Advisory. Date: April Background:

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1 Advisory Sbject: Sppementary Information for Insrance Companies that Determine Segregated Fnd Garantee Capita Reqirements Using an Approved Mode Revised Version Category: Capita Date: Apri 009 Backgrond: On October 8, 008, OSFI annonced changes to the capita reqirements for segregated fnd garantees for companies with an approved capita mode (see Appendix ). These changes offer sch companies an opportnity to determine the segregated fnd garantee capita reqirement sing an aternative method ( Aternative Method ). Since that annoncement, OSFI has discssed the changes and their impementation with stakehoders. From these discssions, it became cear that there are a nmber of different ways of performing the cacations associated with the Aternative Method, particary with respect to the ordering of scenarios nderying the cacation of the CTE(98), CTE and CTE(90) vaes described in the October 8, 008 annoncement and the aocation of the actaria iabiity to the respective cash fow bckets. OSFI has aso received reqests from insrers with segregated fnd garantee exposres in more than one bsiness nit, jrisdiction or entity (hereafter simpy referred to as bsiness nit ) to rank scenarios in a way that is consistent across a bsiness nits to recognize that ony one economic scenario shod occr at any given time. This advisory provides technica information on how the Aternative Method is to be impemented. It aso provides information on the extent to which insrers with segregated fnd garantee exposres in more than one bsiness nit may rank scenarios in a way that is consistent across bsiness nits and describes the precise ranking method that is to be sed. An earier version of this advisory was pbished in December 008. In that version, OSFI indicated that the method for cacating the CTE(98), CTE and CTE(90) vaes associated with the Aternative Method wod be reviewed in 009. This review has now been competed and the appicabe section of the advisory has been pdated accordingy. 55 Abert Street Ottawa, Canada KA 0H

2 OSFI is aware that there may be other vaid ways of impementing the Aternative Method or achieving consistency of rests when a company has segregated fnd garantee exposres in more than one bsiness nit. Accordingy, the methods described in this advisory may be modified in the ftre after additiona research. However, to ensre consistency across the indstry, companies eecting to se the Aternative Method or eecting to rank scenarios in a way that is consistent across bsiness nits mst determine the segregated fnd garantee capita reqirement sing the methodoogy described in this advisory. Cacation of the CTE(98), CTE and CTE(90) Vaes Associated with the Aternative Method Under the Aternative Method, the segregated fnd garantee capita reqirement is to be determined in the foowing way:. A arge nmber of stochastic investment retrn scenarios is generated. For carity in the steps that foow, sppose that 5000 scenarios have been generated.. Segregated fnd garantee cash fows corresponding to these scenarios are determined based on the identified term of the iabiity.. In each scenario, cash fows are partitioned into bckets based on the timing of the cash fow as foows: a. year or ess b. greater than year and ess than or eqa to 5 years c. greater than 5 years 4. For each scenario and each time bcket, the present vae of benefit payments ess garantee premim receipts is cacated. 5. The rest is for distribtions of present vaes based on cash fow period: a. year or ess b. greater than year and ess than or eqa to 5 years c. greater than 5 years d. a periods combined (i.e., no bcketing of cash fows) 6. The tota reqirement is the sm of: a. the tota reqirement for cash fows year or ess (the qantity T defined in steps 8 throgh ) b. the tota reqirement for cash fows greater than year and ess than or eqa to 5 years (the qantity T defined in steps 8 and ) Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page of

