1. CIA Annual Meeting LOOKING BACK…focused on the future

2. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future TOPICS TO BE ADDRESSED Denise Lang Background - Framework for MCCSR Evolution Sylvain St-Georges Need for Change Purpose of Capital Denise Lang Principles for Risk Based Economic Capital 2

3. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future D ENISE L ANG Background - Framework for MCCSR Evolution CIA Solvency Framework Sub-Committee Role of the Advisory Committee Strand Approach to MCCSR Evolution Key Issues for the Advisory Committee 3

4. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Background International direction is towards comprehensive model based Risk Based Capital frameworks:  Basel II for Banks  IAA/IAIS Research Paper CIA Risk & Capital Committee has established the Solvency Framework “Sub-Committee” to develop a model based framework in Canadian context Have articulated the need for change, purpose of capital and key principles for risk based capital  discussing with stakeholders and gathering feedback Currently working through practical implementation issues and defining the key elements supporting each principle 4

5. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Background Large Insurance Holdco’s are interested in moving to this type of framework for internal/external capital adequacy Significant interest and conceptual support for this direction in Canada from key constituents:  Holdco’s  OSFI  CIA  CLHIA  AMF  Compcorp 5

6. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Existing GroupNew Proposed Group CIA Solvency Framework Sub-Committee Assess and advise on broader solvency framework issues Supported by companies and regulators through making technical resources available Risk Based Capital Advisory Committee Technical model development Senior representation from key constituents/stakeholders in industry, regulators, others 6

7. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Role of the Advisory Committee Forum to build consensus of key stakeholders on direction/framework for fundamentally changing the solvency assessment framework Advise CIA Technical Work Group on consistency of emerging technical proposals with broader solvency assessment framework objectives Help remove roadblocks to work of the CIA Technical Group Input to regulators 7

8. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Strand 1 Advisory Committee Strand 2 Strand 3 “Maintenance” changes within existing framework Example: Mortality factors Short Term (2005, 2006) Introduction of advanced model based approaches for specific risks Example: C3 risk, C1 risk Medium Term (2006+) Introduction of comprehensive model based framework Longer Term (2009/2010?) The “Strand” Approach to MCCSR Evolution 8

9. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Key Issues for the Advisory Committee Dual advanced (model) vs. basic (factor?) approaches to accommodate sophisticated and less sophisticated organizations  Significant competitive/market issues Cost and infrastructure implications for advanced models How to develop meaningful capital ratio metrics in a TBSR (Total Balance Sheet Requirement) world? Priority risks for “advanced modeling” treatment 9

10. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Key Issues for the Advisory Committee (Continued) Dealing with current “topical” issues:  Role of negative reserves/CSV deficiencies in ongoing capital adequacy model (i.e. can liquidation risk issues be addressed within the same framework or not?)  Impact of emerging 2007 CICA standard changes (asset fair value rules)  Reinsurance ceded Operational Risk in MCCSR Diversification/Concentration Risk in MCCSR 10

11. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future S YLVAIN S T- G EORGES The Need for Change The Purpose of Capital 11

12. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Need for Considering Change Recent external developments: ERM and Economic Capital frameworks International insurance accounting standards Growing use of stochastic approaches New tests and solvency assessment approaches developed by other countries 12

13. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Need for Considering Change Developments in Canada: CALM DCAT New components (Seg funds, Lapse, Index-linked products, Mortality) Supervision framework based on risks Prescribed target capital level based on the minimum level 13

14. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Need for Considering Change Weaknesses in the current framework: Risks not all explicitly treated Certain risks not appropriately reflected by factor approach Risk mitigation should be taken into consideration more explicitly, including hedging and risk diversification Regulatory target levels set implicitly to reflect risks not covered but their magnitude in relation to other risks can vary significantly by company 14

15. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Need for Considering Change Right time to consider a complete change to the Canadian solvency assessment framework: Pending external pressures and need to further improve the current approach Long lead times to develop, test and implement a framework Need to be proactive to maintain Canadian solvency framework in the lead 15

16. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Purpose of Capital Risk based capital formula Ensure the appropriateness and strength of the total balance sheet (TBS) In a TBS world, capital required is the difference between the TBSR and the reserves Distinction between capital and reserves is important considering the large impact reserves have on earnings and the purpose of capital as a basis to measure ROE (sub-committee is not focussing on this distinction at this time) 16

17. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Purpose of Capital Owners’ primary concerns: Sufficient to gain the necessary confidence (marketplace, policyholders, investors and regulators) Not so conservative that the company is at a competitive disadvantage Basis to measure the rate of return Finance new business development Protect their investment during periods of adverse experience 17

18. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Purpose of Capital Regulators/policyholders perspective: Safeguard when bad things happen Motivate a company to avoid undesirable levels of risk Promote a risk measurement and management culture Alert supervisors to emerging trends Provide a tool to assume control of a failing company and to transfer portfolio to another carrier 18

19. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future D ENISE L ANG Principles for Risk Based Economic Capital 19

20. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principles for Risk Based Economic Capital Articulate proposed future direction Based on best practices and principles used internationally Assume Risk Based Capital is part of an overall framework that includes Regulatory Oversight Governance and Risk Management Practices Disclosure Other Risk Analysis (e.g. DCAT, liquidity management, etc.) 20

21. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #1 – A risk-based economic capital approach will be used to determine the Total Balance Sheet Requirement (TBSR). Focus is the TBSR at an appropriate confidence level. TBSR effectiveness is independent of accounting basis. Capital required is the TBSR less the amount provided in the liabilities. Ultimately economic approaches to solvency assessment should create a ‘level playing field’. 21

22. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #2 – All risks should be reflected. All types of risks (e.g. market, credit, insurance, operational) and all controlled entities should be considered. Off-balance sheet risks included. Methodology and degree of rigour will vary by risk. Reasonable estimates for risks difficult to quantify. Arbitrary increase in required MCCSR ratio for risks not included doesn’t reflect different risk levels by company. Better to reflect risks directly, even if simple approaches used for some risks. 22

23. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #3 – The determination of amounts of assets, liabilities and TBSR should be based on consistent methodology. Necessary to ensure a proper assessment of capital adequacy. Required to determine an effective overall financial strength measure. 23

24. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #4 – The framework must be practical and contain enough flexibility to be effectively implemented by companies of all sizes. Will develop a standardized and one or more advanced approaches for each risk. Build on current tools to the extent possible. Standardized defined so any company can implement. Risk models will be required for most advanced approaches. Standardized approach will be based on results from testing done with more advanced models. 24

25. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #5 – The TBSR should encourage and reward good risk management practices. Framework should reflect the true risks of the company. Pass-through - Risk sharing with policyholders and room to adjust for adverse experience will be considered. Risk Mitigation strategies (e.g. hedging, reinsurance) and the risks created by mitigation will be considered. Aggregation methodology should reflect correlation, diversification and concentration of risks. Credit in capital requirements for strong, demonstrable risk management practices will provide an incentive to make ongoing improvements. 25

26. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #6 – The TBSR should reflect existing risks on a going concern basis. Focus is protecting the rights of inforce policyholders. Consistent with international best practices. Existing risks include all current commitments. Future new business and implications of liquidation scenario recognized and tested in DCAT or other supplements to capital. 26

27. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future Principle #7 – The primary risk measure (i.e. CTE) should be appropriate and consistent across all risks and products. Risk Measure (ie. CTE level), time horizon and terminal value must be internally consistent. A minimum regulatory requirement and an appropriate economic TBSR to be determined for each company. Economic TBSR level set by company based on desired financial strength and credit rating. Economic TBSR at a higher confidence level than the minimum regulatory requirement. 27

28. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future PRACTICAL IMPLEMENTATION ISSUES Important to identify practical implementation issues before developing the details of the framework. Currently thinking through how to address the issues identified to date. These issues are: Standardized versus advanced approaches - When will advanced be allowed, encouraged or required? When will choice be restricted? How to minimize arbitrage? Advanced Model Standards – What will standards look like? Who will prescribe? Criteria to use models? Resource requirements? 28

29. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future PRACTICAL IMPLEMENTATION ISSUES (continued) Implementation costs – For small companies? Mid-sized companies? Large companies? How to meet the needs of companies of all sizes? Impact on supervision? – Insurer/supervisor relationship? Potential supervisor issues? Life versus P&C? Potential volatility of TBSR? Minimize potential pro-cyclicality? How to recognize and encourage effective risk management? For more details check the Solvency Framework Sub-committee’s CIA web page. 28

30. Session 6613 MCCSR in the 21st Century LOOKING BACK…focused on the future