Actuarial Notes

Financial Condition Testing

By Canadian Institute of Actuaries · 2025 · 225095

Study guide: Exam 6C

A CIA educational note guiding actuaries of life and P&C insurers in performing financial condition testing under Section 2500 of the Standards of Practice. Prepared by the Committee on Risk Management and Capital Requirements and dated August 27, 2025 (document 225095), it updates the note first published in April 2020 and revised for IFRS 17 in January 2023; the 2025 version expands the guidance on defining and reporting management actions and adds references and examples on cyber and climate risk.

On the syllabus

  • Exam 6C — objectives C4 and C5; the August 2025 note, with no sections excluded.

Preamble

  • 2025 Updates
  • Process
  • Your feedback

1 Introduction

  • Financial condition testing is one of various stress-testing processes within the insurer's overall risk management; its principal goals are to identify possible threats to the insurer's financial condition and the risk management or corrective management actions to address them, and it should not be viewed as merely a compliance exercise.
  • Its key elements are a base scenario, adverse scenarios, analysis of corrective management actions, a report to management and the board of directors or chief agent, and an opinion signed by the Appointed Actuary.

2 Method

  • Process
    • FCT and the ORSA both relate risk to capital and are complementary, so some consistency between the two processes would be expected.
  • Approach
  • Recent and current financial position
  • Forecast period
    • A typical forecast period is three to five fiscal years, long enough to capture a scenario's impacts, including ripple effects, and the recovery from corrective management actions.
  • Materiality standard
    • The materiality standard is usually less rigorous than for the valuation of insurance contract liabilities, and more rigorous as capital ratios approach the threshold for a satisfactory opinion.
  • 2.1 Scenario determination
    • a. Base scenario
    • b. Adverse scenario selection and assessment of percentile ranking
      • i. Solvency scenarios
      • ii. Going concern scenarios
      • iii. Integrated scenarios
      • A solvency scenario, recommended at least at the 95th percentile, tests whether assets stay above liabilities; a going concern scenario, at least at the 90th percentile, tests whether the regulatory minimum capital ratios are met; at least two solvency, one going concern and one integrated scenario are recommended.
      • Reverse stress testing may be used to develop adverse scenarios and to find how far a risk factor must move to breach a threshold.
  • 2.2 Ripple effects and corrective management actions
    • a. Ripple effects
      • A ripple effect occurs when an adverse scenario triggers a change in interdependent assumptions or risk factors, and may include policyholder, routine management, regulatory and rating agency actions.
    • b. Corrective management actions
      • Actions outside the normal course of business that require escalation beyond routine management actions — for example non-routine rate increases, raising capital, a new reinsurance arrangement or suspending dividends — are corrective.
    • c. Classification of management actions
      • The actuary establishes and describes in the FCT report the threshold that classifies an action such as repricing as routine or corrective.
  • Recent Events

3 Modelling

  • Basic requirements of the model
  • IFRS 17 modelling considerations
    • The FCT model reflects the CSM, loss component and loss recovery component; offsetting a loss component on onerous cohorts with future profits on non-onerous cohorts is not permitted.
  • Model reasonability
    • The model's validity is typically tested with the base scenario, expecting continuity from the most recent actual results to the first projected year.
  • Modelling of ripple effects
  • Organizational considerations

4 Reporting

  • The FCT report is recommended to include at least three scenarios — at least one going concern and two solvency scenarios — and to disclose how each scenario's percentile ranking was assessed.
  • FCT and ORSA integrated report
    • The actuary may report on FCT alone or consolidated with the ORSA, which would include the AA's independent FCT opinion; oversight of FCT lies with the AA, while accountability for the ORSA lies with senior management under board oversight.
  • Disclosure of routine management actions and corrective management actions
  • Investigation and report
    • 1 Executive summary
    • 2 FCT opinion
    • 3 Introduction
    • 4 Results
    • 5 Capital management and adequacy measurement
    • 6 Background discussion
    • 7 Base scenario
    • 8 Adverse scenarios
    • 9 Conclusions and recommendations
    • 10 Appendices
    • Financial condition is satisfactory if, throughout the forecast period, assets exceed liabilities under the solvency scenarios, the regulatory minimum capital ratios are met under going concern scenarios, and the internal target capital ratios determined by the ORSA are met under the base scenario (SOP 2520.09).
    • The opinion remains satisfactory if corrective management actions under the insurer's control are needed to meet a threshold, with those actions disclosed; it is not satisfactory if a threshold is missed even with them, or if the AA is not comfortable with the actions.

Appendices – Discussion and analysis of risk categories

  • For each risk category the appendices give guidance on possible adverse trends, ripple effects and management actions; an insurer writing material life and P&C business would consider both appendices.

Appendix A – Life insurers

  • 1 Mortality risk
  • 2 Morbidity risk
  • 3 Persistency and lapse risk
  • 4 Market and credit risk
  • 5 Inflation risk
  • 6 Reinsurance risk
  • 7 Business volume and mix risk
  • 8 Expense risk
  • 9 Government and political issues risk
  • 10 Off-balance-sheet items risk
  • 11 Related companies risk
  • 12 Climate-related risks
  • 13 Technology and cyber risk

Appendix B – Property and casualty insurers

  • 1 Claim frequency and severity risk
    • Adverse scenarios include single and multiple catastrophic events, single and multiple large claims, and social inflation; ripple effects include reinsurer insolvency, loss of reinsurance coverage, higher reinsurance rates at renewal, post-event inflation and increased PACICC assessments.
  • 2 Liability for incurred claims risk
    • Adverse scenarios include inadequate loss development factors, class actions and new case law effective retroactively, a shift to longer-tailed business, and claims paid faster than assumed.
  • 3 Inflation risk
  • 4 Volume and mix of business risk
  • 5 Reinsurance risk
  • 6 Market and credit risk
  • 7 Expense risk
  • 8 Government and political risk
  • 9 Off-balance-sheet items risk
  • 10 Related companies risk
  • 11 Climate-related risks
  • 12 Technology and cyber risk

Appendix C – Other Considerations

  • IFRS 17 considerations
    • For the threshold for a satisfactory opinion under solvency scenarios, the statement value of an insurer's liabilities includes the CSM.

Related readings

  • CIA CSOP — the Standards of Practice, whose Section 2500 this note gives guidance on and quotes throughout
  • CIA FCT 2 — the CRMCR's 2025 guidance, in line with which the 2025 update expanded its cyber and climate risk references and examples
  • OSFI Stress Testing — Guideline E-18, referred to in §1 for the definitions of stress testing
  • OSFI Target Capital — Guideline A-4, which §2.1 cites for the capital resources a going concern scenario must maintain
  • OSFI ORSA — Guideline E-19, whose guidance a consolidated FCT and ORSA report would include
  • OSFI AA — Guideline E-15, quoted in §2 on reflecting recent events
  • CIA Subsequent Events — the educational note §4 refers to for adverse events after the report date

Sources