3 c. the tota reqirement for cash fows greater than 5 years (the qantity T defined in steps 4 throgh ) 7. Reqired capita is the tota reqirement cacated in step 6 mins the esser of: a. the segregated fnd garantee iabiity reported by the company and determined in accordance with actaria practice standards (denoted by L in the steps that foow) b. the segregated fnd garantee iabiity based on a CTE(85) standard (the qantity L defined in steps 8 and 9) In symbos, reqired capita is T T T min( L, L ), or 0 if this amont is negative. Cacation of L, T and T : 8. The 5000 scenarios generated in step are ordered according to the present vae distribtion for a cash fow periods combined (distribtion in 5d), i.e., withot respect to cash fow bcketing. The resting ordering is abeed sch that scenario represents the greatest present vae and scenario 5000 the east present vae. 9. Cacation of L : The average present vae for the distribtion in 5d (present vae cash fows for a periods combined) corresponding to scenarios throgh 750 is cacated and denoted L. If the cacated vae is negative, a vae of 0 is assigned to L. The qantity L represents the tota segregated fnd garantee iabiity based on a CTE( 85) standard. 0. Scenarios 50 throgh 5000 are discarded.. Scenarios throgh 500 are re-ordered according to the present vae distribtion for cash fows year or ess (distribtion in 5a). The resting re-ordering is abeed sch that scenario * has the greatest present vae with respect to cash fows year or ess and scenario 500 * the east present vae.. Cacation of T : The average of the present vaes for the distribtion in 5a (present vae cash fows year or ess) corresponding to scenarios * throgh 00 * is cacated and denoted T. The qantity T represents the tota reqirement for cash fows year or ess. Note that T cod be negative.. Cacation of T : The average of the present vae cash fows greater than year and ess than or eqa to 5 years corresponding to scenarios throgh 50 is cacated and denoted T. Note that scenarios throgh 50 (i.e., the scenarios for the ordering based on a cash fows combined) are sed here, not scenarios * throgh 50 *. The qantity T Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page of

4 represents the tota reqirement for cash fows greater than year and ess than or eqa to 5 years. Note that T cod be negative. Cacation of T : The tota reqirement for cash fows greater than 5 years is determined in the foowing way: First, pper and ower bonds for the tota reqirement for this cash fow bcket are determined as we as the tota reqirement based on a CTE standard. Then, reqired capita amonts corresponding to the tota reqirement pper and ower bonds and the CTE standard are determined assming that reqired capita amonts are aocated to the three cash fow bckets in proportion to the corresponding tota reqirements foored at 0. Foowing this, the reqired capita amont for the greater than 5 years cash fow bcket is determined sing a weighted average of the previos qarter s reqired capita amont for this cash fow bcket and the crrent qarter amont based on a CTE standard, sbject to the pper and ower bonds on reqired capita previosy cacated. Finay, the tota reqirement for the greater than 5 years cash fow bcket is inferred from the reqired capita amont jst cacated based on the earier assmption that reqired capita amonts are aocated to the three cash fow bckets in proportion to the corresponding tota reqirements. The detaied cacations are described in steps 4 throgh as foows: Determination of pper and ower bonds for the tota reqirement and the tota reqirement based on CTE: 4. Scenarios throgh 500 are re-ordered according to the present vae distribtion for cash fows greater than 5 years (distribtion in 5c). The resting re-ordering is abeed sch that scenario *** has the greatest present vae with respect to cash fows greater than 5 years and scenario 500 *** the east present vae. 5. Cacation of pper bond T : The average of the present vaes for the distribtion in 5c (present vae cash fows greater than 5 years) corresponding to scenarios *** throgh 50 *** is cacated and denoted T. The qantity T represents an pper bond for the tota reqirement before fooring for cash fows greater than 5 years. 6. Cacation of ower bond T : The average of the present vaes for the distribtion in 5c (present vae cash fows greater than 5 years) corresponding to scenarios *** throgh 500 *** is cacated and denoted T. The qantity T represents a ower bond for the tota reqirement before fooring for cash foors greater than 5 years. Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 4 of

