Industry Consultation on OSFI s Review of the Assessment of Financial Institutions Regulations, 2001 For Insurance Companies

Transcription

1 on OSFI s Review of the Assessment of Financial Institutions Regulations, 2001 For Insurance Companies Office of the Superintendent of Financial Institutions (OSFI) July Albert Street Ottawa, Canada K1A 0H2

2 Table of Contents A. PURPOSE... 3 B. CURRENT ASSESSMENT METHODOLOGY Base Assessments Minimum Assessments... 4 C. KEY CONSIDERATIONS IN DEVELOPING A NEW METHODOLOGY Best Proxy for Time and Resources Implications of the International Financial Reporting Standards Simplicity and Flexibility... 6 D. PROPOSED ASSESSMENT METHODOLOGY Required Capital / Required Margin Minimum Assessments New Mortgage Insurance Assessment Category... 8 E. IMPACT OF PROPOSED CHANGES Base Assessments Minimum Assessment F. OTHER CONSIDERATIONS G. CONCLUSIONS H. INDUSTRY CONSULTATION APPENDIX 1 Proposed Calculation Methodology for Insurance Industries Page 2 of 13

3 A. PURPOSE OSFI has undertaken a review of the Assessment of Financial Institutions Regulations, 2001 (the Regulations) for federally regulated insurers (FRIs) 1 to ensure that assessments appropriately reflect the time and resources that OSFI devotes to monitoring, supervising and regulating (hereinafter simply referred to as supervising or supervision of) individual financial institutions. This consultation paper: provides a brief overview of the current assessment methodology for FRIs; identifies and discusses key considerations in developing a new insurance assessment methodology; proposes a new measure on which to base all insurance assessments; proposes updates to the minimum assessment methodology; proposes a new assessment category for mortgage insurers; and, summarizes the aggregate impact of the proposed changes on the life insurance and property and casualty (P&C) insurance sectors. This consultation process is an essential part of how OSFI ensures transparency and identifies issues or unintended consequences that may result from proposed regulatory changes. OSFI looks forward to receiving and considering the insurance industry s feedback on the proposed amendments. B. CURRENT ASSESSMENT METHODOLOGY Section 23 of the Office of the Superintendent of Financial Institutions Act (the OSFI Act) provides that before the end of each calendar year, the Superintendent shall ascertain the total amount of expenses incurred during the immediately preceding fiscal year in connection with the administration of the Bank Act, Trust and Loan Companies Act, Cooperative Credit Associations Act and the Insurance Companies Act (the ICA). The OSFI Act also provides that the Governor in Council may make regulations prescribing the assessment methodology for each type of financial institution, and that each financial institution shall be assessed in accordance with the methodology prescribed by the Regulations. 1. Base Assessments Paragraph 2(d) of the Regulations provides that the basis for calculating Green Shield Canada s base assessment will be the total amount of the net revenue received during the immediately preceding calendar year from its prepayment plans, other than its administrative services only plans. 1 OSFI is consulting separately on proposed changes in assessment methodology for deposit-taking institutions (banks, trust and loan companies, and cooperative credit associations). Page 3 of 13

4 For companies other than Green Shield Canada, societies, and provincial companies that are subject to the ICA, paragraph 2(e) of the Regulations establishes that the basis of calculation will be the aggregate of the total amount of net premiums received in Canada and an amount equal to 25 per cent of net premiums received outside Canada, during the immediately preceding calendar year. 2 Paragraph 2(f) of the Regulations provides that the basis for calculating the base assessments for foreign companies (i.e., foreign companies operating in Canada on a branch basis) will be the aggregate of the total amount of net premiums received in Canada during the immediately preceding calendar year. 2. Minimum Assessments Sections 6 and 7 of the Regulations prescribe the formulae used to determine the base assessments for life insurers and non-life insurers 3, respectively. The Regulations currently establish a minimum assessment of $10,000 for life and P&C companies and foreign companies, and $1,000 for fraternal benefit societies (Fraternals). A separate minimum assessment premium threshold is established for each insurance sector. This threshold varies each year as it is derived from total industry premiums and total OSFI costs. Institutions below the threshold for a given sector are assessed the minimum charge, while those above the threshold are assessed an amount in excess of the minimum charge in accordance with the relevant formula. C. KEY CONSIDERATIONS IN DEVELOPING A NEW METHODOLOGY OSFI has identified three key considerations that should drive the design of an updated assessment methodology. 1. Best Proxy for OSFI Time and Resources The policy objective supporting the design of the existing assessment methodology is to allocate OSFI costs among institutions in a way that most accurately reflects the time and resources OSFI spends supervising individual institutions. When reviewing the Regulations in 2001, OSFI viewed net premiums to be the best unit of measure on which to base assessments for FRIs because this figure generally reflected the size of an institution, and the size of an institution was viewed as a sound proxy for the time and resources OSFI spent supervising an institution. 2 In the case of a life company or society, the base assessment methodology also includes an amount equal to 25 per cent of net premiums received outside Canada during the immediately preceding calendar year by each of its subsidiaries that is engaged in the business of insurance outside Canada. 3 For the purposes of section 7 of the Regulations, Green Shield Canada is considered a property and casualty insurance company. Page 4 of 13

