The Office of the Superintendent of Financial Institutions has put the finishing touches on the capital adequacy test for life insurers. The new test features more stringent risk and capital ratios.

When it takes effect on January 1, 2018, the Life Insurance Capital Adequacy Test (LICAT) will mark the end of a chapter that lasted over 25 years. The current Minimum Continuing Capital and Surplus Requirements (MCCSR) have prevailed since 1992.

“The LICAT guideline represents an important evolution in OSFI’s regulatory capital expectations […] It provides a risk-based capital framework that will continue to protect policyholders, while allowing the industry to compete and take reasonable risks,” superintendent Jeremy Rudin explains.

The product of consultations held in April and May 2016, this new adequacy test targets federally chartered life insurers. The consultations yielded 22 technical changes to the MCCSR. The LICAT integrates many business practices and risk management techniques adopted in the last quarter century. It also reflects the OSFI’s changes in capital adequacy expectations.

Recently, the regulator noted that the MCCSR does not explicitly measure some risks that are very weighty for life insurance companies. The regulator points out that the LICAT will better convey the insurer’s capacity to absorb losses from its capital available during a crisis, and its ability to protect underwriters.

“The new guideline takes into account lessons learned from the financial crisis, recent developments in financial reporting standards, actuarial standards, economic and financial practice, and international advancements in solvency frameworks,” the OSFI points out.

The Office claims that it shaped the new guideline based on the results of its quantitative impact studies (QIS). This series of recent studies aims to regularly test the insurance solvency buffer, should a large-scale crisis recur.

Theory and practice better aligned

The regulator’s risk quantification considered the global landscape. “The OSFI developed the LICAT to better align capital and risk measures with the economic realities of the life insurance business, while taking into account international advancements in the development of solvency frameworks,” says a notice published in September. The Office adds that it has worked closely with Quebec regulator, the Autorité des marchés financiers, and Assuris, the Canadian corporation that protects insured, to develop the new test.

The OSFI adds that the guideline corrects important problems with the current test. In the future test, some components of the available capital will be of higher quality than under the MCCSR system. “Items subject to write-downs during periods of stress have been re-evaluated and their capital treatment adjusted accordingly. Also, the base solvency buffer is more sensitive and captures finer elements of credit, market, insurance and operational risks,” the OSFI explains. 

The OSFI also updated the definition of available capital. Deductions and adjustments are applied at the same level as that of losses. Subject to write-downs during crisis periods, goodwill and intangibles were re-evaluated, along with deferred tax assets.

The LICAT also draws on more advanced risk-based techniques to measure operational, credit, market and insurance risks. “All risks are measured or estimated to the extent possible at a consistent level of confidence,” the OSFI points out. It foresaw risk-sensitive measures that can determine the capital credits to attribute to products with risk-sharing, and credits for risk diversification.

Same targets, different behaviour

Insurers’ capital requirement should not change much compared with the MCCSR, the OSFI says. The current minimum ratio under the MCCSR is 150%. It stays the same for the new test. The minimum core and capital ratios of the LICAT have been set at 90% and 60% respectively, for a total of 150%.

The target core and capital ratios of the LICAT have been set at 100% and 70%, respectively. The core represents the category 1 capital amount available to cover the solvency buffer.

Even if the minimum requirement is unchanged, the OSFI foresees that overall, the LICAT ratios will act very differently from those of the MCCSR. “A simple comparison of the two sets of ratios will therefore be difficult,” the regulator explains. It adds that this new framework may require some institutions to evaluate all their plans according to their sectors, the risk exposure they choose and their risk management.

“…the LICAT provides a framework that improves the overall quality of available capital, provides greater risk sensitivity, better measurement of certain risks and closer alignment of risk measures with the economic realities of the life insurance business,” assistant superintendent, Regulation Sector, Carolyn Rogers sums up.


OSFI still concerned about low interest rates

In a letter sent to designated actuaries at insurance life companies in September, the Office of the Superintendent of Financial Institutions mentioned that sustained weakness of interest rates is a cause for concern.

“As a result, OSFI requires disclosure for scenarios of 0.5%, 1.5%, 2%, 2.5% and 3% for all future reinvestment assumptions,” says the letter, signed by Chris Townsend, senior director, Actuarial Division, Regulation Sector.

The OSFI has also set requirements for additional information on internal control of insurance contract liabilities and changes to methods and assumptions. For standardization purposes, the term reinsurance asset has been replaced by amounts receivable and recoverable from reinsurers. The changes affect the Life Memorandum to the Appointed Actuary, which the OSFI updates each year, as required by the Insurance Companies Act.