5 7. Cacation of CTE proxy T : The average of the present vae cash fows greater than 5 years corresponding to scenarios throgh 50 is cacated and denoted T. Note that the scenarios throgh 50 (i.e., the scenarios for the ordering based on a cash fows combined) are sed here, not scenarios * throgh 50 * or scenarios *** throgh 50 ***. The qantity T represents the contribtion to the tota reqirement of cash fows greater than 5 years when a tota reqirement standard of CTE is sed withot cash fow partitioning. Determination of corresponding reqired capita amonts: 8. Cacation of pper bond RC : If 0 T T T,0) T then set RC 0. Otherwise, if 0 RC max( T L. The qantity RC represents an pper bond on the crrent qarter reqired capita for cash fows greater than 5 years. T then set maxt T T min( L, ),0 9. Cacation of ower bond RC : If T 0 then set RC 0. Otherwise, if T 0 then T set RC maxt T T min(, ),0 max( T T,0) T L L. The qantity RC represents a ower bond on the crrent qarter reqired capita for cash fows greater than 5 years. 0. Cacation of RC RC : If T 0 then RC 0. Otherwise, if T 0 then set T maxt max( T T, 0) T T T min( L, L ),0. The qantity RC is the crrent qarter reqired capita amont to be sed in the averaging forma. Cacation of reqired capita for cash fows greater than 5 years based on averaging forma: p. Define RC maxrc, minrc,95% RC 5 RC p %, where RC represents the previos qarter reqired capita for cash fows greater than 5 years. The qantity RC represents the crrent qarter reqired capita for cash fows greater than 5 years. Cacation of corresponding tota reqirement for cash fows greater than 5 years: *. The tota reqirement for cash fows greater than 5 years is T max( T, min( T, T )) * where the qantity T is determined as foows: If RC 0 then T * 0. Otherwise, if Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 5 of

6 RC 0 then RC max( T * T is the niqe positive sotion of the eqation * T T,0) T * max T T T * min( L, L ),0. Note that companies that determine segregated fnd garantee iabiity and capita reqirements withot separating garantee fees from non-garantee fees mst add the absote vae of the recoverabe portion of the namortized amont of the deferred acqisition cost to the tota reqirement sms in steps 6, 8, 9, 0 and (For exampe, in step 8, the namortized amont of the deferred acqisition cost wod be added to T T T bt not to the nmerator or T denominator of ) and the qantity L in step 9 in order to determine the max( T T,0) T appropriate reqired capita amonts. Companies reqiring frther gidance on this matter shod contact OSFI. L The qantity defines a cap on the segregated fnd garantee iabiity that may offset the tota reqirement in the determination of segregated fnd garantee reqired capita (see step 7). The cacation of L described in step 9 is based on a CTE(85) iabiity standard and represents an interim measre. The cacation of L wi be reviewed and may be modified in ftre reporting periods to become more cosey aigned with the CTE(80) maximm iabiity standard promgated by the Canadian Institte of Actaries. Other aspects of the Aternative Method may be reviewed and modified in the ftre. Determination of Segregated Fnd Garantee Capita Reqirement When There is Segregated Fnd Garantee Exposre in More Than One Bsiness Unit Prior to the pbication of the December 008 version of this advisory, companies with segregated fnd garantee exposre in more than one bsiness nit determined segregated fnd garantee capita reqirements as if the bsiness nits were competey separate companies, i.e., segregated fnd garantee tota reqirements were determined based on bsiness-nit-specific orderings of the present vae distribtions. To recognize that ony one economic scenario shod occr at a given time, companies with segregated fnd garantee exposre in more than one bsiness nit and approved capita modes in a the impacted bsiness nits now have the option of determining the segregated fnd garantee capita reqirement for the consoidated enterprise in the foowing way: I. A singe set of integrated stochastic investment retrn and exchange rate scenarios (i.e., 5000 or more integrated scenarios) is generated and appied consistenty to a bsiness nits, i.e., scenario in bsiness nit X is the same as scenario in bsiness nit Y, etc, sbject to necessary adjstments to oca crrency. Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 6 of

