In early September, the Office of the Superintendent of Financial
Institutions (Canada) (OSFI), Canada's prudential regulator
of domestic life insurance companies and foreign life insurance
company branches, released its first-ever Life Insurance Regulatory Framework
paper.
The paper, which includes a number of noteworthy themes and
elements, is intended to provide regulated life insurance companies
and industry stakeholders with an overview of OSFI's current
approach on regulatory initiatives affecting the industry. To that
end, the paper outlines the key elements in the evolution of
OSFI's regulatory framework, the aim of which is to achieve the
following broad objectives:
- life insurance companies' governance infrastructure and culture fully oversee their risk-taking through increased integration between risk measurement, risk management and risk pricing;
- OSFI's regulatory framework continues to support and complement this risk-governance and information-sharing culture; and
- life insurance companies provide transparent information, allowing stakeholders to better understand the insurance business and companies' risk-taking activities and challenge institutions to continue to better measure and manage their risks.
To achieve these objectives, OSFI intends to introduce
enhancements to the regulatory framework through:
- increased corporate governance guidance, including the new draft Corporate Governance Guideline released for comment in August, as well as other guidance addressing how companies should approach their Own Risk and Solvency Assessments (ORSA);
- revised regulatory capital requirements guidance; and
- additional disclosure to support the revised regulatory capital requirements.
OSFI acknowledges in the paper that life insurance companies are
in many ways significantly different from banks, particularly due
to the long-term nature of traditional life insurance coverage.
Consequently, in considering international regulatory and
accounting developments, OSFI will not indiscriminately implement
any of them (e.g. Basel III) into the life insurance industry.
Rather, OSFI recognizes that changes must be evolutionary rather
than revolutionary and, notably, OSFI is approaching the review of
regulatory capital requirements with the view that, in the
aggregate, the life insurance industry currently has adequate
financial resources for its current risks.
OSFI expects that, for life insurers, the cumulative impact of the
initiatives will be that:
- boards of directors may need to be augmented with a broader set of skills;
- companies may need to devote additional resources to governance and risk management;
- capital levels may change in order to meet internal capital targets set by boards of directors;
- regulatory capital may need to be re-allocated to various risks or business lines, which may have implications for business models and strategies; and
- capital will improve in terms of its ability to absorb losses, from the perspective of both a "going concern" and a "gone concern" basis.
The bulk of the paper addresses risk management and governance
and evolving regulatory capital requirements. With respect to risk
management, OSFI notes that its revised framework will more
expressly emphasize the principle that companies have primary
responsibility for measuring and managing their risks.
Consequently, OSFI's approach to risk management and governance
will be primarily "principles-based" and applied
consistently to all federally-regulated financial institutions. The
related OFSI guidance will underscore that the primary
responsibility for the safety and soundness of financial
institutions lies with senior management and boards of directors.
OSFI recognizes that different institutions will implement
different governance structures, and its guidance and related work
is meant to explain OSFI's expectations without being overly
prescriptive in respect of how a company implements them.
With respect to ORSA, OSFI notes that each institution has its own
risk appetite and history of risk-taking. The minimum capital
requirements set out in OSFI's regulatory framework may not be
adequate to address such institution-specific risk-taking, as the
regulatory capital requirements are based on industry averages
which, at any point in time, may not fully capture new risk
exposure or product developments. For this reason, institutions
should have their ORSA process, which represents an insurer's
view of its risks and solvency requirements. OSFI guidance will be
provided in an ORSA guideline that will describe principles for
setting internal capital targets and OSFI's expectations with
respect to reporting and controls that should be established to
ensure the integrity of the ORSA process. In OSFI's view, ORSA
should not be viewed as an OSFI compliance exercise but rather as a
sound business practice. OSFI plans to issue draft ORSA guidelines
for public comment later this year.
With respect to internal models, OSFI notes that internal models
can currently only by used to determine the regulatory capital
requirements for segregated fund guaranty risk by those companies
that can demonstrate the capability to do so. In the future, OSFI
may eventually consider the use of internal models for other risks.
In the longer term, those models may eventually qualify to be used,
with limitations and/or subject to floors, for measuring minimum
regulatory capital requirements. OSFI plans to issue a draft
guideline on capital models in the summer of 2014.
With respect to evolving regulatory capital requirements,
OSFI's objective is to improve its regulatory capital approach
by taking a more comprehensive approach, improving risk measurement
and taking into account specific integrations and considerations.
As noted above, OSFI is approaching this review with the view that,
in aggregate, the industry currently has adequate financial
resources for its current risks. OSFI is also developing a new
methodology for segregated fund guarantees to determine the
appropriate level of regulatory capital required to support these
liabilities. Overall, the revised regulatory capital requirements
are expected to be similar in many respects to the current
regulatory framework. The evolution of the regulatory capital
requirements into a more risk-sensitive framework may result in
more volatile regulatory capital requirements (capital available
and/or capital required). OSFI will consult with the industry to
assess whether that volatility provides a true reflection of the
evolution of the risk and is thus "appropriate" for
purposes of setting regulatory capital requirements, or whether the
volatility in capital requirements amplifies the variations in risk
and is thus "inappropriate". Where necessary, OSFI will
consider measures to address inappropriate volatility.
Consultations with industry on a variety of regulatory of capital
workstreams will continue through to 2014 and are planned for
implementation over the 2014 to 2016 period. To assist with the
development of these components, OSFI is using a number of
Quantitative Impact Studies (QIS), three of which have been
conducted and two of which are planned for 2012 and 2013. As part
of the consultation process, OSFI will be releasing draft papers
over the next few years on a number of issues, including
requirements for measuring total assets, segregated fund
guarantees, the definition of capital, and operational risk.
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