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Capital frameworks in Canada are ready for IFRS 17

By Michelle John, FCIA, Director, Life Insurance Capital at OSFI

On July 21, the Office of the Superintendent of Financial Institutions (OSFI) released final insurance capital guidelines that reflect the transition to International Financial Reporting Standard 17 – Insurance Contracts (IFRS 17) for fiscal years beginning on or after January 1, 2023.

The accounting transition to IFRS 17 represents the most significant change to insurance accounting requirements in over 20 years. Implementation will impact insurance companies by fundamentally changing accounting, actuarial, and reporting practices, and by significantly impacting supporting systems and practices.

This article will focus on the capital guideline changes applicable to federally regulated life insurance companies.

The Life Insurance Capital Adequacy Test (LICAT) was implemented in 2018 and represented a significant update and modernization of the capital framework, replacing the Minimum Continuing Capital and Surplus Requirements first put in place in 1992. OSFI’s capital test is based on the IFRS balance sheet, therefore we needed to make changes to reflect IFRS 17 approaches and methodology. We decided to keep the framework “as is” and only reflect changes that were necessary because of IFRS 17. We also determined that we would minimize industry-wide capital impacts at transition.

LICAT 2023, the version of LICAT that will be effective in 2023, was developed over a five-year period, starting in 2017. During that time, extensive consultations and discussions with industry and other stakeholders were conducted. This culminated in a public consultation and final industry quantitative impact study in June 2021, which included pro forma financial statements, capital calculations, and actuarial data. While the pandemic did cause some pause and downsizing of the work in 2020, the industry and OSFI adapted to working virtually and the development work continued. In November 2021, the critical path and timeline for finalizing the guideline were communicated to insurers. Regular updates and interim decisions were shared through industry letters and information sessions. The final step on that path was accomplished with the publication of the guideline, forms, and instructions on OSFI’s website.

What are the key changes?

  • Contractual service margins (CSMs), as defined under IFRS 17, are implicitly part of available capital under current accounting. To mimic the current treatment, available capital will be adjusted to add back CSMs that are liabilities (or subtract CSMs that are assets). This does not apply to segregated fund guarantee CSMs because an interim approach will be in place until 2025.
  • Policy-by-policy negative reserves that are included in the numerator of the total ratio – but not the core ratio – are currently calculated on a padded basis; i.e., including provisions for adverse deviation. Under IFRS 17, this will switch to the best-estimate basis because the allocation of the risk adjustment to each individual policy may not be done consistently. To mitigate the impact of the switch, offsets against negative reserves were increased.
  • Under IFRS 17, reinsurance contracts held assets may differ from the direct liabilities, so adjustments were made to the treatment of reinsurance to account for this. Also, to be consistent with the change to the best-estimate basis for negative reserves, similar changes were made to the unregistered reinsurance requirements.
  • Geographic allocation is not changing for liabilities; however, assets will be allocated to the regions in which they are currently held. The change reflects the de-linking of the valuation assets and liabilities under IFRS 17.
  • Keeping in mind the goal to minimize capital impacts on transition, a few other refinements were made to the capital test. The most substantial of which was to reduce the base solvency buffer scalar from 1.05 to 1.00. This margin was initially set in anticipation of IFRS 17 impacts, so it made sense to reduce it now.

What has not significantly changed

  • The solvency buffer calculations for market, credit, insurance, and operational risks are largely unchanged. The diversification and participating credit calculations are also largely unchanged. This is important as insurers’ current models and approaches can be leveraged.
  • A new standard approach is being developed for segregated fund guarantee risk, which will be implemented January 1, 2025. In the interim, the existing approach to calculating total gross calculated requirement with factors or approved models will be retained, with some small modifications to address IFRS 17 changes.
  • Minimum and Supervisory Targets remain the same for 2023.
  • No new transition measures were implemented after considering the industry-wide impacts.

In summary, the LICAT framework has been adapted to the new accounting rules in a prudentially sound way while minimizing capital impacts for the industry overall. Canada’s life insurance industry is generally well capitalized under current accounting rules and will remain so after the implementation of IFRS 17. It is important to note that IFRS 17 is a new standard for the industry, and OSFI expects insurers to act conservatively when making decisions that would result in changes to their levels of capital.

Join us for the “LICAT 2023” session at the Appointed Actuary Seminar, September 13–15, to hear more!

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