The Office of the Superintendent of Financial Institutions has issued a consultation paper on possible reforms of the capital rules for life insurers.

Over the last year, OSFI has been consulting with the life insurance industry on the general direction future life insurance capital rules should take, it notes. So, given the issues raised in those talks and new international regulatory developments, OSFI has prepared a consultative paper summarizing its findings and making a proposal for further work. Institutions are invited to provide comments by March 31.

That paper reports that current initiatives that may result in changes to the capital rules include:

  • reviewing the reporting of negative reserves and cash surrender value deficiencies and consulting the industry regarding more explicit definitions;
  • working with the Canadian Institute of Actuaries to develop a methodology that better measures mortality risk;
  • working with an external consultant to refine capital requirements for segregated fund guarantee risk with particular attention to investment return and lapse risk assumptions; and
  • consulting with the industry on a capital framework for holding companies that will recognize capital tests in certain foreign jurisdictions where Canadian companies have significant foreign Life subsidiaries.

OSFI notes that the insurance industry has monitored the development of new capital rules for banks, known as Basel II, and has expressed an interest in adapting some elements of its more risk-sensitive approach into insurance capital rules. Many of the more risk sensitive elements of the Basel II standardized approach for credit risk are already included in the insurers’ rules, OSFI says, but adds consideration could be given to incorporating “the expanded recognition of collateral and guarantees, special treatment of retail loans and modification of securitization rules. In addition, operational risk is not specifically measured.”

The regulator reports that current capital adequacy formula does not take into account all the risks incurred by an insurer. “Examples of potentially significant risks not included are operational risk, foreign exchange mismatch related to surplus and assets backing surplus, and counterparty risk related to reinsurance.” It notes that, “the definition of operational risk in an insurance context will need to be reviewed. For example, past experience has shown problems with product design and marketing are large operational risks for insurers.”

Other examples of changes that could be considered include: a capital requirement for counterparty risk with respect to business ceded to registered life insurers; adjustments due to changes in accounting for financial instruments and insurance contracts; introduction of an explicit operational risk charge in place of the current implicit approach; and, changes to align the MCCSR more closely to the Basel II framework.