OSFI.MCT Flashcards
What is the minimum supervisory target for OSFI’s MCT Ratio
150%
What is the MCT ratio requirement for federally regulated insurers
100% (OSFI’s requirement of 150% is a more strict requirement)
Are insurers required to meet capital requirements at all times
Yes
Identify the main components of MCT capital required [IMCO]
- Insurance Risk
- Market Risk
- Credit Risk
- Operational Risk
Define MCT Insurance Risk
Risk of loss FROM the potential for claims (from policyholders & beneficiaries)
Define MCT market risk
Risk of loss FROM changes in prices in various markets
Define MCT credit risk
Risk of loss FROM counterparty’s potential INABILITY of UNWILLINGNESS to fully meet contractual obligations due to the insurer
Define MCT operational risk
Risk of loss FROM inadequate or failed internal processes, people, systems or from external events
Define “target capital required” (give the statistical definition)
Capital level corresponding to CTE(99%) on the loss distribution over 1-yr time horizon
(CTE = Conditional Tail Expectation)
Identify a proxy for capital available that appears in the Statement of Financial Position
Total Equity (line 699 from Statement of Financial Position - Liabilities & Equity)
- Sometimes an exam problem does not provide the components required to directly calculate capital available
- But if the question provides equity, you can use that instead as a proxy
Identify the principles of allocation regarding MCT capital requirements
[FACCS]
Allocation method should be
- Free from bias
- Accurate when allocating revenue & costs
- Consistent with allocation methods used by the insurer for other business decision-making purposes
- Consistent over time
- Systematic & reasonable
Describe the transitional arrangement for MCT capital requirements for business combination effective before June 30, 2019
The contractual service margin (CSM) arising from favorable development can be included in capital available
Identify qualitative considerations in defining MCT capital available [APAS]
- Availability: is the capital element fully paid & available to absorb losses
- Permanence: the period for, and extent to which, the capital element is available
- Absence of encumbrances and mandatory servicing costs: the extent to which the capital element is free from mandatory payments or encumbrances
- Subordination: the extent to which and the circumstances under which the capital element is subordinated to the rights of policyholders and creditors of the insurer in an insolvency or winding-up
Identify the main components of MCT capital available (3+1)
- Category A capital
- Category B capital
- Category C capital
- Non-controlling interests in subsidiaries, subject to certain conditions (category A, B or C)
Identify the subcomponents of category A capital available as listed in the MCT source text [RC CORNA]
- Residual Interest, reported either as equity or as a liability, of owner-policyholders of mutual entities
- Common shares issued by the insurer that meet the category A qualifying criteria
- Surplus (share premium) resulting from the issuance of instruments included in common equity capital and other contributed surplus
- Retained earnings
- Earthquake, nuclear and general contingency reserves
- AOCI (Accumulated other comprehensive income)
Identify the subcomponents of category A capital available as listed on page 20.11 in the financial statements
Under Policyholders’ Equity:
- Residual Interest
Under Shareholders’ Equity: (include everything except Preferred Shares)
- Common Shares
- Contributed Surplus
- Other Capital
- Retained Earnings
- Nuclear and Other Reserves
- AOCI
Should dividends paid to stockholders be removed from capital available
Yes
Briefly describe the MCT capital composition limits
BC Limit:
- (category B) + (category C) ≤ 40% x (total capital available - AOCI)
C Limit:
- (category C) ≤ 7% x (total capital available - AOCI)
Which regulatory adjustment to MCT capital availabe is an addition
CSM associated with title insurance contracts
Which regulatory adjustment to MCT capital available is an addition or deduction
Adjustments to owner-occupied property valuations
Which regulatory adjustments to MCT capital available are deductions
- Interests in and loans or other forms of lending provided to non-qualifying subsidiaries, associates, and joint ventures in which the company holds more than a 10% ownership interest
- Unsecured unregistered reinsurance exposures and self-insured retentions
- The earthquake premium reserve (EPR) not used as part of financial resources to cover earthquake risk exposure
- Insurance acquisition cash flows
- Accumulated other comprehensive income on cash flow hedges
- Goodwill and other intangible assets
- Deferred tax assets
- Cumulative gains and losses due to changes in own credit risk on fair valued financial liabilities
- Defined benefits pension fund assets and liabilties
- Investments in own instruments (treasury stock)
- Reciprocal cross holdings in the common shares of insurance, banking and financial entities
Identify the two uncertainties required for a risk to be considered “insurance risk”
- Uncertainty in the amount of payments
- Uncertainty in the timing of payments
Identify the subcomponents of insurance risk (4)
- LIC or Liability for Incurred Claims
- Unexpired coverage (includes catastrophes other than earthquake and nuclear)
- Unregistered reinsurance
- Earthquake and nuclear catastrophes
How is diversification risk accounted for regarding MCT insurance risk
- Risk factors for each class of insurance contains an implicit diversification credit
- This is based on the assumption that insurers have a well-diversified portfolio
Formula 1: margin(LIC)
margin(LIC) = 1.1 x risk factor x (net LIC(issued) – AIC(reins held)]
LIC net of S&S, both LIC and AIC exclu RA