5 While the original policy objective has not changed, OSFI is considering whether net premiums continues to be the best proxy for OSFI s time and resources. During the recent financial crisis, for example, OSFI found that the risk profile of regulated institutions was also a significant driver of OSFI s resources. As such, OSFI proposes that an assessment methodology that is calibrated to be risk-sensitive would better reflect the time and resources that OSFI spends supervising individual institutions. A risk-calibrated approach to assessments would also be consistent with OSFI s riskbased supervisory framework, the latter of which drives OSFI s supervisory planning processes and resource allocation decisions. 2. Implications of the International Financial Reporting Standards The International Accounting Standards Board (IASB) develops International Financial Reporting Standards (IFRS) that many countries have chosen to adopt, including Canada. As of January 1, 2011, in Canada, publicly accountable entities were required to adopt IFRS. At that time, Canadian insurers were required to implement IFRS 4 Insurance Contracts, which prescribes the accounting and reporting of insurance contracts. Phase I of IFRS 4 introduced a new definition of an insurance contract, which has resulted in some contracts previously accounted for as insurance contracts to be reclassified as investments or service contracts. Insurers are no longer able to report in their financial statements these contracts as insurance premiums. As a result, Phase I reduced the net premiums reported by insurers in Canada, all else being equal. While certain insurers will be materially impacted by Phase I, the aggregate impact will be fairly small for the life insurance industry, and almost negligible for the P&C industry. However, any reduction in net premiums will have a corresponding impact on the assessment calculations for both industries. In 2010, the IASB released an exposure draft on Phase II of IFRS 4 Insurance Contracts 4. The Phase II proposals, if implemented as currently drafted, would have more significant impacts on the reporting practices of insurers. Under those proposals, the presentation of insurance contracts and investment contract income will change substantially. In addition, volume information, such as premium income, may not be readily available (depending on future decisions by the IASB). As such, the proposed changes to premium reporting practices will affect OSFI s current assessment methodology. Phase II changes would mean that net premium information, the basis of the assessment methodology prescribed by the Regulations, would no longer be readily accessible. 4 Currently, the IASB plans to issue a re-exposure or review draft of the Phase II standard in late While the IASB has not indicated its timeline for the issuance of a final standard, nor its likely mandatory implementation date, it is expected that the new standard may be finalized in 2013 and insurers will be required to implement the finalized Phase II standard no earlier than Page 5 of 13

