Following public consultation, the Office of the Superintendent of Financial Institutions (OSFI) recently published the final versions of new Guideline E-19: Own Risk and Solvency Assessment and amended Guideline A-4: Regulatory Capital and Internal Capital Targets (the Guidelines). Both Guidelines have an implementation date of January 1, 2014, and require action in the first quarter of the New Year. In this bulletin, we set out what federally regulated insurers need to know about these Guidelines, as well as some of their history.
OSFI also recently provided an update on the progress it is making on implementing the Life Insurance Regulatory Framework published in September 2012, including revised timelines. The update is summarized below.
WHAT IS AN OWN RISK AND SOLVENCY ASSESSMENT (ORSA)?
OSFI intends an ORSA to be a comprehensive approach to the analysis and management, by an insurer, of its capital requirements. In part, it subsumes the current Dynamic Capital Adequacy Testing (DCAT) and capital target requirements, and integrates them with the insurer's risk management function.
An ORSA is a comprehensive risk assessment process, and it is meant to be integrated with the insurer's enterprise risk management and other management processes. An insurer's board of directors (or the Chief Agent in the case of the Canadian operations of a foreign insurance company) is responsible for overseeing the ORSA and any changes to the ORSA, though the associated tasks may be delegated to senior management. The ORSA should be performed on a regular basis and should be clearly and formally documented in a report to the board (or Chief Agent) at least annually or more often if warranted. An insurer should conduct regular reviews of its ORSA process for integrity, accuracy and reasonableness, and the ORSA should also be subject to periodic objective reviews (internal or external).
OSFI describes an ORSA as a dynamic, forward-looking self-assessment process that is intended to enhance an insurer's understanding of the connection between its risk profile and capital needs. OSFI states that there is no single correct approach to an ORSA and requires that each insurer tailor its ORSA to its own risk profile and appetite, and to the nature, scale and complexity of the insurer. However, Guideline E-19 provides that an insurer's ORSA should contain, at a minimum, the following five key elements:
- Comprehensive identification and assessment of risks
- Relating risk to capital
- Board oversight and senior management responsibility
- Monitoring and reporting
- Internal controls and objective review
The risk identification process should identify, define and assess the materiality of all known, reasonably foreseeable, emerging and other relevant risks that may have an impact on an insurer's ability to continue operations, in both normal and stressed situations. The assessment should include all material risks, whether they are explicitly captured in the regulatory capital framework or not, as well as risks that are not easily quantifiable, such as the risks associated with reinsurance, hedging or securitization transactions, or with cross-border activities.
An insurer's determination of its own capital needs and the setting of internal target capital levels accordingly will now be key aspects of the insurer's ORSA process. Insurers should determine whether, for each risk, an explicit quantity of capital should be held and how the results for each risk should be aggregated. Insurers' capital assessments should reflect their own choice of data sets, distributions, measures, confidence levels, time horizons, valuation approaches, financial tools and methodologies. However, the approaches and tools used should be calibrated to determine the total amount of capital needed to cover extremely severe losses. Insurers are also expected to consider publications and professional and other research materials dealing with quantification of risks and risk mitigants.
Once an insurer has determined its own capital needs, it must establish its internal target capital levels, and OSFI's expectations for this process are still set out in Guideline A-4. The recent changes to Guideline A-4 incorporate the concept of an ORSA and make Guideline A-4 consistent with new Guideline E-19. In determining target capital levels, insurers must (as they are already doing) consider the impact of a range or series of adverse scenarios of varying nature or severity and their ability to avoid supervisory interventions or continue as a going concern, but now this function is encompassed within an ORSA. The results of stress testing, along with other single and combined forward-looking stress and reverse stress tests, including an insurer's DCAT scenarios, should be directly incorporated, referenced or otherwise used in an ORSA for setting the insurer's internal capital targets.
WHO IS SUBJECT TO AN ORSA?
Guideline E-19 applies to all federally regulated life and property and casualty insurers in Canada, including Canadian operations of foreign life and property and casualty companies operating in Canada on a branch basis, as well as fraternal benefit societies operating in Canada.
