1. MCCSR in Canada: What Comes Next? PD 11 – Vancouver CIA Meeting June 28 th, 2007 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

2. 2 Today’s Agenda 1.The Evolving Landscape for RBC in Canada - Simon Curtis 2.Update on CIA Advanced Modeling Work - Michael White 3.OSFI Perspective on Key Issues - Allan Brender 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

3. The Evolving Landscape for Risk Based Capital Adequacy Simon Curtis June 28 th, 2007 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

4. 4 Why is the Landscape Changing? Factor based models are no longer viewed as adequate  are too inflexible to accurately capture most risks  do not capture emerging product or risk issues  do not give sufficient information on level of risk covered  provide limited information to management  do not capture diversification/aggregation impacts on risk Tools are becoming available to more accurately model risk  stochastic tools that can generate and process thousands of scenarios to generate probability distribution of outcomes  advanced probabilistic models based capital frameworks are frequently called “economic capital” frameworks 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 1

5. 5 Where is Pressure for Change Coming From? Company ManagementBank Sector Advanced Probabilistic Models Banking has moved to more advanced capital models for Solvency (Basel II) and internal management Companies require models for internal capital/risk management “Economic Capital” Rating Agencies Rating agencies are requiring development and wide internal use of advanced models to sustain high ratings and are moving to use these models themselves International Insurance Solvency European Insurance Industry/Regulators are adopting advanced models as part of “Solvency II” framework Existing Framework Limitations Existing framework increasingly incapable of reflecting advanced products and risk mitigation OSFI OSFI wishes to move industry towards advanced models/enhanced risk based framework consistent with international insurance and banking developments 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 2

6. 6 Key Attributes of Economic Capital Models Comprehensive coverage of all risks measured on a consistent basis Risk distributions modeled or determined for all risks  stochastic models used where significant tail risks  analytic techniques may be used for simpler risks  specific quantifications of confidence levels Focus is generally on total balance sheet requirement for risks  “capital” falls out as “total requirement – balance sheet provisions” Risk diversification/aggregation reflected 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 3

7. 7 What does Economic Capital Achieve? Enable better business decisions through:  consistent measurement of risk and return for existing and emerging risks  understanding which products are adding value and the value contribution of various businesses  understanding the impact of diversification/aggregation of risk Allows companies to appropriately set internal and regulatory capital targets  consistent measurement and explicit risk quantification allows understanding of key solvency risk exposures  target capital levels linked to financial strength objectives and desired credit rating Influence regulators and regulatory capital developments 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 4

8. 8 Industry Development of Economic Capital – Current State Most large insurers are developing economic capital frameworks Frameworks reflect all risks although degree of sophistication in the modeling often varies by risk Total Balance Sheet approach is typically used Primary risk measure is either CTE or percentile (VaR) Time Horizon used by many companies is 1 year but some use a lifetime horizon – Terminal provision is critical in a 1 year horizon  the confidence level is higher for shorter time horizons, e.g. if CTE95 is a reasonable capital level using a lifetime horizon, a 1 year horizon might use CTE99 for the first year with a CTE70 terminal provision calculated at the end of the year for the remaining life of the business 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 5

9. 9 Industry Development of Economic Capital – Current State Risk mitigation and pass-through are typically reflected  need to consider effectiveness of mitigation in the tail scenarios (e.g. will the instruments required for hedging be available and at what cost?) Companies are reflecting diversification benefits and risk concentrations – typically using correlation matrices or copulas rather than integrated models Stochastic techniques are used for investment related financial risks (market and credit), particularly risks with skewed distributions Stochastic techniques are being contemplated, but generally not yet developed for insurance risks Less advanced scenario techniques are typical for policyholder behaviour risks and little consensus in how to determine capital for operational risk 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 6

10. 10 Evolving the Regulatory Capital Framework OSFI/CIA jointly have established MCCSR Advisory Committee (MAC) to develop framework for how regulatory capital regime in Canada can evolve to reflect emerging capital adequacy measurement techniques Goals of industry/CIA include  reasonable consistency between economic and revised regulatory capital frameworks for life insurance  ensuring the Canadian industry/profession keep pace with international developments in this area  adoption of a framework that appropriately measures all risks and appropriately reflects impacts of risk aggregation/diversification and risk management 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 7

