PD 8 OSFI Capital Update Stuart Wason Senior Director Actuarial Division OSFI CIA Appointed Actuary Seminar September 18, 2009

2 Capital Update Agenda:  Stress Testing  Life - Standard Approach QIS  Life - Segregated Funds  P&C MCT and internal models  Q&A

3 Stress Testing  OSFI Guideline E-18 on stress testing has been issued for consultation  Applies to all federally regulated financial institutions  Purpose is to share best practices, to ensure consistency as well as make clear OSFI expectations  Market events over the past two years have reinforced the merits of stress testing to address the fact that past events are not always a perfect predictor of the future

4 Lessons from financial crises  Insufficient consideration of extreme events – “It is hard for us without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.” August 2007, Joseph Cassano, a former AIG executive –“Almost no one expected what was coming. It’s not fair to blame us for not predicting the unthinkable.” Daniel Mudd, former chief executive of Fannie Mae

5 Stress Testing  OSFI’s guidance is based in part on principles established by the Basel Committee on Banking Supervision as well as best practices in insurance  OSFI expects all institutions to follow this guidance but also recognizes that each institution’s risk profile and investment strategy may be different  Stress testing has been done by OSFI for many years and is an integral part of our ongoing supervisory regime - OSFI asks financial institutions about their risk exposures and stress tests are done to help identify potential risks  Stress testing is done by most prudential financial regulators

6 What is stress testing?  Stress Testing: Risk management technique used to evaluate the potential effects on an institution’s financial condition, of a set of specified changes in risk factors, corresponding to exceptional but plausible events.  Scenario Testing: Form of stress testing which uses a hypothetical future state of the world to define the changes in the risk factors affecting the insurer.  Sensitivity Test: Form of stress testing which typically involves an incremental change in a risk factor to determine the impact on an insurer.

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8 Guideline E-18  Broad purpose of stress testing –Stress testing should be embedded in enterprise wide risk management –It should be actionable, playing an important role in development of risk mitigation or contingency plans –It should feed into the institution’s decision making process (e.g. setting risk appetite, exposure limits, and evaluating strategic choices) –Stress testing should be clearly documented & available for review

9 Guideline E-18  Specific purposes of stress testing –Risk identification and control –Complementary perspective to other RM tools –Supporting capital management –Improving liquidity management  Role of the Board and senior management –Board has ultimate responsibility for the overall stress testing program and that it is “fit for purpose” –Senior management is accountable for the program’s implementation, management and oversight.

10 Guideline E-18  General considerations –Stress testing should take account of views from across the organisation and cover a range of perspectives and techniques –Written policies and procedures governing the stress testing program - Appropriate operating documentation –Robust and flexible infrastructure for changing stress tests –Regular and independent assessment  Methodology and scenario selection –Deliver a complete picture of institution-wide risk –Cover range of scenarios, including non-historical scenarios, and take into account system-wide interactions and feedback effects –Include range of severities, including events capable of generating the most damage (e.g. size of loss or reputation) - determine what scenarios could challenge viability of institution (reverse stress tests)

11 Guideline E-18  Supervisory considerations –In assessing stress testing programs OSFI may: –Evaluate consistency with risk appetite –Assess whether scenarios appropriate –Assess frequency and timing –Ask for specific scenarios –Examine future capital resources and requirements –Take account of capital transferability within groups –Review range of management actions –Recommend remedial action to address weaknesses –From time to time, OSFI may conduct analysis of system- wide stress scenarios

12 Implications for DCAT  Annual DCAT report expected to be integral part of overall stress testing program as well as the risk management & strategic planning process  Starting in 2010, OSFI expects the DCAT report to be presented to Board no later than 6 months after year end  The reports must be filed with OSFI within 30 days after presentation to Board.  OSFI expects DCAT report to be used to identify risks that must be addressed in planning process - not the other way around

13 In conclusion…  Stress testing is an important risk management tool  Guideline E-18 outlines OSFI expectations for stress testing for all FRFI’s  OSFI expectations are broader and more fundamental than DCAT alone  OSFI will continue to work with the industry and the CIA to strengthen risk management

14 Other topics  Life - Standard Approach QIS –OSFI, AMF and Assuris are preparing to issue a QIS on the topics of market and credit risk this fall –Purpose is to test feasibility of new standard approach for determining capital – calibration will come later –Separate mortality QIS under consideration  Life - Segregated Funds –Fundamental OSFI review of SF policy liability and capital is underway  P&C MCT and internal models

15 Questions and Answers ?????