OSFI to review earthquake risk and minimum capital tests 

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. 

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

“We’re looking at the financial resources that are supporting earthquake risk exposures,” she said during Insurance Bureau of Canada’s Financial Affairs Symposium. “This was an issue that was raised by industry.” 

Possible “double counting” is an element the regulator will examine, Peterson said. While she didn’t elaborate, a 2018 discussion paper on OSFI’s reinsurance framework at the time said OSFI requires the establishment of an earthquake reserve under the MCT Guideline. A federally regulated insurer (FRI) can reduce its earthquake reserve using eligible financial resources, but this reduction may result in counting the same resource twice, which may inappropriately reduce the overall level of capitalization. 

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

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

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Earthquake risk has been on the industry’s radar for a while. In absence of a government backstop, the Property and Casualty Insurance Compensation Corporation has been looking at ways to prevent a chain reaction of insurers failing in the event of a massive earthquake in Canada. 

As part of its potential policy changes, OSFI plans to undertake a more comprehensive review of the MCT for P&C insurers, something that was last comprehensively reviewed in 2015. “And quite honestly, it wasn’t developed with the new accounting standard in mind,” Peterson said in regard to IFRS 17.

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

OSFI is also looking at capital and liquidity treatment for cryptoasset exposures following the publishing of an advisory on the topic in August 2022. “There have been developments for this space, and our intention is to update the guidance… We will be launching a public consultation on that in the coming months.” 

As well, 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 are looking to update and increase the scope of the guideline such that it would apply not just to banks but to the broader spectrum of financial institutions.” 

When it comes to IFRS 17, OSFI’s lead supervisory team, capital specialists, and data analytics experts will monitor submissions from insurers and engage in dialogue, Peterson reported. “The purpose of this is to assess whether there’s any issues or areas that would warrant further investigation.” 

Any clarifications with broader industry applications have already been addressed and published on OSFI’s website, Peterson added. The changes take effect immediately and will be incorporated into 2024 guidelines, to be published this fall. “Beyond these critical matters of interpretation, these are the only changes that we intend on making to the 2024 frameworks.” 

Now that IFRS 17 is in practice, the industry will need to understand how accounting procedures may operate from one quarter to another under different conditions, Peterson said. “We’re encouraging insurers, all insurers, to be prudent with respect to their capital management decisions over the coming quarters and certainly as they gain more familiarity and more experience with the new accounting standard.” 

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