2007 General Meeting Assemblée générale 2007 Montréal, Québec

1. Canadian Institute of Actuaries L’Institut canadien des actuaires 2007 General Meeting Assemblée générale 2007 Montréal, Québec

2. PD 15 OSFI Update Stuart Wason

3. Agenda • OSFI first impressions • OSFI introduction • DCAT reviews • Insurer solvency frameworks

4. OSFI First Impressions • Language • Group dynamics • Controls • Rewards

5. Language – No problem use acronyms! AA AAR ABM ACI ACL AFC AFID AFTR AG AICPA ALAE ALCO ALM AML APB APD APM ASB ATF ATIA AuG-15 AuG 43 BA BAA BAAC BAAT BCP BDN BID BoD BP BPS BRP BSII BTW BU CAD CAG CALM CAMEL CAO CAPSA CAR CaR CAS CBA CBO CBRS CCIR CCMD CCRA CD CDE CDIC CDO CDS CE CEO CFO CFR CGAAP CIA CIAA CICA CID CIM CIO CIRC CLHIA CLIFR CLO CMD CMHC CMO CMPF CMRAS CMS COB COO CPAB CPC CRAD CRC CRD CRM CRO CROAS CRR CSIS CSV CSWS CTE CVaR DAR DAT DCAT DEM DoF DPAC DPAE DPB DSO DSS DST DTI DTIAAC DTIC EAG EAP EBIT EC EDF EDMS EDP EL EM EMU EO EPM EPR EPS ETH EV FADM FAQ FAS FASB FBB FBI FCAC FCG FIC FIFO FIG FIRP FIRS FIS FISC FMV FRA FRB FRC FRDB FRFI FRIDB FRI FSA FSAP FSCO FSTD FTE FVO FX FYE GA GAAP GAAS GATS GATT GBP GFI GIL GNAIE GNPL GRS HKIA HKMA HL HRMS IAA IAASB IAG IAIS IAR IAS IASB IBC IBG IBNR ICA ICAO IDA IFA IG IEM IFRS IIF IM IMF IMM IPO IPU IRB IRR ISR IT IVaR JIT JPS JPY JUMP KOB LAD L&PI LoC LCMS LDC LDF LE LIAAC LIBOR LIFO LIIC LLE LLP LOB LRA LTP MAC MfAD MAS MASD MAT MBS MCCSR MCT MDB MD&A MIRS MIS MOU MRV MTM

6. OSFI First Impressions • Group dynamics – Bumper to bumper meetings! • Controls – No worries, there is a form for almost everything…. • Rewards – That’s easy, the people, responsibilities, industry relationships!

7. OSFI Introduction • Julie Dickson – Superintendent • Ted Price – Assistant Superintendent, Supervision Sector • Bob Hanna – Assistant Superintendent, Regulation Sector • Coleen Volk – Assistant Superintendent, Corporate Services Sector • Jean-Claude Ménard – Chief Actuary • JoAnne Bagnall – Senior Director, Audit & Consulting Services

8. OSFI Introduction • Ted Price – Assistant Superintendent, Supervision • Kent Andrews – Senior Director, Financial Conglomerates Group • Karen Badgerow-Croteau – Senior Director, Financial Institutions Group • Other direct reports

9. OSFI Introduction • Bob Hanna – Assistant Superintendent, Regulation • Patty Evanoff – Senior Director, Legislation & Approvals • Gilbert Ménard – Senior Director, Capital Division • Nick Burbidge – Senior Director, Compliance • Kim Norris – Managing Director, International Advisory Group • Alain Prévost – General Counsel • Stuart Wason – Senior Director, Actuarial Division

10. OSFI Introduction • Stuart Wason – Senior Director, Actuarial Division • David Oakden – Managing Director • Helmut Engels – Director • Sheldon Selby – Actuarial Specialist • 6 other Actuarial Division staff

11. Actuarial Division Mandate • Ensure appropriate actuarial knowledge, advice and standards are applied in OSFI’s regulatory and supervision systems so policyholders are safeguarded from undue loss and public confidence is enhanced

12. Actuarial Division Roles • Identify insurer specific risk in conjunction with Supervision • Review insurer AAR’s, DCAT’s, external reviews • Lead insurer model approval process • Monitor & analyze emerging risks • Share actuarial expertise within Supervision and Regulation Sectors • Active participant in relevant committees of CIA, IAA and IAIS

13. DCAT Reviews • Actuarial Division will use common template to review and score majority of DCAT’s (both life and P&C) in coming months • Feedback to industry on non-confidential findings via open forum spring 2008 • Goal: Strengthen this valuable and useful risk & capital management tool

14. Insurer Solvency Frameworks • Global developments • IASB IFRS 4 Phase II January 1, 2011 (2012?) • Solvency II in Europe • IAA & IAIS Guidance papers • Canadian developments • Life MCCSR II project underway • P&C need for MCT II becoming important

15. IASB Developments • Move to IFRS • Importance to OSFI • Key Impacts • Overview of Proposed Accounting for Insurance Contracts • What OSFI is doing • Implementation Challenges • Other IFRS to watch for • Further Questions

