Fair Value Accounting and the Minimum Capital Test

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Fair Value Accounting and the Minimum Capital Test

• September 21, 2006
• Toronto

Jane Voll, Vice-President and Chief
Economist Grant Kelly, Director, Policy
Development and Assistant Chief Economist
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Agenda

• Fair Value Accounting
• Status update on the MCT
• Outstanding concerns regarding the MCT

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Fair Value Accounting

• OSFI guidelines
• Regulatory capital treatment of certain items
  under the new financial instruments standards
• Guideline D-10 Accounting for financial
  instruments designated as Held for Trading
  (Fair Value Option)

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Fair Value Accounting

• Industry position on OSFIs guidelines
• Insurance risk should not be classified as
  financial risk.
• Concern over the timeline
• Permanence of assets
• Tax impacts
• Impact on hedging own credit risk, loans and
  receivables
• PC insurance cycle is volatile
• OSFI guideline D-10 should be open to PC
  insurance

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Fair Value Accounting

• Aggregate industry statistics (2005)
• BV bonds 51.1 billion (MV 51.8 billion)
• BV portfolio excl real estate 60.9 billion (MV
  63.4 billion)
• Bonds BV yield 4.83 (MV yield 4.76)
• Bond investment income 2.5 billion
• Liabilities net of reinsurance 35.5 billion
• Source IBC with data from MSA.

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Fair Value Accounting

• IBC member survey
• Average duration of bonds 4.05 years
• (Max 11.1 years Min 0.3 years)
• Average duration of claims liabilities 2.81
  years
• (Max 5.0 years Min 0.25 years)
• MV/BV Bonds 100.8
• (Max 103.6 Min 98.0)
• Sample of 21 companies/groups (51 of aggregate
  industry bonds 57.5 of liabilities). Results
  are weighted based on portfolio.

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Fair Value Accounting

• IBC member survey
• Investment split for cos that selected an
  investment option
• 24.4 HFT 75.3 AFS 0.3 HTM
• of surveyed cos that selected 100 HFT 9.5
• of surveyed cos that selected 100 AFS 42.9
• of surveyed cos choosing a mixed of investment
  categories 23.8
• 16 out of 21 companies/groups sampled.

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Fair Value Accounting

• IBC recommendations/comments to Dept of Finance
  Canada
• No amendment to the definition of specified debt
  obligations SDOs as market to market
  properties (142.2(1) (b) of the Income Tax Act
  ITA)
• If Finance considers a transition period for the
  expected income tax reserve change, a 3-4 year
  period would be appropriate and reasonable.
• Maintain the current methodology for calculating
  balances of the Canadian Investment Fund and
  related values for investment property in Part
  XXIV of the ITA regulations.
• Matching (PC vs life)???

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Agenda

• Fair Value Accounting
• Status update on the MCT
• Outstanding concerns regarding the MCT

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Status update on the MCT

• IBC recommendations to CCIR on the MCT Review
• Canadian PC regulatory capital requirements
  remain significantly higher than other nations
  with similar or higher risk profiles
• Capital factors for PC insurers are higher than
  other FIs.
• Margins on margins

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Status update on the MCT

• IBC recommendations to CCIR on the MCT Review
  (cont)
• Penalty (margin) on cessions to sister companies
  should be eliminated, since these companies are
  already regulated under OSFI
• Regarding group vs legal entity supervision, the
  MCT should recognize group level transferability
  of capital within a group
• Canadian standards will need to evolve to
  incorporate both standard tests and internal
  modeling for risk and solvency assessment

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Status update on the MCT

• 3 stages to MCT review
• Immediate Changes to the test for 2007
• Medium term Asset factor review (IBC survey)
• Long Term Internal modeling for capital/risk
  management

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Outstanding concerns with the MCT

• Margins on Margins
• Asset factors (risk sensitivity)
• Solvency requirements vs international

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Thank you