6 3. Simplicity and Flexibility OSFI believes that the assessment methodology should be both simple and flexible. A straightforward assessment methodology will facilitate OSFI s calculation of assessments, and it will allow financial institutions to more easily predict and validate their assessments, thereby increasing regulatory transparency. Although a single assessment methodology would ideally be applied across all financial institution sectors, the methodology would have to be sufficiently flexible to accommodate the differences between different types of institutions. Further, any new methodology should be sufficiently flexible to remain up-to-date over time, and work with anticipated IFRS and other changes to international standards. D. PROPOSED ASSESSMENT METHODOLOGY OSFI is proposing to make three changes to its current assessment methodology. The first change would amend the basis on which minimum and non-minimum assessments are calculated (i.e., from net premiums and net revenues to a risk-based assessment methodology). The second change would not only update the minimum amount assessed, it would also ensure that it remains up-to-date over time. The third change would move mortgage insurers from the current assessment category that combines all P&C insurers to a new assessment category that would be limited to mortgage insurers. As discussed below, this new mortgage insurance assessment category will facilitate the appropriate allocation of OSFI s expenses across all P&C insurers as we move to the proposed assessment methodology. 1. Required Capital / Required Margin While OSFI considered and analysed different assessment options, it proposes to base its new assessment methodology on Required Capital for insurance companies and Required Margin for foreign branches, as defined in OSFI s capital adequacy and adequacy of assets guidelines. OSFI has concluded that using Required Capital and Required Margin offer a number of benefits relative to the three key considerations that OSFI determined should drive the design of an updated assessment methodology: Required Capital and Required Margin are risk sensitive measures that capture, among other risks, asset default, insurance, interest rate, and foreign exchange 5 risks, and, therefore, may serve as a strong proxy for the time and resources OSFI dedicates to supervising individual institutions. In moving to a more risk-sensitive measure, OSFI believes that the assessment base will be less prone to major impacts resulting from future accounting changes. 5 Currently, foreign exchange risk is only captured in the capital adequacy and adequacy of assets guidelines applicable to life insurers; amendments to the property and casualty guidelines are expected in Page 6 of 13

7 Required Capital and Required Margin are simple in that they are obtained from a single item reported in a quarterly return. OSFI has well-established risk-based capital adequacy and adequacy of assets frameworks any future adjustments to these frameworks would only serve to better refine the allocation of OSFI s expenses and the accuracy of assessments. The proposed assessment methodology would be calculated using the sum of the minimum assessment and the institution s share of OSFI expenses. This share would be determined through a calculation of the institution s per cent share of Required Capital or Required Margin compared to the sector s total Required Capital and Required Margin. Please refer to Appendix 1 for a detailed summary of the proposed assessment methodology and for example calculations. 2. Minimum Assessments In addition to modifying the basis for calculating assessments, OSFI also proposes to update the minimum amount assessed. Although minimum assessment charges represent a small percentage of total assessments, they have not been updated in more than 10 years, and have not kept pace with increases in non-minimum assessments. As shown in Table 1, the total value of assessments for all life and P&C insurers has increased by approximately 65 per cent from 2000 to 2010, while the total value of minimum assessments has decreased by approximately 61 per cent. These results reflect the fact that fewer institutions now fall below the minimum threshold. Total Assessments Table 1 Final Final Change Life 13,080,363 17,900,754 37% P&C 6,866,813 15,045, % Total 19,947,176 32,946,463 65% Sum of Minimum Assessments Life 1,287, ,000-64% P&C 2,150, ,000-59% Total 3,437,000 1,342,000-61% Regardless of an institution s size, OSFI performs a minimum amount of supervision for all financial institutions. OSFI has determined that it spends, on average, fifteen to twenty days per year supervising small insurance companies and foreign branches, and two to three days per year on small Fraternals. Using a conservative rate of $1,000 per day, this would equate to a cost of $15,000 - $20,000 for insurance companies and foreign branches, and $2,000 - $3,000 for Fraternals. Page 7 of 13