Formula 2: margin(unexpired coverage)
margin(unexpired coverage) = (risk factor) x MAX [ net unexpired coverage) , 30% x (net premiums received past 12 months) ],
Net premium received = premiums received - associated reinsurance premiums paid
Formula 2a: Net unexpired coverage
Net unexpired coverage = (unexpired coverage for insurance contracts issued) - (unexpired coverage for reinsurance contracts held)
Formula 2b: (GMM): unexpired coverage for insurance contracts issued
(Unexpired coverage for insurance contracts issued) = PV (estimate of future cash flows excluding premium cash flows)
Formula 2c (PAA): unexpired coverage for insurance contracts issued
(Unexpired coverage for insurance contracts issued) = (LRC - LC + unamortized insurance acquisition cash flows + premiums receivable) x ELR + costs
Formula 2d (GMM): unexpired coverage for reinsurance contracts held
(Unexpired coverage for reinsurnance contracts held) = PV (estimate of future cash flows for current and future reinsurance contracts held)
Formula 2e (PAA): unexpired coverage for reinsurance contracts held
(Unexpired coverage for reinsurance contracts held) = (A + C + P1 + P2) x ELR - P3
where:
- A = ARC excluding loss recovery component
- C = unamortized reinsurance commission
- P1 = premiums payable to the assuming insurer
- P2 = expected future reinsurance premiums
- P3 = expected future reinsurance premiums net of reinsurance commissions
- ELR = Expected Loss Ratio
Identify the risks of holding a reinsurance contract with a reinsurer
- reinsurer won’t pay insurer what is owed
- mis-assessment of required provision (the amount the insurer expects to be paid)
Define “SIR” (Self-Insured Retention)
Portion of a loss payable by the policyholder
Condition for admitting recoverability of SIRs (Self-Insured Retentions)
OSFI must be satisfied of collectability - may require collateral (Ex: LOC from policyholder)
Identify the subcomponents of MCT market risk (6) [IFERRO]
- Interest rate risk
- Foreign exchange risk
- Equity risk
- Real estate risk
- Right-of-use asset risk
- Other market risks
What is the formula for margin(equities)
margin(equities) = 30% x (market value of equity)
Example of types of equities to which the 30% risk factor applies are:
- Common shares
- Joint ventures where insurer holds ≤ 10% ownership interest
- Futures
- Forwards
- Swaps
Identify the conditions for a hedge to qualify (for being recognized in the calculation of equity margin) (2)
The hedge must be issued to an entity that:
- Issues obligations which attract a 0% factor under section (6.1.2) (Credit risk factors)
- Is rated A- or better (including clearing houses rated A- or better)
What is the formula for margin(credit risk)
margin(credit risk) = margin(Balance Sheet Assets) + margin (Off-Balance Sheet Exposure) + margin(Collaterals and Guarantees), where
margin (Balance Sheet Assets) = Risk Factor x Net Exposure (Net Exposure = Balance Sheet Value - Redistribution of Exposure for Collateral/Guarantees)
Briefly describe what the “risk factor” is for calculating the margin for credit risk
The risk factor either:
- Corresponds to the external credit rating of the counterparty
- Respresents a prescribed factor determined by OSFI
What are “off-balance sheet” exposures + 4 examples
Risk exposures that are not listed on a company’s balance sheet
Examples are:
- Structured settlements
- LOC (Letters of Credit)
- NOD (Non-Owned Deposit)
- Derivatives
What is the formula for: margin(off-balance-sheet exposures)
margin(credit risk for off-balance sheet exposures) = [ (CEA – eligible collateral) x CCF ] x (risk factor)
where:
- CEA = Credit Equivalent Amount = an approximation to the true credit risk exposure
- CCF = Credit Conversion Factor = a factor reflecting the nature and maturity of the instrument
- Eligible collateral = collateral or guarantees held by the insurer to offset amounts owed by counterparty
Is legal risk included in operational risk?
Yes, legal risk is included as part of operational risk
Identify risks that are excluded from MCT operational risk (2)
- Strategic risk
- Reputation risk
Describe the purpose of the cap on operational risk of 30% x CR(0)
To dampen operational risk for business that satisfies these conditions
- High-volume
- Complexity
Identify scenarios linked with rapid premium growth (3)
- Mergers
- New LOBs
- Changes to products or U/W criteria
Briefly describe the impact of unregistered reinsurance on MCT operational risk
When unregistered reinsurance goes UP, then CapReq(OpnRsk) goes UP because:
- Operational risk depends on: insurance and credit risk
- and insurance risk goes UP because unregistered reinsurance is one of its components
Define “diversification credit”
A reduction to capital required recognizing that not all risk categories are likely to suffer their maximum loss simultaneously
State the formula for the diversification credit
DC = A + I - SQRT (A^2 + I^2 + 2RA*I)
where
A = C + M (Asset Risk = Credit Risk + Market Risk)
and usually R = 0.5 (R is the correlation coefficient between A and I)
Does the diversification credit consider correlation between and within all risk components
No
- Credit and market risk are summed to get asset risk
- Then the diversification credit considers the correlation between asset and insurance risk
How to calculate Foreign Exchange Risk Margin
10% of the greater of aggregate NET LONG position or NET SHORT in each currency, adj by effective allowable foreign exchange rate hedges if any are used
Calculate Foreign Exchange Risk (Example): An insurer has $100 of US assets and $50 US liabilities
Net spot position = A - L = long position of $50
[ positive = long, negative = short]
Carve out = 25% liabilities
= 25%*50
= 12.5
10% MAX (net spot position - carve out, 0)
= 10% MAX (50-12.5, 0)
= 10% * 37.5
= 3.75