11. 11 Key Committees in Canada Established to Oversee Development of New Solvency Framework Regulatory Capital CIA Risk and Capital Committee Task Force (“SFSC”) MCCSR Advisory Committee (“MAC”) Industry Economic Capital Technical work on advanced modeling framework Supported by companies and regulators through making technical resources available Joint industry/Regulatory Committee assessing direction and advising on longer term solvency framework for Life Insurers Senior representation from industry, regulators, Assuris 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 8

12. 12 Key Milestones 2006 Agreement on solvency framework principles Agreement on working framework for “technical” aspects of the capital model (time horizon, confidence level, terminal value measure, role of risk neutral vs. real world basis, risk mitigation 2007 Agreement on advanced modeling best practices guidelines Agreement on “Vision” for structure of future regulatory solvency regime Finalize market risk advanced approach Substantially complete work on framework for risk aggregation across risks (diversification, covariance) 2008 Finalize credit risk advanced approach Finalize framework for risk aggregation across risks (diversification, covariance) for advanced approach 2009 Finalize insurance risks and operations risk advanced approaches 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 9

13. 13 Key Principles for the Solvency Framework Agreed Between Stakeholders 1.Consider all risks 2.Determine assets and liabilities on a consistent basis for risk measurement purposes 3.Be practical, but technically sound 4.Reflect existing risks ongoing concern basis and consider winding-up and re-structuring 5.Use measures (e.g. CTE) that are comparable across risks and products 6.Ensure that capital is prudent 7.Encourage good risk management 8.Adapt international principles and best practices 9.Allow comparison of similar risks across Financial Institutions 10.Be transparent, validated and based on credible data 11.Use reliable processes with assumptions sustainable in time of stress 12.Be part of intervention levels for supervisory action 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 10

14. 14 MAC “VISION” for Life Insurer Solvency Framework Minimum Asset Requirement Target Asset Requirement regulatory control level determined using “standard” approach threshold investment grade security level – regulator going concern level determined using “advanced” approach or scale up of standard approach minimum likely to target 1 year CTE(99) sufficiency level 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 11

15. 15 MAC “VISION” – Advanced vs. Basis Approaches Advanced ApproachStandard Approach uses company models sophisticated scenario modeling integrated with insurer risk management measures all risks, including risk mitigation risk dependencies within and between risks modeled (correlation, concentration) use of advanced approaches requires regulatory approval advanced approach to be encouraged for large insurers, technically able insurers, and insurers with complex risks selection of advanced vs. standard approach may be made separately for credit, market, insurance and operational risk industry formulaic or factor based while not as advanced, developed to be consistent and reflect all key risks and risk mitigation of advanced approach risk dependencies within risks only partially recognized designed to produce appropriate requirement across the industry 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 12

16. 16 MAC “VISION” - Technical Framework – Total Asset Requirement Required capital is determined indirectly as difference between modeled total asset requirement and balance sheet provisions Required = Total Asset - Balance Sheet Capital Requirement Policy Liabilities Assets Liabilities & Capital solvency buffer expected asset requirements margins required capital CGAAP policy liabilities best estimate policy liability total asset requirement 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 13

17. 17 MAC “Vision” - Technical Framework - Total Asset Requirement Key Advantages of Focus on Total Asset Requirement  automatically adapts to different accounting regimes  takes into account levels of conservatism in policy liabilities  removes disconnects between liabilities/capital Key Challenges  disclosure metrics need to be thought through carefully (a company with relatively more conservatism in margins may appear to be “capital light” when looking only at capital): disclose margin + capital?  increased model risk for total asset requirement approach as opposed to stand alone capital  difficulty in developing “simple” standard approaches to a total asset requirement as opposed to stand alone capital 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 14

