OSFI’s capital guidelines include new 2.5% charge for risk-sharing pools

Canada’s federal solvency regulator has released its final capital guidelines for the P&C insurance sector, and one new wrinkle includes a fresh approach to handle the provincial risk-sharing pools administered by Facility Association — a new 2.5% capital charge.

The Office of the Superintendent of Financial Institutions (OSFI) published its new capital guidelines as part of the industry’s transition to the new International Financial Reporting Standard 17 scheduled for Jan. 1, 2023.

Under OSFI’s finalized capital guidelines, “the Provincial Risk Sharing Pools (RSP) administered by the Facility Association (FA), as well as the Groupement des assureurs automobiles (GAA), are now subject to credit risk charges,” OSFI explains in an introductory MCT letter to P&C companies.

“The 2.5% risk charge is used to capture the credit risk for third party reinsurance. The provincial risk sharing pools are treated similarly to third party reinsurance, with the same risk charge applied.”

Facility Association is an industry-wide organization based on private auto insurance company membership. It administers two different aspects of writing auto insurance business: provincial risk-sharing pools, and the residual market. Provincial risk-sharing pools are for writing “grey-area” private passenger risks, while the residual market is for risks that can’t find a home in the voluntary private auto insurance market.

“Under the new IFRS 17 accounting standards, the 2.5% charge is for P&C insurers, which is part of the new MCT guidelines,” Facility Association explained in an email to Canadian Underwriter. “The charge will be paid for by the industry, and is 2.5% of the balance held by the insurer due from FA.”

FA said it was well aware of the capital charge and met with several auditing firms to discuss how the risk-sharing pools should be approached, since they are not specifically mentioned in IFRS 17 standards.

“When it was announced the accounting standards would be updated and transition from IFRS 9 to IFRS 17, it presented an opportunity to have a fresh set of eyes review how RSPs [risk-sharing pools] should be treated under the new standards,” Facility Association explained in the email.

“In fact, it was actually FA that led the conversation on determining how RSP should be treated going forward. FA worked with KPMG to facilitate a joint discussion amongst external audit firms (KPMG, PwC, Deloitte and E&Y), who reached the consensus that RSP should be treated as reinsurance, recognizing there was no explicit guidance in the IFRS 17 standard.

“It was also concluded Facility Association is considered a legal structure and not an insurer, which was important in assessing who takes on the risk of the policy. The conclusion was that the entire industry collectively took on the risk, leading to the assessment that the RSP is a reinsurance arrangement.”

OSFI’s new guidelines include explanatory notes for its decisions, including early industry feedback on its proposed new capital charge for the risk-sharing pools.

“With Risk Sharing Pools now considered registered reinsurance, there are credit risk charges on the recoverable of 2.5% and operational risk charges that are not currently applicable,” as OSFI characterized the concerns of an IBC-led group of insurers. “OSFI should adjust the 2023 MCT to ensure capital neutrality with the current guideline.”

OSFI rejected that suggestion in its comments posted along with the capital guidelines.

“We are not considering changes to the credit and operational risk factors,” the regulator stated. “We understand…there will be capital implications on some components of capital required due to accounting differences under IFRS 17 compared to IFRS 4.

“OSFI’s commitment was for industry-wide neutrality, and it is not possible or practical for every element of the MCT 2023 guideline to be neutral.”

Feature photo courtesy of iStock.com/sgustok