7 II. In each bsiness nit, the scenario-specific present vae reqirements are determined. In scenarios where the present vae reqirement is ess than 0, a vae of zero is sbstitted, i.e., scenario-specific reqirements are foored at 0. For companies adopting the Aternative Method, the present vae reqirements for the varios time bckets are to be set eqa to 0 in scenarios where the present vae reqirement withot cash fow partitioning is ess than 0. III. Scenario-specific present vae reqirements for the enterprise as a whoe are determined by adding together the respective scenario-specific present vae reqirements for the varios bsiness nits determined in step II sing time 0 exchange rates to convert the amonts to a common crrency as necessary. Note that the scenario-specific present vae reqirements for the varios bsiness nits are to be foored at 0 before being smmed. So, for exampe, if in scenario the present vae reqirements for bsiness nits X, Y and Z are 0, -5 and respectivey then the corresponding scenario reqirement for the enterprise as a whoe is (= ), not 8. IV. The rest of step III is a distribtion of present vae reqirements for the enterprise as a whoe (or for companies foowing the Aternative Method, for distribtions of present vae reqirements based on time bcket for the enterprise as a whoe). The segregated fnd garantee capita reqirement for the enterprise as a whoe is determined sing this (these) distribtion(s). The method for determining the segregated fnd garantee capita reqirement for consoidated enterprises is being reviewed and may be modified for ftre reporting periods. The method for determining reqirements within bsiness nits is aso being reviewed and may be modified for ftre reporting periods. Companies that determine segregated fnd garantee iabiity and capita reqirements withot separating garantee fees from non-garantee fees shod contact OSFI for frther gidance on this cacation. * Advisories describe how OSFI administers and interprets provisions of existing egisation, regations or gideines, or provide OSFI s position regarding certain poicy isses. Advisories are not aw; readers shod refer to the reevant provisions of the egisation, regation or gideine, incding any amendments that came into effect sbseqent to the Advisory s pbication, when considering the reevancy of the Advisory. Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 7 of

8 Appendix October 8, 008 Mr. Frank Swedove President Canadian and Heath Insrance Association Inc. Qeen Street East, Site 700 Toronto, Ontario M5C X9 Dear Mr. Swedove: Sbject: Revisions to the Segregated Fnd MCCSR Gideines As yo know, Gideine A, Minimm Contining Capita and Srps Reqirements (MCCSR) estabishes the minimm capita res for segregated fnd garantee (SFG) obigations for ife insrers that have approva to se interna modes. Whie OSFI s MCCSR interna modes project is on a path to pdate sch res by 0, market deveopments have highighted the need to more expeditiosy pdate these res. As sch, OSFI is revising sch SFG capita res. SFG capita res are crrenty based on a singe confidence eve of CTE95, regardess of the date on which an insrer is expected to make payments. As sch, these res may not sfficienty distingish between the ower capita reqired to spport distant payment obigations and the higher capita reqired to spport near term payment obigations. This is de in arge part to the evotion of the SFG prodcts (e.g. SFG contracts generay had a term of 0 years or ess when the crrent MCCSR res were deveoped; they now have mch onger terms, sch as 0 years, or indefinite terms based on an annitant s ife). Frther, the crrent SFG capita res are point in time estimates of the risk associated with SFG obigations. As sch, these res may case SFG capita reqirements to be ssceptibe to dramatic swings that may not refect changes in risk. The extent of this voatiity in capita reqirements is inconsistent with the prpose of biding capita to absorb ftre nexpected osses. Or approach for immediatey revising the SFG capita res for approved interna mode companies is attached. These revisions seek to redce voatiity in capita reqirements, to ensre that appropriate capita is hed in respect of onger term payment obigations and shorter term payment obigations and to increase capita as payment dates become more proximate. These revisions wod be an interim step nti OSFI revises its approach to sing modes for MCCSR prposes. Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 8 of

9 We wi prepare an amendment to or MCCSR Gideine to give effect to the attached approach. Provided an interna modes-based SFG insrer eects to adopt these revisions, we intend that these changes wod have effect for its SFG MCCSR cacations reqired after October, 008. Pease commnicate this approach to yor members. Shod yor members have any comments or wish to discss the approach, we wod be peased to discss these modifications. Pease direct any comments or qestions to Bernard Dpont, Capita Division. Mr. Dpont may be reached by teephone at or by e-mai at Yors sincerey, Robert Hanna Assistant Sperintendent Regation Sector Enc. Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 9 of