18. 18 MAC “Vision” - Technical Framework - One Year Stress Test Metric Total asset requirement is determined as assets required to withstand extreme event over one year period with residual value sufficient to run-off or sell the business One year approach with residual value can be calibrated to consistent level of general conservatism as a lifetime run-off approach – appropriate determination of residual value is key One Year CTE99 Metric with CTE(60-80) Residual Lifetime CTE95 Run-Off Metric 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 15

19. 19 MAC “Vision” – Technical Framework - One Year Stress Test Metric One Year consistent with broader risk management (e.g. Basel II, VAR) focuses risk analysis and management on actionable timeframe appropriate residual value methodology can reflect long term risks long term models overweight very subjective analysis of catastrophic long term risk modeling Both One Year and Lifetime Perspectives Have Advocates Lifetime consistent with traditional actuarial approaches (e.g. Segregated fund guarantees) some long term risk exposures cannot truly be captured in shorter term metric it is difficult to develop reliable residual values for 1 year metric 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 16

20. 20 MAC “Vision” - Technical Framework - One Year Stress Test Metric Technically proposed framework for residual values requires a “stochastic on stochastic” calculator since first year paths and residual value on each path should be determined stochastically Year 1 Path Take CTE(99) result with residual values Path dependent Residual values Run off at CTE(60)-CTE(80) result is based on CTE(99) outcome of 1 year paths with calculated residual values 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 17

21. 21 MAC “Vision” – Technical Framework - Residual Value Residual value based on available close out strategy for the risk availability of robust market prices lack of robust market prices directly use these prices (e.g. risk neutral prices for certain market risks) actuarial modeling using “real world assumptions: 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 18

22. 22 MAC “Vision” – Technical Framework - Residual Value Accepted that first year paths must be generated stochastically Practitioners suggest need for practical compromise in developing approximations or closed form solutions to residual values because of complexity of stochastic on stochastic Does this need to approximate residual values call into question the one year approach given risks are long term? 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 19

23. 23 Looking Forward – Where are Current Initiatives Going? Progress has been slow  advanced frameworks taking significant time to develop  credit and market risk unlikely to be fully completed until 2008, insurance, aggregation and operational risks not until 2009  resource crunch (a few companies providing most of resources)  no agreed plan yet on how “standard” approach will be developed  momentum has slowed The regulatory burden for adopting advanced techniques is likely to be heavy  significant independent vetting  significant parallel testing  significant calibration and on-going control/reporting requirements  unclear how regulator will resource to meet its needs and whether companies will view the trade off of effort versus benefit favourably 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 20

24. 24 Looking Forward – Where are Current Initiatives Going? Updated framework may need to be implemented “risk” by “risk” rather than big bang approach  risk by risk approach leads to difficulties in assessing end state impact, and there may be tendency to move on items leading to capital increases rather than reductions first Current “moratorium” on MCCSR changes is leading to significant backlog of issues  reinsurance counter-party risk  currency risk  Others Credit for risk diversification is likely to be contentious issue between industry and regulators  has already emerged as issue in Europe in both Basel II and Solvency II  regulator reluctant to give credit for risk diversification in tail scenarios (to what extent do observed correlations survive in tail events) 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 21

25. 25 Looking Forward – Where are Current Initiatives Going? 2011 and the expected move to IASB accounting standards is likely a “hard” date for a significant change to existing MCCSR  IASB reserves will not consider C1/C3 risk and will not be asset adequacy based  Regulatory RBC (MCCSR) will likely need to make up for this gap up 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 22

26. 26 Key Papers CIA – Risk & Capital Committee Time Horizon Paper (lifetime vs. 1 year) Risk Measure Paper (CL vs. CTE) Terminal Provision Paper Key Principles for Reflecting Pass- through and Risk Mitigation Guidance Note for Risk Assessment Models OSFI/MCCSR Advisory Committee Initial Communication to Industry on establishment of Advisory Committee, key principles and timeline (April 2006) Canadian Vision for Life Insurer Solvency Assessment (May 2007) Available on CIA website Available on OSFI website 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007 23