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Life Insurance Capital Adequacy Test
255 Albert Street
Ottawa, Canada
K1A 0H2
www.osfi-bsif.gc.ca
Guideline
Subject: Life Insurance Capital Adequacy Test
No: A Issue Date: September 2016
Effective Date: January 1, 2018
Subsection 515(1), 992(1) and 608(1) of the Insurance Companies Act (ICA) requires federally
regulated life insurance companies and societies, holding companies and companies operating in
Canada on a branch basis, respectively, to maintain adequate capital or to maintain an adequate
margin of assets in Canada over liabilities in Canada. Guideline A: Life Insurance Capital
Adequacy Test is not made pursuant to subsections 515(2), 992(2) and 608(3) of the ICA.
However, the guideline along with Guideline A-4: Regulatory Capital and Internal Capital
Targets provide the framework within which the Superintendent assesses whether a life insurer
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maintains adequate capital or an adequate margin pursuant to subsection 515(1), 992(1) and
608(1). Notwithstanding that a life insurer may meet these standards; the Superintendent may
direct the life insurer to increase its capital under subsection 515(3), 992(3) or 608(4).
This guideline establishes standards, using a risk-based approach, for measuring specific life
insurer risks and for aggregating the results to calculate the amount of a life insurer‟s regulatory
required capital to support these risks. The guideline also defines and establishes criteria for
determining the amount of qualifying regulatory available capital.
The Life Insurance Capital Adequacy Test is only one component of the required assets that
foreign life insurers must maintain in Canada. Foreign life insurers must also vest assets in
Canada per the ICA.
Life insurers are required to apply this guideline for reporting periods ending on or after
January 1, 2018. Early application is not permitted.
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For purposes of this guideline, “life insurers” or “insurers” refer to all federally regulated insurers, including
Canadian branches of foreign life companies, fraternal benefit societies, regulated life insurance holding
companies and non-operating life insurance companies.
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Contents
Chapter 1 Overview and General Requirements ………………………………..4
1.1. Overview ………………………………………………………………………………………4
1.2. Minimum and Supervisory Target ratios …………………………………………..6
1.3. Accounting basis ……………………………………………………………………………6
1.4. General requirements ……………………………………………………………………..7
1.5. Minimum amount of Available Capital …………………………………………….8
Chapter 2 Available Capital ………………………………………………………………9
2.1. Tier 1 ……………………………………………………………………………………………9
2.2. Tier 2 ………………………………………………………………………………………….27
2.3. Capital Composition and Limitations ……………………………………………..34
2.4. Transition ……………………………………………………………………………………35
Appendix 2-A Information Requirements for Capital Confirmations …………37
Chapter 3 Credit Risk – On-Balance Sheet Items ……………………………..39
3.1. Credit Risk Required Capital for On-balance Sheet Assets ………………..39
3.2. Collateral …………………………………………………………………………………….49
3.3. Guarantees and credit derivatives …………………………………………………..56
3.4. Asset backed securities …………………………………………………………………61
3.5. Repurchase, reverse repurchase and securities lending agreements …….64
Chapter 4 Credit Risk – Off-Balance Sheet Activities ……………………….66
4.1. Over-the-counter derivatives contracts ……………………………………………66
4.2. Netting of derivative contracts ……………………………………………………….69
4.3. Off-balance sheet instruments other than derivatives ………………………..73
4.4. Commitments ………………………………………………………………………………76
Chapter 5 Market Risk ……………………………………………………………………80
5.1 Interest rate risk……………………………………………………………………………80
5.2 Equity risk …………………………………………………………………………………..89
5.3 Real estate risk …………………………………………………………………………….96
5.4 Mutual funds ……………………………………………………………………………….96
5.5 Index-linked products risk …………………………………………………………….97
5.6 Currency risk ……………………………………………………………………………….99
Chapter 6 Insurance Risk ………………………………………………………………103
6.1. Projection of insurance liability cash flows ……………………………………104
6.2. Mortality risk …………………………………………………………………………….105
6.3. Longevity risk ……………………………………………………………………………110
6.4. Morbidity risk ……………………………………………………………………………111
6.5. Lapse and policyholder behaviour risk ………………………………………….115
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6.6. Expense risk ………………………………………………………………………………117
6.7 Credit for reinsurance and special policyholder arrangements ………….118
Chapter 7 Segregated Fund Guarantee Risk …………………………………..122
7.1. Products…………………………………………………………………………………..122
7.2. Documentation and reporting …………………………………………………….123
7.3. Total gross calculated requirement ……………………………………………..126
7.4. Classifying the asset exposure ……………………………………………………131
7.5. Determining the risk attributes……………………………………………………135
7.6. Retrieving the appropriate nodes ………………………………………………..141
