Actuarial Notes

Regulatory Capital and Internal Capital Targets

By Office of the Superintendent of Financial Institutions · 2017 · Guideline A-4

Study guide: Exam 6C

OSFI's guideline setting out its expectations for the capital and solvency assessment of federally regulated insurers, within its Supervisory Framework. Guideline A-4, in the Capital Management category, is dated December 2017 with an effective date of January 1, 2018, and applies to federally regulated insurers, including Canadian branches of foreign life and P&C companies, fraternal benefit societies, regulated insurance holding companies and non-operating insurance companies. It covers the role of capital in OSFI's risk assessment, the regulatory minimum and supervisory target capital levels, internal capital targets and the capital management policy.

On the syllabus

  • Exam 6C — objectives C2–C4; Guideline A-4, December 2017, with no sections excluded.

I The Role of Capital in OSFI's Risk Assessment Process

  • OSFI evaluates the inherent risk in each significant activity and the quality of risk management applied to it, rates each activity's net risk and direction, combines these into the Overall Net Risk (ONR), and then develops a Composite Risk Rating after considering earnings, capital and liquidity.
  • Regulatory capital is an important factor, but OSFI's Capital Assessment Criteria also include the adequacy of capital for the insurer's risk profile and business plan (including risks not fully captured in the capital guidelines), access to capital at reasonable rates, the quality of capital, and the quality of the capital management policy and processes.
  • The number, severity and overall quality of the stress scenarios an insurer uses to assess its capital adequacy are important considerations when OSFI assesses the strength of its capital.

II Regulatory Capital

  • The Insurance Companies Act requires federally regulated insurers to maintain adequate capital, and branches an adequate margin of assets in Canada over liabilities in Canada; the Capital Guidelines — MICAT, the MCT and LICAT — are the framework within which the Superintendent assesses it.
  • For P&C insurers the capital requirement is the minimum capital required and the Capital Resources are capital available; for life insurers they are the Base Solvency Buffer and Available Capital plus Surplus Allowance and Eligible Deposits.
  • Minimum Capital
    • Minimums are the levels of capital necessary to cover the risks specified in the Capital Guidelines; if Capital Resources approached or fell below them, OSFI would be very concerned about the insurer's ongoing viability.
  • Supervisory Target Capital
    • Supervisory Targets cover the risks specified in the Capital Guidelines and provide a margin for other risks; set above the Minimums, they give an early signal so that intervention is timely.
    • An insurer whose Capital Resources approach or fall below the Supervisory Targets will attract increased supervisory attention, generally including an early warning intervention status (stage 1).
  • Regulatory Capital Levels
    • As a percentage of capital requirements, the Minimums and Supervisory Targets are 100% and 150% for MICAT and for MCT/BAAT, and for LICAT/LIMAT 90% and 100% of total and 55% and 70% of core.

III Internal Capital Targets

  • Minimums and Supervisory Targets rest on simplifying industry-wide assumptions and are not tailored to an insurer's risk profile, so an insurer should conduct its Own Risk and Solvency Assessment and establish Internal Targets of total capital (and, for life insurers, of core capital).
  • Internal Targets should be set above Supervisory Targets, and OSFI should be notified when an insurer changes them.
  • Parent or head office guarantees, potential future capital injections and other potential management actions are not assumed in setting Internal Targets; they are considered only in the level at which the insurer will operate.
  • Insurers are expected to operate above their Internal Targets; if Capital Resources fall below them, or are anticipated to within two years, the insurer should inform OSFI promptly and provide plans to restore them within a relatively short period.

IV Capital Management Policy

  • Capital management is the ongoing process of determining and maintaining the quantity and quality of capital appropriate to support the insurer's planned operations.
  • Capital should be managed to maintain financial strength, absorb losses, allow for growth and, in extreme cases such as imminent failure or insolvency, provide sufficient assets to transfer or run off policyholder obligations and pay creditor claims.
  • Supported by the ORSA and the strategic and business plans, the policies and procedures include clearly defined roles and responsibilities and a policy that states capital adequacy goals relative to risk and sets the Internal Targets.

Related readings

  • OSFI ORSA — Guideline E-19, which the guideline cites for setting Internal Targets on the basis of an insurer's ORSA
  • OSFI MCT — the Minimum Capital Test, one of the Capital Guidelines §II names
  • OSFI Corporate Governance — the Corporate Governance Guideline, to which §IV refers for OSFI's expectations of Boards on managing capital and liquidity

Sources