MCCSR

Question 1

MCCSR minimum capital requirements (67)

Answer 1

The minimum capital requirement is the sum of five risk components:

1. Asset default (C-1) risk
2. Mortality, morbidity, and lapse risks
3. Changes in interest rate environment (C-3) risk
4. Segregated funds risk
5. Foreign exchange risk

The MCCSR ratios compare capital available to capital required

1. Total ratio = total available capital / base required capital - the minimum total ratio for life insurers is 120%, with a supervisory target of 150%
2. Tier 1 ratio = adjusted net tier 1 capital / base required capital - the majority of the capital held should be in tier 1. The minimum adjusted net tier 1 ratio is 60%, with a supervisory target of 105%

Question 2

Components of gross tier 1 capital (68)

Answer 2

Tier 1 (core capital) consists of the highest quality capital elements

1. Common shareholders’ equity
2. Participating accounts
3. Qualifying non-controlling interests in subsidiaries arising on consolidation from tier 1 capital instruments
4. Qualifying tier 1 instruments other than common shares
5. Non-participating accounts (for mutual companies)
6. Accumulated foreign currency translation adjustments reported in Other Comprehensive Income (OCI)
7. Accumulated net unrealized loss on available-for-sale equity securities reported in OCI
8. Accumulated changes in liabilities reported in OIC under shadow accounting
9. Accumulated defined benefit pension plan remeasurements reported in OCI

Question 3

Formulas for net tier 1 capital (69)

Answer 3

Net tier 1 capital = gross tier 1 capital minus:

1. Goodwill
2. Intangible assets in excess of 5% of gross tier 1 capital
3. Adjusted negative reserves calculated policy by policy and negative reserves ceded to unregistered insurers
4. Cash surrender value deficiencies calculated on a grouped aggregate basis
5. Back-to-back placements of new tier 1 capital between financial institutions
6. Each net defined benefit pension plan recognized as an asset on the insurer’s balance sheet net of any associated deferred tax liability

Adjusted net tier 1 capital = net tier 1 capital minus:

1. 50% of deductions/adjustments
2. Deductions from tier 2 capital in excess of total tier 2 capital available

Question 4

Types of tier 2 capital (69)

Answer 4

Tier 2 (supplementary capital) falls short of tier 1 by not being permanent or not being free of mandatory fixed charges against earnings. But tier 2 still contributes to the financial strength of a company.

1. Tier 2A: hybrid capital instruments (having certain characteristics of both equity and debt)
2. Tier 2B: limited life instruments
3. Tier 2C: other capital items
4. Net tier 2 capital is total tier 2 capital minus:
   a. 50% of deductions/adjustments
   b. Back-to-back placements of new tier 2 capital between financial institutions

Question 5

MCCSR morbidity risk requirement for accident and sickness insurance (72)

Answer 5

1. Disability income insurance and waiver of premium benefits
   a. Component to cover the risk of new claims – calculated as a % of earned premiums, varying based on the length of premium guarantee remaining
   b. Component to cover the risk related to continuing claims – calculated as a % of claim reserves. The factors apply only to claims incurred in prior years and range from 2-8%, varying by duration of disability and length of benefit period remaining
2. Accidental death and dismemberment – in most cases should be included in mortality risk component
3. Other accident and sickness benefits
   a. Component to cover risk of new claims – 12% of annual earned premium
   b. Component to cover the risk related to continuing claims – 10% of the provision for incurred but unpaid claims relating to prior years
4. Adjustment for statistical fluctuation (SFF) – total capital requirement is multiplied by a factor based on the size of all morbidity risks (M) for the company
   a. SFF(M)=1 if M lt $9M
   b. Otherwise SFF(M)=.7+900/M^.5
5. Adjustments for group business
   a. Requirement is multiplied by a scaling factor when a full transfer of risk is made through guaranteed no risk, a deficit repayment by policyholders, or a hold harmless agreement. The scaling factor is 5% for Canadian government group policyholders and 15% for all other policyholders
   b. No morbidity component is required for ASO group contracts where the insurer bears no risk and has no liability for claims
6. Amounts used in these calculations should be net of all registered reinsurance.
7. Certain amounts may be used to reduce the morbidity component requirement (eg qualifying policyholder deposits and claims fluctuation reserves)

Question 6

MCCSR mortality risk (70)

Answer 6

1. Mortality risk = volatility risk + catastrophe risk
2. Volatility risk = (sum of S^2)^.5 where S = 2.5ABE/F
   a. A=standard deviation of death claims – a simplified version is 1.75(C*F/n)^.5
   b. B=complicated so just use 1
   c. C=expected value of death claims
   d. E=net amount at risk
   e. F=total face amount
   f. N=# lives
3. Catastrophe risk = sum of K where K=aCE/F
   a. a=.05-.1
4. If have a hold harmless agreement multiply S and K by 5% for Canadian govt policyholders, 15% for others
5. Can reduce total mortality risk by value of claim fluctuation reserve (min with something else complicated)