7.7. Use of supplied functions to determine the requirement ………………..142
7.8. Margin Offset Adjustment …………………………………………………………150
7.9. Credit for reinsurance ceded or capital markets hedging ………………..150
7.10. Custom factors and internal models …………………………………………….151
7.11. Analysis of results …………………………………………………………………….152
Chapter 8 Operational Risk …………………………………………………………..153
8.1 Operational risk formula ……………………………………………………………..153
8.2 Operational risk exposures and factors ………………………………………….153
Chapter 9 Participating and Adjustable Products …………………………..156
9.1. The participating product credit ……………………………………………………156
9.2. The contractually adjustable product credit ……………………………………158
Chapter 10 Credit for Other Risk Mitigation and Risk Transfer ………161
10.1. Introduction ……………………………………………………………………………….161
10.2. Definitions…………………………………………………………………………………162
10.3. Valuation basis for ceded liabilities ………………………………………………163
10.4. Deductions from Available Capital for unregistered reinsurance ………164
10.5. Collateral and letters of credit ………………………………………………………166
10.6. Calculation of required capital/margin or eligible deposits ………………169
Chapter 11 Aggregation and Diversification of Risks ……………………….172
11.1. Within-risk diversification …………………………………………………………..172
11.2 Between-risk diversification ………………………………………………………..175
11.3 Base Solvency Buffer …………………………………………………………………177
Chapter 12 Life Insurers Operating in Canada on a Branch Basis ……178
12.1. LIMAT Ratios ……………………………………………………………………………178
12.2. Available Margin ……………………………………………………………………….179
12.3. Surplus Allowance and Eligible Deposits………………………………………182
12.4. Required Margin ………………………………………………………………………..182
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Chapter 1 Overview and General Requirements
This chapter provides an overview of the Life Insurance Capital Adequacy Test (LICAT)
guideline and sets out general requirements. Details on specific components of the LICAT are
contained in subsequent chapters.
1.1. Overview
1.1.1. LICAT Ratios
The LICAT measures the capital adequacy of an insurer and is one of several indicators used by
OSFI to assess an insurer‟s financial condition. The ratios should not be used in isolation for
ranking and rating insurers.
Capital considerations include elements that contribute to financial strength through periods
when an insurer is under stress as well as elements that contribute to policyholder and creditor
protection during wind-up.
The Total Ratio focuses on policyholder and creditor protection. The formula used to calculate
the Total Ratio is:
ase
The Core Ratio focuses on financial strength. The formula used to calculate the Core Ratio is:
Tier 1 apital
ase
1.1.2. Available Capital
Available Capital comprises Tier 1 and Tier 2 capital, and involves certain deductions, limits and
restrictions. The definition encompasses Available Capital within all subsidiaries that are
consolidated for the purpose of calculating the Base Solvency Buffer, which is described below.
Available Capital is defined in Chapter 2.
1.1.3. Surplus Allowance
The amount of the Surplus Allowance included in the numerator of the Total and Core Ratios is
based on provisions for adverse deviations (PfADs) calculated under the Canadian Asset
Liability Method (CALM), or any other method prescribed under the Standards of Practice of
the Canadian Institute of Actuaries, that is used to determine insurance contract liabilities
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reported on the insurer‟s financial statements.
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The specific PfADs included in the Surplus
Allowance used to calculate the LICAT ratios are:
1) All PfADs relating to scenario assumptions for risk-free interest rates associated with
insurance contracts other than segregated fund contracts, calculated net of all reinsurance;
and
2) All PfADs for non-economic assumptions associated with insurance contracts other than
segregated fund contracts, calculated net of registered reinsurance only.
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All other PfADs, including PfADs for economic assumptions other than those for risk-free
interest rates (e.g. credit spreads and foreign currencies), and PfADs associated with segregated
fund contracts, are excluded from the Surplus Allowance.
1.1.4. Eligible Deposits
Subject to limits, excess deposits placed by unregistered reinsurers (reference sections 6.7.1 and
10.6.4) and claims fluctuation reserves (reference section 6.7.4) may be recognized as Eligible
Deposits in the calculation of the Total Ratio and Core Ratio. Recognition of these amounts is
subject to the criteria for risk transfer described in section 10.6.
1.1.5. Base Solvency Buffer
Insurers‟ capital requirements are set at a supervisory target level that, based on expert judgment,
aims to align with a conditional tail expectation (CTE) of 99% over a one-year time horizon
including a terminal provision. The risk capital requirements in this guideline are used to
compute capital requirements at the target level.