8 In light of the foregoing, OSFI proposes to increase the minimum assessments from $10,000 to $15,000 for both insurance companies and foreign branches and from $1,000 to $2,000 for Fraternals. OSFI also proposes to annually index, based on the Consumer Price Index, the minimum assessments to ensure that these minimum charges keep pace with non-minimum assessments. 3. New Mortgage Insurance Assessment Category OSFI does not currently differentiate between different types of P&C insurers when allocating expenses to the P&C sector. Going forward, however, OSFI is proposing to create a new assessment category for mortgage insurers for the following two reasons: i) Required Capital The capital requirements for mortgage insurers are markedly different than those of all other types of P&C insurers, taking into account factors unique to the mortgage insurance sector. Consequently, with the proposed shift to an assessment methodology based on Required Capital, if mortgage insurers remain grouped with all other P&C insurers they would be assessed a disproportionately higher share of OSFI expenses relative to their P&C peers. By creating a new assessment category unique to mortgage insurers, the proposed methodology can be applied while ensuring the appropriate and fair allocation of OSFI s expenses. ii) Protection of Residential Mortgage or Hypothecary Insurance Act The Government of Canada introduced new mortgage insurance legislation Protection of Residential Mortgage or Hypothecary Insurance Act (PRMHIA) in its 2011 Budget implementation legislation. PRMHIA sets out a new guarantee framework for private mortgage insurers. 6 This legislation contemplates OSFI administering certain provisions of the statute, and grants OSFI additional assessment powers over private mortgage insurers to recover its expenses related to the new statute. It is proposed that Required Capital also form the basis of the PRMHIA assessment methodology. To be clear, this new assessment power is strictly linked to OSFI s role in administering some aspects of the Government s guarantee framework under the new statute; it is not related to OSFI s prudential supervision of private mortgage insurers, which will continue to be assessed under the OSFI Act and the Regulations. With the introduction of a new assessment power that is specific to private mortgage insurers, OSFI further believes it is necessary and appropriate to separate those insurers from the rest of the P&C sector. 6 PRMHIA does not apply to the Canada Mortgage and Housing Corporation (CMHC). It is expected that OSFI will recover its expenses from CMHC pursuant to section 21.3 of the National Housing Act, as proposed to be enacted by Bill C-38: Jobs, Growth and Long-term Prosperity Act. Page 8 of 13

9 E. IMPACT OF PROPOSED CHANGES It is important to reiterate that the changes to the assessment formula impact only the allocation of OSFI s expenses across institutions and not the total amount assessed by OSFI. As such, the proposed amendments do not generate additional revenue for OSFI. The results that follow separately illustrate the impact of implementing the proposed change in assessment methodology (i.e., using Required Capital or Required Margin as the basis for the assessment methodology), and the proposed changes to the minimum assessment charged. 7 OSFI has modeled the impact of the proposed changes using 2008 and 2009 data, which data is not affected by changes to IFRS. It should also be noted and understood that the total number of insurers may vary each year as institutions enter and exit from federal jurisdiction, and/or as institutions cross the applicable minimum assessment threshold. 1. Base Assessments a) Life Insurers and Fraternals Table 2 illustrates the impact of a change from the current net premiums calculation to the proposed Required Capital or Required Margin methodology, using past assessment periods. # of Life Insurers Table 2 Life Insurance Change in Assessment from Net Premium Method < 15% change 2008 Between 15% and 50% change Greater than 50% change Increase Decrease Increase Decrease Table 2 illustrates that a change to the proposed risk-based methodology would benefit the majority of life insurers, with approximately two-thirds experiencing decreases in their assessments. OSFI believes that this outcome better reflects the actual time and resources spent supervising these institutions. 7 OSFI has chosen not to illustrate the impact of the proposed assessment methodology on the new category for mortgage insurers since there are very few mortgage insurers active in the sector. Page 9 of 13

10 b) P&C Insurers Table 3 illustrates the impact of a change from the net premiums calculation to the proposed Required Capital and Required Margin methodology for P&C insurers, excluding private mortgage insurers 8, using past assessment periods. # of P&C Insurers Table 3 P&C Insurance (Excluding Mortgage Insurers) Change in Assessment from Net Premium Method < 15% change 2008 Between 15% and 50% change Greater than 50% change Increase Decrease Increase Decrease Table 3 illustrates that a change to the proposed risk-based methodology would benefit the majority of P&C insurers, with approximately two-thirds experiencing decreases in their assessments. OSFI believes that this outcome better reflects the actual time and resources spent supervising these institutions. 2. Minimum Assessment a) Life Insurers and Fraternals When compared to the 2009 assessment period, Table 4 illustrates that the proposed changes in minimum assessments would impact 56 life insurers and Fraternals Required Capital / Margin Companies/ Branches # of Institutions Assessed Minimum Current Assessment $10,000 / $1,000 $ Table 4 Life Insurance % of Life Assessment Minimum # of Institutions Assessed Minimum Proposed Assessment $15,000 / $2,000 $ % of Life Assessment , % , % Fraternals 11 11, % 12 24, % Total , % , % 8 Given the proposed bifurcation between private mortgage insurers and all other P&C insurers, Table 3 excludes private mortgage insurers. Page 10 of 13

