Guaranteed Withdrawal Benefits under pressure from regulators

The Office of the Superintendent of Financial Institutions (OSFI) and Quebec regulator, the Autorité des marchés financiers (AMF), have each launched a consultation on changes to their regulatory capital requirements for life and health insurance companies. Both regulators have set October 22, 2024 as the deadline for their consultation.

In its public consultation document presenting the version under consideration of its Life Insurance Capital Adequacy Test (LICAT) – Guideline 2025, OSFI says it is developing a new framework for determining risk-based capital requirements for segregated fund policy guarantees. The Canadian regulator points out that the final version of the guideline will be published on November 21, 2024, and will come into effect on January 1, 2025.

The new framework includes a capital surcharge based on unhedged or undervalued risks, as stated by the AMF in its consultation document on the version of the Life Insurance Capital Adequacy Test (LICAT) currently under review.

Impact on segregated funds  

The Canadian Institute of Actuaries (CIA) has responded to OSFI's consultation on the current version of the LICAT. In its comments sent to OSFI on May 30, 2024, the CIA adds that it will do the same with the Quebec regulator regarding the version of the LICAT under consideration.

Actuaries say the impact on required capital could be significant, since it is measured as a percentage of required capital for segregated fund guarantees. “The CIA would encourage OSFI/AMF to keep the level of required capital for operational risks for segregated funds unchanged as it is not expected that insurers’ operations will be different in 2025, other than the calculation of the capital requirement for segregated fund business,” says the association.

OSFI has set the ratio of its target level of regulatory capital resources to be met by life and mortgage insurance companies at 100%. The minimum ratio has been set at 90%.

The CIA's comment letter on the revisions to Segregated Fund Guarantee (SFG) Capital Quantitative Impact Study (QIS) 7 is entitled Draft LICAT Guideline – Segregated Fund Guarantee Capital Framework. 

Risks ignored  

The Canadian Institute of Actuaries notes that OSFI's proposed framework takes into account a greater number of risks associated with segregated fund guarantees than the current framework. However, it is concerned that OSFI has postponed consideration of certain risks. These include interest rate risk, foreign exchange volatility risk, basis risk and future deposits risk. “These items may be material and should be considered in the calibration of the standard approach,” write the authors of the letter.

The actuaries are also concerned that OSFI's approach is based on the IFRS-17 valuation of insurance contracts. In their view, this approach may reward an insurance company that uses less conservative accounting methods and assumptions, by recognizing higher available capital.

The CIA also believes that a “smoothing” mechanism should be used to mitigate the volatility of required capital against segregated fund guarantees from quarter to quarter. It advocates the use of a mechanism similar to that permitted under the current framework.

The letter adds that some elements in the proposed framework “remain operationally complex for many companies” who must calculate them quarterly. “We welcome the opportunity to discuss with OSFI and the AMF in the future where approximations may be appropriate,” writes the Institute in its comments.

Fragile market  

Guaranteed Minimum Withdrawal benefit funds can be an important part of a retirement income strategy. However, several insurers who used to offer this product have stopped selling it over the years. The market was born with the launch of IncomePlus by Manulife in October 2006, imitated by several others in the years that followed. This market is now suffering from a lack of supply.

Only three insurers have told InsuranceINTEL, the insurance product information centre owned by the Insurance Journal Publishing Group, that they offer segregated funds with guaranteed withdrawal benefits: Empire Life (Class Plus 3.0), iA Financial Group (IAG Savings and Retirement Plan – FORLIFE Series) and Sun Life (Sun GIF Solutions - Income Series and Sun Lifetime Advantage GIF). Sun Life was the second player to join the market, in April 2007. Desjardins Insurance followed that fall with its Helios product.

After the financial crisis of 2008, insurers successively exited the market or replaced their product with a formula that was less demanding in terms of the regulatory capital required to maintain the lifetime guarantee. This is the case for iA Financial Group. After withdrawing Ecoflextra from the market for segregated fund products with lifetime withdrawal guarantees in 2012, the Quebec-based insurer launched the FORLIFE Series two years later. A product it described at the time as less capital-intensive and better adapted to the current regulatory environment.

Segregated fund withdrawal guarantees allow the policyholder to withdraw an amount for life. Empire Life guarantees the greater of market value or 75% of net deposits to the segregated fund. iA Financial Group and Sun Life specify that they guarantee 75% at maturity (the year in which the annuitant reaches age 100 at iA and age 105 at Sun Life). A benefit is paid on the death of the fund owner. The fund's minimum income rate is based on a percentage that will be higher when withdrawals begin at a later age.

Disbursement issues at retirement  

Some sources fear that the tightening of regulatory capital requirements will harm the few remaining products. Among them, Carlos Cardone addressed the subject in an interview as part of the special feature on segregated funds in the September 2024 issue of the Insurance Journal. The Managing Director of ISS Market Intelligence in Canada (formerly Investor Economics) believes that the proposed changes will have little impact on traditional segregated funds.

The same cannot be said for segregated funds with minimum withdrawal guarantees, says Cardone. “Changes in some OSFI capital requirements brings almost no changes for segs overall, but the GWB cost will increase. That will push carriers to get out from GWBs or bring changes to them. OSFI changes are not firm yet,” he added. 

The timing doesn't seem right, he said. “At times like these, with so many Canadians retiring, how can the Canadian government make policies that put GWBs (out of the market)?” questions Cardone, adding that this is his opinion, and not that of ISS.

A survey conducted by Sun Life in collaboration with the Canadian Association of Retired Persons (CARP) elicited over 3,500 responses. Among other things, it revealed that 43% of retirees fear that their savings will run out during their lifetime.