An insurer’s Base Solvency Buffer (reference section 11.3) is equal to aggregate capital
requirements net of credits, multiplied by a scalar of 1.05. Aggregate capital requirements
comprise requirements for each of the following five risk components:
1) credit risk (Chapters 3 and 4);
2) market risk (Chapter 5);
3) insurance risk (Chapter 6);
4) segregated funds guarantee risk (Chapter 7); and
5) operational risk (Chapter 8).
2
If approximations are permitted by the CIA Standards of Practice and used to calculate the PfADs those
approximations should continue to be used for LICAT purposes.
3
The PfADs in the Surplus Allowance include insurance risk PfADs for all business that an insurer has assumed
under modified coinsurance arrangements, and exclude insurance risk PfADs for business that the insurer has
ceded under registered modified coinsurance arrangements.
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Aggregate requirements are reduced by credits for:
1) qualifying in-force participating and adjustable products (Chapter 9);
2) other risk mitigation and risk transfer (Chapter 10); and
3) risk diversification (Chapter 11).
The Base Solvency Buffer used in the LICAT ratios is calculated net of registered reinsurance.
1.1.6. Foreign life insurers
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The Life Insurance Margin Requirements and Adequacy of Assets in Canada Test (LIMAT)
Ratios are designed to measure the capital adequacy of foreign insurers. These ratios and their
components (Available Margin, Surplus Allowance and Required Margin) are described in
Chapter 12, “Life insurers Operating in anada on a ranch asis”.
The LIMAT is only one element in the determination of the required assets that foreign insurers
must maintain in Canada. Foreign insurers must also vest assets in Canada pursuant to section
610 of the Insurance Companies Act.
1.2. Minimum and Supervisory Target ratios
OSFI has established a Supervisory Target Total Ratio of 100% and a Supervisory Target Core
Ratio of 70%. The Supervisory Targets provide cushions above the minimum requirements and
facilitate OSFI‟s early intervention process
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. The Superintendent may, on a case by case basis,
establish alternative targets in consultation with an insurer based on that insurer‟s individual risk
profile.
Insurers are required, at minimum, to maintain a Total Ratio of 90% and a Core Ratio of 60%.
Insurers should refer to Guideline A4 – Regulatory Capital and Internal Capital Targets for
OSFI‟s definitions and expectations around the Minimum and Supervisory Target ratios and
expectations regarding internal capital targets and capital management policies.
1.3. Accounting basis
Unless indicated otherwise, the starting basis for the amounts used in calculating Available
Capital, Available Margin, Surplus Allowance, Base Solvency Buffer, Required Margin and any
of their components are those reported in, or used to calculate the amounts reported in, the
insurer‟s financial statements and other financial information contained in the Life Quarterly
4
Within this guideline, the term “foreign life insurer” has the same meaning as life insurance “foreign company”
in section 2 of the Insurance Companies Act.
5
Industry-wide Supervisory Targets are not applicable to regulated insurance holding companies and non-
operating insurance companies.
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Return and Life Annual Supplement, all of which have been prepared in accordance with
Canadian GAAP
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in conjunction with OSFI instructions and accounting guidelines.
For LI AT purposes, the insurer‟s balance sheet, financial statements and other financial
information as reported in the LICAT Annual Supplement deconsolidation reconciliation page
are subject to the following additional specifications:
1) Financial statements should be restated so that only subsidiaries (whether held directly or
indirectly) that carry on a business that an insurer could carry on directly (e.g., life
insurance, real estate and ancillary business subsidiaries) are reported on a consolidated
basis.
2) Consolidated equity investments in non-life solvency regulated financial corporations
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that are controlled should be deconsolidated and reported using the equity method of
accounting.
1.4. General requirements
1.4.1. Opinion of the Appointed Actuary
The Appointed Actuary is required to sign, on the front page of the LICAT Annual Supplement,
an opinion as to the accuracy of the return in accordance with subsection 2480 of the CIA
Practice-Specific Standards for Insurers (Standard). The text of the required opinion is:
“I have reviewed the calculation of the LICAT Ratios of [Company name] as at
[Date]. In my opinion, the calculations of the components of Available Capital,
Surplus Allowance, Eligible Deposits and Base Solvency Buffer have been
determined in accordance with the Life Insurance Capital Adequacy Test guideline
and the components of the calculation requiring discretion were determined using
methodologies and judgment appropriate to the circumstances of the company.”
