Fair Value Accounting and the Minimum Capital Test

1. Fair Value Accounting and the Minimum Capital Test September 21, 2006 Toronto Jane Voll, Vice-President and Chief Economist & Grant Kelly, Director, Policy Development and Assistant Chief Economist

2. Agenda • Fair Value Accounting • Status update on the MCT • Outstanding concerns regarding the MCT

3. Fair Value Accounting OSFI guidelines: • Regulatory capital treatment of certain items under the new financial instruments standards • Guideline D-10: Accounting for financial instruments designated as “Held for Trading” (Fair Value Option)

4. Fair Value Accounting Industry position on OSFI’s guidelines: • Insurance risk should not be classified as “financial” risk. • Concern over the timeline • Permanence of assets • Tax impacts • Impact on hedging own credit risk, loans and receivables • P&C insurance cycle is volatile • OSFI guideline D-10 should be open to P&C insurance

5. Fair Value Accounting Aggregate industry statistics (2005): • BV bonds $51.1 billion (MV $51.8 billion) • BV portfolio excl real estate $60.9 billion (MV $63.4 billion) • Bonds BV yield 4.83% (MV yield 4.76%) • Bond investment income $2.5 billion • Liabilities net of reinsurance $35.5 billion * Source: IBC with data from MSA.

6. Fair Value Accounting IBC member survey: • Average duration of bonds: 4.05 years (Max 11.1 years; Min 0.3 years) • Average duration of claims liabilities: 2.81 years (Max 5.0 years; Min 0.25 years) • MV/BV Bonds: 100.8% (Max 103.6%; Min 98.0%) * Sample of 21 companies/groups (51% of aggregate industry bonds; 57.5% of liabilities). Results are weighted based on portfolio.

7. Fair Value Accounting IBC member survey: • Investment split for co’s that selected an investment option*: 24.4% HFT; 75.3% AFS; 0.3% HTM • % of surveyed co’s that selected 100% HFT: 9.5% • % of surveyed co’s that selected 100% AFS: 42.9% • % of surveyed co’s choosing a mixed of investment categories: 23.8% * 16 out of 21 companies/groups sampled.

8. Fair Value Accounting IBC recommendations/comments to Dept of Finance Canada: • No amendment to the definition of specified debt obligations “SDO’s” as market to market properties (142.2(1) (b) of the Income Tax Act “ITA”) • If Finance considers a transition period for the expected income tax reserve change, a 3-4 year period would be appropriate and reasonable. • Maintain the current methodology for calculating balances of the Canadian Investment Fund and related values for investment property in Part XXIV of the ITA regulations. • Matching (P&C vs life)???

9. Agenda • Fair Value Accounting • Status update on the MCT • Outstanding concerns regarding the MCT

10. Status update on the MCT IBC recommendations to CCIR on the MCT Review: • Canadian P&C regulatory capital requirements remain significantly higher than other nations with similar or higher risk profiles • Capital factors for P&C insurers are higher than other FI’s. • Margins on margins

11. Status update on the MCT IBC recommendations to CCIR on the MCT Review (con’t): • Penalty (margin) on cessions to sister companies should be eliminated, since these companies are already regulated under OSFI • Regarding group vs legal entity supervision, the MCT should recognize group level transferability of capital within a group • Canadian standards will need to evolve to incorporate both standard tests and internal modeling for risk and solvency assessment

12. Status update on the MCT 3 stages to MCT review: • Immediate: Changes to the test for 2007 • Medium term: Asset factor review (IBC survey) • Long Term: Internal modeling for capital/risk management

13. Outstanding concerns with the MCT • Margins on Margins • Asset factors (risk sensitivity) • Solvency requirements vs international

14. Thank you