16. The Move to International Financial Reporting Standards (IFRS) Canada will adopt IFRS for “publicly accountable enterprises” on January 1, 2011 - so all regulated financial institutions will need to convert. The move to IFRS will more than likely include a new standard on accounting for Insurance Contracts

17. Importance of IFRS to OSFI • Accounting measurement is important as we try to meet our objectives of: • Continued use of reliance framework on auditors work and thus the financial statements • Understanding arbitrage possibilities between banks and insurers due to accounting differences • Reliable financial statement values that can be incorporated into regulatory capital

18. International Accounting for Insurance Contracts “The IASB has been working on the insurance contracts project with little respite for ten years. If it were easy, it would have been completed ten years ago.” Past: • Issues Paper (1999) • Draft Statement of Principles (2001) • ED 5 (2003) • IFRS 4, Insurance Contracts (2004) Current: • Phase II Discussion Paper (comments due) Future: • Finalization of a new Insurance Accounting Standard (2009/10) • Implementation of a new Insurance Accounting Standard (2011)

19. Key Impacts for Non-Life Insurers • Unearned Premium Reserve gone (but may serve as a proxy for pre-claims liabilities) • Deferred policy acquisition costs gone – include in future cash flows • Impacts to key financial ratios • Explicit margins

20. Key Impacts for Life Insurers • CALM gone (no linkage of assets to liabilities; no ALM or asset credit risk in liabilities; discount rate not tied to assets on the book) • Reinsurance presented gross • Investment contracts accounted for as financial instruments • Investment components unbundled • Devil is always in the details – there could be more

21. Insurance Contracts Accounting Same accounting principles apply to Life and Non-Life Insurance Contracts – a change Contracts without significant insurance risk are accounted for as financial instruments – i.e. non-life contingent annuity – a change Measurement attribute is current exit value – “the amount the insurer would expect to pay at the reporting date to transfer it’s remaining contractual rights and obligations immediately to another entity”

22. Insurance Contracts Accounting The current exit value is not typically observable, so three basic building blocks serve as a proxy: An estimate of the future cash flows The effect of the time value of money A margin

23. Insurance Contracts AccountingFuture Cash Flows • Current estimates • Unbiased • Probability weighted (expected value) • Use observable market inputs, where they exist • Principles, not detailed guidance

24. Insurance Contracts AccountingDiscount Rate • Both Life and Non-Life discounted • Current market interest rate - some interpret as “risk-free” rate • Expected returns on actual assets are not relevant (no linkage) – unless they affect liability cash flows

25. Insurance Contracts AccountingMargins • Explicit • Required by market participants for bearing risk and providing service • Not a shock-absorber • Principles based – likely Cost of Capital • Issue of calibration – profit at issue

26. What OSFI is doing • OSFI monitors developments in IFRS and provides input to standard setters mainly through the BCBS and IAIS • OSFI’s solicits input from interested parties – FI’s, other regulators, auditors, industry associations • OSFI has a priority project on the Move to IFRS

27. Implementation Challenges for OSFI & Insurers • Time is short – 3 years • Resources are limited • Standards are complicated • Competing priorities • Lessons learned from EU introduction of IFRS 4 Phase I: • Start early • Devil is in the details • Don’t underestimate the time and effort • Educate users of financial information

28. Other IFRS to watch for • Fair Value Measurements • Revenue Recognition • Derecognition/Consolidation • Financial Statement Presentation • Conceptual Framework • Liabilities & Equity • Improvements to Financial Instruments

29. Solvency II in Europe • Proposal for Framework Directive on Solvency II to the European Parliament and European Council on July 10, 2007 • Provides for target & minimum capital requirements for insurers • Target can use internal model approach (subject to supervisor approval) • Applies to life & non-life in 2011 (2012?) • Quantitative Impact Studies

30. IAIS Solvency Developments • Recent Guidance Papers • ERM for capital adequacy and solvency purposes • Use of internal models for risk and capital management by insurers • Structure of regulatory capital requirements • Expected Guidance Papers • Group issues • Valuation of assets and liabilities, including technical provisions for solvency purposes • Capital resources, the forms of capital

31. IAA Solvency Developments • Recent Guidance Papers • Use of internal models for risk and capital management by insurers • Risk margins • Enterprise risk management

32. Canadian Insurer Solvency Framework - Forces of change • Emergence of IASB standards for insurance accounting means that CICA will cease to be an accounting standards setter for insurers • Advanced probabilistic models, • Now used by larger insurers for internal risk & capital management • Solvency II • Existing framework not capable of reflecting advanced products and risk mitigation • Allowed by Basel II

33. Canadian Insurer Solvency Framework - Forces of change • Current standard approach • Originally designed and calibrated many years ago before market values used • Market risk component uses simple factor • No allowance for diversification or concentration • Increasingly includes fairly complex to calculate elements (i.e. no longer a “standard” approach?) • Not suitable for IASB insurance liabilities

34. Work completed/underway 2006 • Life insurer stakeholder working group formed (MAC) • Agreement on solvency framework principles • Agreement on working framework for “technical” aspects of the capital model 2007 • Agreement on advanced modeling best practice guidelines • Agreement on “Vision” for structure of future regulatory solvency regime • Initiate work on new standard approach • Finalize market risk advanced approach

35. Key milestones 2008 • Work on non-life (P&C) issues commences • Finalize credit risk advanced approach • Finalize framework for risk aggregation for advanced approach • Draft standard approach ready for QIS 2009 • Further QIS on revised standard approach • Standard approach finalized 2010 • Implementation measures necessary for new standard approach put in place 2011 • New standard approach takes effect January 1, 2011 • Approval of new advanced approach for large insurers?