[Note: For a foreign insurer “LICAT Ratios”, “Available Capital” and “Base
Solvency Buffer” are replaced by “LIMAT Ratios”, “Available Margin” and
“Required Margin”.]
The memorandum that the Appointed Actuary is required to prepare under the Standard to
support this certification must be available to OSFI upon request.
6
The Canadian Accounting Standards Board has adopted International Financial Reporting Standards (IFRS) as
Canadian GAAP for publicly accountable enterprises, including insurers. The primary source of Canadian
GAAP is the Chartered Professional Accountants of Canada Handbook.
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Non-life solvency regulated financial corporations include entities engaged in the business of banking, trust and
loan business, property and casualty insurance business, the business of cooperative credit societies or that are
primarily engaged in the business of dealing in securities, including portfolio management and investment
counselling.
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1.4.2. Authorized official signature
Each life insurer is required to have an authorized Officer endorse the following statement on the
LICAT Quarterly Return and the LICAT Annual Supplement:
“I confirm that I have read the Life Insurance Capital Adequacy Test guideline and related
instructions issued by the Office of the Superintendent of Financial Institutions and that this
form is completed in accordance with them.”
The Officer attesting to the validity of this statement on the LICAT Annual Supplement must be
different from the insurer‟s Appointed Actuary.
1.4.3. Audit requirement
Life insurers are required to retain an Auditor appointed pursuant to section 337 or 633 of the
ICA to report on the year-end LICAT Quarterly Return in accordance with the relevant standards
for such assurance engagements, as promulgated by the Canadian Auditing and Assurance
Standards Board (AASB).
1.4.4. Best Estimate Assumptions
Best Estimate Assumptions used to calculate the capital requirements for insurance and market
risks are the assumptions used in the CALM base scenario and consist of:
1) base scenario assumptions for interest rates as specified by CIA standards of Practice;
and
2) best estimates for all other assumptions, where these assumptions are consistent with the
base scenario for interest rates.
1.5. Minimum amount of Available Capital
Notwithstanding the minimum and target Total and Core Ratios described in the Guideline,
insurers are required to hold a minimum amount of Available Capital /Available Margin, as
calculated in this Guideline, of $5 million or such amount as specified by the Minister of
Finance.
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Chapter 2 Available Capital
This chapter defines the elements included in Available Capital, establishes criteria for assessing
instruments and sets capital composition limits.
The primary considerations for assessing the capital elements of an insurer include:
1) availability: the extent to which the capital element is fully paid and available to absorb
losses;
2) permanence: the period for which the capital element is available to absorb losses;
3) absence of encumbrances and mandatory servicing costs: the extent to which the capital
element is free from mandatory payments or encumbrances; and
4) subordination: the extent to which and in what circumstances the capital element is
subordinated to the rights of policyholders and general creditors of the insurer in an
insolvency or winding-up.
Total available capital comprises Tier 1 and Tier 2 capital, which are defined in sections 2.1 and
2.2 below.
2.1. Tier 1
2.1.1. Gross Tier 1
Gross Tier 1 is equal to the sum of:
Tier 1 Capital Instruments
1) Common shares issued by the insurer, other than those issued by consolidated
subsidiaries and held by third party investors, that meet the criteria specified in section
2.1.1.1;
2) Tier 1 Capital Instruments other than Common Shares issued by the insurer, other than
those issued by consolidated subsidiaries and held by third party investors,
a. that meet the criteria specified in sections 2.1.1.2 to 2.1.1.4;
b. prior to August 7, 2014 that do not meet the criteria specified in sections 2.1.1.2
to 2.1.1.4 but that meet the Tier 1 criteria specified in Appendix 2-B and
Appendix 2-C of the OSFI guideline Minimum Continuing Capital and Surplus
Requirements effective January 1, 2016, subject to transition measures in section
2.4.1;
3) Instruments issued by consolidated subsidiaries of the insurer and held by third party
investors
a. that meet the criteria for classification as Common Shares as specified in section
2.1.1.1, or as Tier 1 Capital Instruments other than Common Shares as specified
in sections 2.1.1.2 to 2.1.1.4, subject to section 2.1.1.5 and transition measures in
section 2.4.2;
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b. prior to August 7, 2014 that do not meet the criteria specified in sections 2.1.1.2
to 2.1.1.4 but that meet the Tier 1 criteria specified in Appendix 2-B and
Appendix 2-C of the OSFI guideline Minimum Continuing Capital and Surplus
Requirements effective January 1, 2016, subject to transition measures in sections
2.4.1 and 2.4.2.
