rules,” Prince said.

The Canadian life insurance space involves some long-term contracts, Deganis said: “So if you take out your life insurance policy when you’re 20, you hope that’s a 60-year policy. So that creates a very large, long kind of CSM.”

The LICAT — which OSFI has been using since 2018 to assess each life insurer’s financial condition — is a complex formula based on several numbers, including available capital, liabilities, insurance risk and credit risk, among others. Until 2018, OSFI used the minimum continuing capital and surplus requirements. The LICAT ratio must be at least 90%, and the larger the ratio, the better.

On June 30, LICATs for Canada Life, Sun Life Assurance and Manufacturers Life Insurance Company were 117%, 124% and 137% respectively.

Great-West Lifeco Inc. will begin reporting under the new LICAT in its March 31, 2023 filing, the Winnipeg-based insurer said on Aug. 3.

“Based on an initial review of the guideline under the current market and economic conditions, the company expects a positive impact to the March 31, 2023 LICAT ratio on transition,” Great-West said in its Q2 2022 earnings release. “The actual impact will depend on market and economic conditions and the company’s operating results at the time of transition.”

In its July 21 letter to life insurers, OSFI highlighted other key revisions to the LICAT 2023 guideline. Among them are a requirement for lifecos to use IFRS 9 to specify credit risk requirements and to stop multiplying the denominator in the LICAT by 1.05.