36. MAC Vision concepts Future solvency financial requirements should: • take into account all credit, market, underwriting & operational risks • recognize all cash flows from all of the assets and liabilities • value the cash flows consistently and realistically • reflect the risk mitigation strategies used by the insurer • consider the dependencies within risks and between risks and recognize when appropriate and measurable • ensure that insurer assets are sufficient, with high degree of confidence, to withstand adversity emerging over a defined regulatory control time horizon (e.g. might be one year) • ensure that there are sufficient assets at the end of the defined time horizon to provide for the: • transfer of the remaining obligations to another insurer or • run-off of the remaining obligations

37. Minimum Asset Requirement Target Asset Requirement MAC Vision Threshold investment grade security level – regulator going concern level Regulatory control level Determined using “advanced” or “standard” approach Determined using “standard” approach Target 1 year CTE(99) sufficiency

38. Uses company models Sophisticated scenario modeling integrated with ERM Measures all risks & risk mitigation Risk dependencies modeled Requires regulatory approval Encouraged for large insurers, technically able insurers & those with complex risks Selection of advanced approach separate for credit, market, insurance and operational risk Industry formulaic, factor based or stress scenario Not as advanced but developed to be consistent & reflect key risks & mitigation of advanced approach Risk dependencies partially recognized Designed to produce an appropriate requirement across the industry Advanced Approach Standard Approach MAC Vision

39. Key Discussion Points • Risk horizon will be one year (working hypothesis) • Risk measure will be CTE (working hypothesis: CTE99) • Hedgeable risks at post-stress market consistent valuations • Non-hedgeable risks at post-stress BEL + post-stress risk margin (working hypothesis: CTE based) • How will standard approach differ from advanced approach?

40. Focus on Target Asset Requirement Required capital to be determined indirectly: Required = Target Asset - Reported IFRS Capital Requirement Liabilities Assets Liabilities & Capital required capital solvency buffer margins target asset requirement best estimate policy liability IFRS liabilities expected asset requirement

41. Risk Horizon • Working Hypothesis: One year extreme risk horizon (but coupled with Terminal Provision that reflects lifetime risk horizon) • Focuses extreme event risk analysis and management on actionable time frame • When coupled with appropriate Terminal Provision at end of One Year that reflects full distribution of post-stress risk events, also incorporates long term risk horizon

42. 90% 95% CTE90 Risk Measure • Working Hypothesis: CTE99 over one year • Considered Percentile (VaR/CL) but CTE (TailVaR or Exp Shortfall) chosen as theoretically superior: • CTE more robustly reflects the “fatness” of the tail.

43. Risk Margins • Working hypothesis: Risk margins are implicit in post-stress market consistent values for hedgeable risks, and to be CTE based for non-hedgeable risks Hedgeable: if robust market and prices available and intent to close Risks closed out/hedged at post-stress market consistent prices; risk margin implicit in MV Risks retained for lifetime with Terminal Provision set at post-stress BEL plus risk margin based on conservative CTE using post-stress “real world” scenario projections Non-hedgeable: if lack of robust market and prices or no intent to close • Reflect 1st yr stress scenario fully for Hedgeable and Non-hedgeable risks & full lifetime post-stress risk distribution for Non-hedgeable risks

44. Frameworks Compared Canadian Framework: Assets required today to ensure that assets at end of 1 year are sufficient to support obligations under CTE99 stress scenarios, where sufficiency means: • MVA exceeds MV obligations for Hedgeable risks AND • Assets exceed BEL + post-stress CTE risk margin for Non-hedgeable risks Solvency II: (Technical Provisions + SII Capital Required) MVA required today to ensure that MVA at end of 1 year exceeds MVL with 99.5% confidence, where: • MVL = BEL + MVM for Non-hedgeable risks, with MVM assumed to be unchanged (?) post-stress

45. Key Elements of Frameworks • Frameworks align • Frameworks differ

46. Assessment of progress • Progress has been slow • Advanced frameworks taking time to develop • Resource crunch (a few companies providing most resources) • Standard approach is just getting started • Much to be done but ability of insurers to perform many of the calculations already exists • 2011 and the move to IASB standards is a “hard” date for changes to Canadian solvency framework

47. Key issues • Who will provide the guidance needed to supplement the IASB insurance accounting standard? • What will Solvency II and other frameworks look like? • How to decide the issue of allowances for risk diversification & concentration? • Since the standard approach must be ready by 2011, what is the relative priority for the advanced approach? • How best should the work requiring the cooperation and participation of the entire industry be organized?

48. Questions and Discussion