10 Revisions to Segregated Fnd Garantee MCCSR Res OSFI s minimm capita res for segregated fnd garantee (SFG) obigations for ife insrers that have approva to se interna modes are estabished in Gideine A, Minimm Contining Capita and Srps Reqirements (MCCSR). The MCCSR SFG capita res are revised as foows:. Minimm Capita Dependent on Expected Payment Date: Crrenty SFG capita is estabished based on a confidence eve of CTE over the term of a contract, regardess of whether the payments are expected to be de next qarter or in 0 years. OSFI beieves that the confidence eve and the capita reqirement shod refect the proximity of the expected cash fows. Therefore, cash fows wod be groped into categories according to expected dates and the foowing minimm confidence eves wod appy: i) de in year or ess, CTE(98); ii) de between and 5 years, CTE; and iii) de after 5 years, CTE(90).. >5 Yr Capita Increases Towards Capita Based On CTE: To hep ensre sfficient capita is methodicay accmated for cash fows beyond 5 years and to aow sch capita to grow towards a CTE capita reqirement, a cacation wi be performed to measre the amont (the Adjstment Amont ) that wod, if accmated over the next 0 qarters (and no other changes occr i.e. a parts of the eqation remain the same), be reqired to adjst the acta >5 year capita at the end of the prior qarter (the >5Yr Previos Q Reqired Capita ) to eqa the capita reqired at the end of the crrent qarter measred at a CTE confidence eve (the Crrent Q >5Yr CTE Capita). The Adjstment Amont wod eqa 5% of the amont obtained when the >5Yr Previos Q Reqired Capita is sbtracted from the Crrent Q >5Yr CTE Capita.. Acta >5Yr Reqired Capita: To mitigate voatiity in capita reqirements, the capita reqired to be hed at the end of any qarter for >5 year cash fows is, sbject to the minimm capita at CTE(90) (discssed above in para. ) and sbject to a maximm based on CTE (i.e. testing the > 5 year cash fows at the end of the crrent qarter at CTE), the aggregate of >5Yr Previos Q Reqired Capita and the Adjstment Amont (i.e. added if positive; sbtracted if negative). 4. New Contracts and Ageing Contracts: Capita for new SFG cash fows in the >5 year category wi be estabished indirecty by carrying forward the >5Yr Previos Q Reqired Capita and adding the Adjstment Amont; the protection against capita inadeqacy being the CTE(90) minimm capita reqired for >5 year cash fows. Simiary, capita redctions in the >5 year category (de to cash fows moving from the >5 years category into <5 years category, etc.) may occr as a rest of appying the Adjstment Amont bt wi not be directy cacated in the >5 year category; the accmation of nnecessary capita wi be avoided by capping the maximm reqired capita at CTE for >5 year cash fows. 5. Aocation of TGCR and Actaria Liabiities: As capita is cacated by dedcting actaria iabiities from the tota gross cacated reqirement (TGCR), both TGCR and iabiities for SFG wi need to be aocated between the different categories of cash fows. This aocation wi need to be performed on a consistent basis appying the principes of conservatism, matching and maintaining sfficient reserves/iabiities and capita for a ftre obigations. Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page 0 of

11 6. Impementation: The revised MCCSR res for SFG capita contained in this docment may be adopted by insrers with approved interna SFG modes for any qarter end commencing with their 008 year end. Insrers are reqired to irrevocaby eect by [March, 009] to adopt these revised res or to contine to cacate SFG capita (nti the interna modes project is impemented) sing existing res. For the first qarter sing the revised res, as OSFI determines is appropriate, the >5 year reqired capita wi be estabished at CTE(90) at sch date (i.e. the >5Yr Previos Q Reqired Capita wi be assmed to be zero) or wi be based on an amont cacated at earier date (e.g. the >5Yr Previos Q Reqired Capita). It is expected that these revisions represent an interim step and wod be repaced by the new capita res resting from OSFI s interna modes-based approach. These changes to the SFG capita res wi bid on the existing SFG capita res and, except as otherwise expressy amended once the gidance to impement this proposa is issed, the existing SFG capita res (e.g. restrictions on switching from a modes approach to a factor approach) wi otherwise contine to appy. APPENDIX A - EXAMPLE Period Period Period Period 4 Cash Fows Year or Less CTE Liabiity Reqired Capita Cash Fows -5 Years 4 CTE Liabiity Reqired Capita.5 6 Cash Fows >5 Years 7 CTE CTE Liabiity 0 Upper Bond for RC 6 6 Lower Bond for RC Previos Period RC n/a % of () + 5% of (0) n/a Reqired Capita ( () capped by (0) 4 and foored by () ) Tota Reqired Capita ( () + (6) + (4) ) Apri 009 Sppementary Information to Determine Segregated Fnd Garantee Capita Reqirements sing an approved Mode Page of