Tier 1 Elements other than Capital Instruments
4) Contributed Surplus
a. Share premium resulting from the issuance of capital instruments included in
Gross Tier 1
8
;
b. Other contributed surplus, resulting from sources other than profits (e.g.,
members‟ contributions and initial funds for mutual companies and other
contributions by shareholders in excess of amounts allocated to share capital for
joint stock companies) excluding any share premium resulting from the issuance
of capital instruments included in Tier 2;
5) Adjusted Retained Earnings;
6) Adjusted Accumulated Other Comprehensive Income (AOCI);
7) Participating account (joint stock companies);
8) Non-participating account (mutual companies); and
9) Tier 1 elements, other than capital instruments, attributable to non-controlling interests,
subject to section 2.1.1.5.
To determine Adjusted Retained Earnings, the following items are reversed from retained
earnings
9
:
1) Changes to own credit risk: Accumulated after-tax gains or losses on fair-valued
liabilities that arise from changes to the insurer‟s own credit risk;
2) Real estate:
a. After-tax fair value gains or losses on owner-occupied property upon conversion
to IFRS (cost model)
10
;
b. Accumulated after-tax revaluation loss on owner-occupied property (revaluation
model);
c. Accumulated net after-tax fair value gains after transition to IFRS on investment
properties that do not back policy liabilities under CALM
11
;
8
Where repayment of the premium is subject to the Superintendent‟s approval.
9
The amount of retained earnings reported by fraternal benefit societies for LICAT purposes should be the lower
of the insurance fund surplus or the total surplus.
10
The amount reversed should equal the difference between deemed cost on transition to IFRS, and the moving
average market value immediately prior to conversion to IFRS.
11
For investment property acquired before transition to IFRS that was previously classified as owner-occupied
property, the cost base for calculating the gain is either the property‟s deemed cost on transition to IFRS (cost
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d. Gains or losses up to the transfer date on owner-occupied property that was
previously classified as investment property
12
;
3) Discretionary participation features reported in a component of equity that is included in
Gross Tier 1.
and the following item is added to retained earnings:
4) Accumulated gains reported in Other Comprehensive Income (OCI) up to the transfer
date on investment property that was previously classified as owner-occupied property,
and that does not back policy liabilities under CALM.
To determine Adjusted AOCI, the following items are reversed from total reported AOCI:
1) Changes in own credit risk: Accumulated after-tax gains and losses on fair-valued
liabilities that arise from changes to an insurer‟s own credit risk;
2) Cash flow hedge reserve: Accumulated fair value gains and losses on derivatives held as
cash flow hedges relating to the hedging of items that are not fair-valued on the balance
sheet (e.g., loans and debt obligations); and
3) Owner-occupied property: Accumulated after tax fair value revaluation gains on own-use
property (revaluation method).
2.1.1.1 Qualifying Criteria for Common Shares
Capital instruments classified as common shares must meet all of the following criteria:
1) The shares represent the most subordinated claim in liquidation of the insurer.
2) The investor is entitled to a claim on the residual assets that is proportional with its share
of issued capital, after all senior claims have been paid in liquidation (i.e., has an
unlimited and variable claim, not a fixed or capped claim).
3) The principal is perpetual and never repaid outside of liquidation (setting aside
discretionary repurchases or other means of effectively reducing capital in a discretionary
manner that are allowable under relevant law and subject to the prior approval of the
Superintendent).
4) The insurer does not, in the sale or marketing of the instrument, create an expectation at
issuance that the instrument will be bought back, redeemed or cancelled, nor do the
statutory or contractual terms provide any feature that might give rise to such expectation.
5) Distributions are paid out of distributable items (retained earnings included). The level of
distributions is not in any way tied or linked to the amount paid in at issuance and is not
subject to a contractual cap (except to the extent that an insurer is unable to pay
model) or its carrying value immediately after transition to IFRS (revaluation model). For similarly reclassified
investment property acquired after transition to IFRS, the cost base for calculating the gain is the property‟s
original acquisition cost.
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The amount of the reversal is the difference between the property‟s deemed cost on the date of transfer into
owner-occupied property, and either the moving average market value immediately prior to conversion to IFRS
net of subsequent depreciation if the property was acquired before conversion to IFRS, or the original acquisition
cost net of subsequent depreciation if the property was acquired after conversion to IFRS.
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distributions that exceed the level of distributable items or to the extent that distributions
on senior ranking capital must be paid first).
6) There are no circumstances under which the distributions are obligatory. Non-payment is
therefore not an event of default.
7) Distributions are paid only after all legal and contractual obligations have been met and
payments on more senior capital instruments have been made. This means that there are
no prefere
