OSFI to review earthquake risk and minimum capital tests

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Canada’s solvency regulator will take a closer look at earthquake risk and the Minimum Capital Test (MCT) for P&C insurers, an executive from the Office of the Superintendent of Financial Institutions (OSFI) said during an industry event last week.

Lisa Peterson, managing director of OSFI’s capital and liquidity standards division, said earthquake risk and a more comprehensive review of the capital framework for P&C insurers are among the policy changes under consideration for 2025.

“We are looking at financial resources that support exposure to earthquake risk,” she said during the Insurance Bureau of Finance Canada symposium. “This was an issue that was raised by the industry.”

The potential “double count” is an element that the regulator will examine, Peterson said. Although it didn’t elaborate, a 2018 discussion paper on OSFI’s reinsurance framework at the time said OSFI required the creation of an earthquake reserve under MCT guidelines. A federally regulated insurance company (FRI) can reduce its earthquake reserve using eligible financial resources, but this reduction may result in the same resource being billed twice, which may inappropriately reduce the overall level of capitalization.

Both domestic and foreign financial institutions may include 10% of their consolidated/global capital and surplus as eligible financial resource to reduce earthquake risk reserve.

“The concern that arises is that part of the capital and surplus is used as an eligible financial resource to reduce the earthquake reserve, which reduces the capital requirement, and then also included as part of FRI’s available capital used to cover overall capital requirements,” OSFI cautioned in the discussion paper. Possible double for the same financial resource.

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Earthquake hazards have been on the industry’s radar for a while. In the absence of government support, the PCC is looking for ways to prevent a chain reaction of failure for insurance companies in the event of a massive earthquake in Canada.

As part of potential changes to its policy, OSFI plans to conduct a more comprehensive review of MCT for P&C insurers, something it reviewed comprehensively in 2015. “And quite frankly, it was not developed with the new accounting standard in mind,” Peterson said regarding the international standard. To prepare financial reports No. 17.

“And so, there are areas of improvement that we can undoubtedly make for MCT testing. We intend to start the conversation with the industry via a discussion paper that we hope to publish in the first half of next year.”

OSFI is also looking into the capital and liquidity treatment of crypto-asset exposure after publishing an advisory on the subject in August 2022. “There have been developments in this area, and we intend to update the guidance… We will launch a public consultation on this in the coming months.”

In addition, a guideline on model risk governance that currently only applies to banks will be updated as a result of developments in artificial intelligence and machine learning, Peterson said. “We also look forward to updating and broadening the scope of the guideline so that it applies not only to banks but to a broader range of financial institutions.”

Peterson reports that when it comes to IFRS 17, OSFI’s lead oversight team, capital specialists and data analysis experts will monitor submissions from insurers and engage in dialogue. The purpose is to assess whether there are any issues or areas that require further investigation.

Peterson added that any clarifications regarding broader industry applications have been discussed and posted on OSFI’s website. The changes are effective immediately and will be incorporated into the 2024 guidance, which will be published this fall. “Other than these critical matters of interpretation, these are the only changes we intend to make to the 2024 frameworks.”

Now that IFRS 17 is operational, Peterson said, the industry will need to understand how accounting procedures work from quarter to quarter under different circumstances. “We encourage insurers, and all insurers, to exercise caution in their capital management decisions over the coming quarters, certainly as they gain more knowledge and more experience with the new accounting standard.”

Featured image via iStock.com/PeopleImages

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