An ORSA can be prepared on an individual insurer basis or on a group basis (Group ORSA). However, when an insurer's business and risk profiles or circumstances are not adequately reflected in a Group ORSA, OSFI expects the insurer to have a separate ORSA that covers only the consolidated Canadian operations of the insurer and not the operations of its parent, home office or other related insurers. In response to industry comments on this issue, OSFI has said that while it does not seek to create duplicative or redundant work for insurers, an OSFI-regulated insurer operating in Canada is expected to comply with OSFI guidance.
WHERE DID AN ORSA ORIGINATE?
The term "ORSA" originated in the United Kingdom in the mid-2000s when the Financial Services Authority developed the concept of an "Own Risk and Capital Assessment." The European Commission endorsed the concept and embedded it within the Solvency II Directive (changing the word "Capital" to "Solvency"). In recent years, the International Association of Insurance Supervisors (IAIS) included an ORSA as one of its insurance core principles. Insurance regulators in a number of different countries have implemented an ORSA principle or are in the process of doing so.
WHY IS OSFI IMPLEMENTING AN ORSA IN CANADA?
Canada is an IAIS member, and this is another example of OSFI importing an international principle into its local regulatory framework. OSFI regularly monitors international practices and considers whether it is appropriate to implement international standards in Canada. OSFI's predisposition to adopt standards from international organizations in which it is a participant continues with an ORSA.
Following the global economic crisis, OSFI increased its emphasis on internal risk assessment, as illustrated in its updated Corporate Governance Guideline, which was published earlier this year (see Blakes Bulletin: OSFI Releases Final Corporate Governance Guideline, February 2013). In implementing an ORSA, OSFI is further emphasizing for insurers the importance of linking the enterprise-wide risk assessment process with the determination of the capital needs of the insurer.
WHEN MUST THE ORSA BE IMPLEMENTED?
The Guideline Impact Analysis Statement issued with the new Guidelines indicates that implementation of the Guidelines is expected to occur throughout 2014. OSFI approval of an ORSA is not required. In a letter to insurers released when the final Guidelines were published, OSFI said that, while the Guidelines will have an effective date of January 1, 2014, OSFI recognizes that a number of insurers will not immediately meet all of the expectations of the Guidelines. OSFI also stated in the letter that it expects insurers to make their initial ORSA report available to OSFI at some point in 2014 and has requested that insurers inform their relationship manager by March 31, 2014, of the expected date in 2014 when the first ORSA report will be available. In reviewing the initial ORSA report, OSFI said it will take into consideration the time required for board education and for developing/implementing necessary processes.
Going forward, Guideline E-19 provides that OSFI may review an ORSA and, upon request, the ORSA reports made to the board to determine whether an ORSA is consistent with OSFI's own understanding and assessment of the insurer's risk appetite and risk profile. The depth and frequency of supervisory review of an insurer's ORSA will be proportional to the nature, scale and complexity of its activities, and the risks assumed by an insurer as assessed through OSFI's supervisory framework.
UPDATE ON IMPLEMENTATION OF OSFI LIFE INSURANCE REGULATORY FRAMEWORK
In September 2012, OSFI issued its Life Insurance Regulatory Framework (the Framework), which outlines OSFI's priorities and initiatives with respect to the life insurance industry. The Framework addresses issues such as corporate governance and risk management, evolving regulatory capital requirements and promoting the transparency of information by life insurance companies. OSFI's updated Corporate Governance Guideline and new Guideline E-19 are specific enhancements to the Framework that OSFI has introduced in the last year.
OSFI has updated its timelines for implementing its various regulatory capital initiatives set out in the Framework. Notably, the milestone for finalizing the life insurance capital framework has been shifted from 2014 to 2016, with implementation now targeted for 2018 (originally 2015). The revised timeline is to provide OSFI with more time to consult with industry stakeholders and to develop the framework components, and also gives life insurers more time to prepare for the upcoming changes. In addition, work on developing an internal models framework for segregated funds has been halted to accelerate the development of the standardized approach for segregated funds.
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