OSFI considers incorporating risk management benefits of diversification into its capital testing of insurers

CORRECTION: This article first appeared on Apr. 20 with incorrect information. The version below represents the amended version, based on a follow-up interview with the Office of the Superintendent of Financial Institutions (OSFI).

Canadian Underwriter apologizes for the errors contained in its initial report of Judith Roberge’s presentation at the Insurance Bureau of Canada (IBC)’s 16th Annual Financial Affairs Symposium on Apr. 19.

Canada’s solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI), is considering incorporating the risk management benefits of diversification into its capital testing of insurers.

OSFI is currently reviewing its Minimum Capital Test (MCT), which is a measure of capital adequacy. The office is working on a revised capital framework, which will be circulated for public consultation in December 2012, with the new rules scheduled to take effect Jan. 1, 2014.

Currently, the MCT is based on minimum capital levels, capturing risk categories such as insurance risk, credit risk, market risk and operational risk.

OSFI is amending its risk margin factors and shock, seeking a target level of capital rather than a minimum capital level. Since this reform will increase confidence that the capital levels are adequate, OSFI is now willing to consider diversification among risk categories and within the insurance risk category.

For example, an insurer would meet a target level of capital based on an analysis of all risk categories — insurance risk, credit risk, market risk operational risk — and then OSFI would consider non-correlated risks across risk categories or within the insurance risk category.

“Basically we are saying that OSFI recognizes that it is unlikely that all these risks will happen at the same time,” says Judith Roberge, director of P&C insurance capital for OSFI. She cited the example of an increased number of car accidents not being correlated to an interest rate increase.

“OSFI recognizes that where there is no correlation or a minimal amount of correlation between risks, OSFI is prepared to consider allowing a capital credit.”