11 In the case of life insurers, 33 would see their minimum assessments raised from $10,000 to $15,000, and 11 additional life insurers would be captured by the minimum assessment of $15,000. Regarding Fraternals, 11 would see their minimum increase from $1,000 to $2,000, while 1 additional Fraternal would be captured by the new minimum assessment. b) P&C Insurers Compared to life insurers, Table 5 illustrates that increasing the minimum assessment would have a more material impact on P&C insurers, excluding mortgage insurers 9, since there are a larger number of P&C insurers currently assessed the minimum. Table 5 P&C Insurance (Excluding Mortgage Insurers) 2009 Required Capital / Margin Companies/ Branches # of Institutions Assessed Minimum Current Assessment $10,000 $ % of P&C Assessment Minimum # of Institutions Assessed Minimum Proposed Assessment $15,000 $ % of P&C Assessment , % 94 1,410, % 79 P&C insurers would see their minimum assessments raised from $10,000 to $15,000, and 15 additional insurers would be captured by the minimum assessment of $15,000. F. OTHER CONSIDERATIONS The current Regulations not only address the minimum and base assessments of financial institutions, they also prescribe the assessment surcharge methodology for OSFI to recover additional expenditures associated with supervising staged financial institutions. Accordingly, OSFI also reviewed whether the surcharge calculation should be amended. After reviewing numerous cases where surcharges had been applied, OSFI concluded that no change to the current surcharge methodology would be required. Cases reviewed demonstrated that although staged institutions showed increased pressure on their solvency ratios, their situation did not necessarily increase the Required Capital or Required Margin. 9 Given the proposed separation of private mortgage insurers from all other P&C insurers, Table 5 excludes private mortgage insurers. Page 11 of 13

12 G. CONCLUSIONS OSFI has concluded that the proposed assessment methodology based on Required Capital and Required Margin will permit the allocation of OSFI expenses in a risk-based manner that more closely reflects the actual time and resources spent supervising individual institutions. It is a more simplified approach as well as a methodology that reflects OSFI s supervisory practices. The proposed methodology would also avoid anticipated IFRS complications that may surface under the current assessment methodology. Further, OSFI believes that the proposed minimum assessment amounts, and subsequent annual indexing, will help to ensure the appropriate allocation of OSFI s costs going forward. Finally, OSFI has concluded that it is necessary to create a new assessment category for private mortgage insurers to account for their unique capital requirements, and to facilitate the implementation of OSFI s new and separate assessment power under PRMHIA. H. INDUSTRY CONSULTATION OSFI would like to invite all federally regulated insurers and insurance industry associations to participate in this consultation process by submitting comments to: Philipe-A. Sarrazin Managing Director, Legislation and Policy Initiatives 255 Albert St Ottawa ON K1A 0H2 philipe.sarrazin@osfi-bsif.gc.ca The consultation will be conducted for a period of 45 days from the publication of this document. OSFI will review all comments received and report back to industry on the outcome of this consultation and next steps. Page 12 of 13

13 Proposed Calculation Methodology for Insurance Industries Given a Minimum Assessment (A) = $2,000 for Fraternals, $15,000 for all other entities* the base assessment of a financial institution that is an insurance company in a particular sector (e.g., life insurance, property and casualty insurance, or mortgage insurance) will be equal to: a) A, if A > H or b) A, where H = G/D*B, and represents the initial cost allocated to the institution G = Institution Required Capital (RC) or Required Margin (RM) D = Sum of RC and RM for all institutions for the sector B = OSFI's costs to be recovered from the sector plus, an amount determined by C/E*(B-F) where C = H-A E = Sum of C for the sector B = OSFI's costs to be recovered from the sector F = Sum of the minimum assessments for the sector * these amounts to be indexed annually CALCULATION EXAMPLES (G) Required Capital Institution 123 with a reported Required Capital of: 350,000 Institution 234 with a reported Required Capital of: 5,000 where MIs Minimum assessment* (A): $15,000 $15,000 OSFI's costs to be recovered from the sector (B): $12,218,744 $480,000 Sum of RC and RM for the sector (D): $8,970,957 $415 Sum of C for the sector (E): $10,578,436 $1,344 Sum of minimum assessments for the sector (F): $2,775,000 $15,000 A = Minimum Residual Total Assessment Assessment Assessment Institution , , ,186 Institution , ,000 * Non-Fraternal Page 13 of 13