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.