The Mortality Mortgage: Pricing Practices and Reform in the Life Insurance Industry

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This booklet addresses risks associated with mortgage banking, relevant laws and regulations, accounting principles, regulatory guidance, and risk management. For more information regarding a bank's origination of mortgage loans to be retained in its own portfolio, refer to the " Retail Lending " and " Residential Real Estate Lending " booklets of the Comptroller's Handbook.

This booklet applies to the OCC's supervision of national banks and federal savings associations.

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References to national banks in this booklet also generally apply to federal branches and agencies of foreign banking organizations. What are you searching for in OCC. Office of the Comptroller of the Currency. Search OCC Website. The total assets are equal to 1 the estimate of its policyholder obligations and other liabilities plus 2 solvency buffers, both calculated for all risks that could have a financial impact on the life insurance company. One of the key principles of a TAR approach is that both expected and unexpected losses are considered in the calculation.

Using insurance obligations as an example, expected losses are included in policyholder obligations for the lifetime of all the policies. Policyholder obligations would normally include a margin for uncertainty about the expected losses typically a provision for adverse deviations or a risk margin. The margin for uncertainty is necessary as expected losses will vary from the best estimate.

However, the intent of the risk margin is not to cover significant adverse conditions or unusual circumstances.


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Unexpected losses resulting from adverse conditions should be covered in the solvency buffers. The estimation of the solvency buffer is the key element of the TAR approach, and is the focus of much of our ongoing development work. Modifications to the regulatory capital requirements may be necessary once the accounting standards have been finalized.

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A distinct, but related, issue is how the regulatory capital requirements will be expressed. The options are either as an add-on to the liabilities the current approach , or in a way that refers more directly to the TAR liabilities plus solvency buffers. To a large extent, this will also depend on the outcome of the proposed accounting standards.

OSFI will co-ordinate release of a guideline for public comment and the final guideline, with developments by the IASB for the accounting of insurance contracts. The revised regulatory capital requirements will retain the current intervention ladders that incorporate a minimum and a supervisory target capital level. The minimum capital requirement, including any floors associated with the use of internal models, will be based on the standardized test for all companies.

For the supervisory target, companies will use the standardized test or, for segregated fund guarantees, their internal model. Consistent with ORSA, companies are expected to establish their own internal capital targets. OSFI will specify a factor or a level of confidence for minimum regulatory capital requirements that will be similar for all risks. This is desirable as it:. When sufficient quality data are not available and it is necessary to rely more heavily on expert judgment, the level of confidence can be used as a guide for making decisions.

Under current regulatory capital requirements the supervisory target is defined, for each risk, as an addition to the policyholder obligations. However, the supervisory target is at a different and unknown level of confidence for each risk. Policyholder obligations are set using a principles-based approach guided by actuarial standards of practice which provide companies with some discretion in the level of their policyholder obligations. Consequently, the total policyholder obligations plus supervisory target results in differing confidence levels between companies for the same risk.

Under the revised minimum regulatory capital requirements, the level of solvency buffer will be defined so a more uniform confidence level for each risk can be achieved.

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Periodic recalibration, in light of international developments and as new data becomes available, will be done to maintain consistency over time. It is also not reasonable to require insurers to hold sufficient capital to cover extremely devastating. When determining the amount of the TAR, there is a trade-off between the level of protection and the cost of capital. The higher the level of protection, the higher the cost will be for policyholders and, to a certain extent, the Canadian financial system as a whole.

The level of protection being tested by OSFI in QIS 3 is for each risk separately to cover a 1-in year event a rare, but plausible scenario over a one-year time horizon.


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  • OSFI believes this level of protection would be equivalent to the low end of the investment grade range. The use of a one-year time horizon provides for the development of stress scenarios that are relatively easy to calculate and to explain. Developing stress scenarios over multi-year time horizons would present a number of challenges. Using longer time horizons provides a similar level of protection but can lead to over-reliance on judgment due to greater uncertainty and is inconsistent with expectations for objectivity.

    The minimum level would be determined in a similar fashion but at a lower level of confidence, yet to be determined. The current approach to determining liability and regulatory capital requirements for financial guarantees embedded in segregated fund products has the following drawbacks:. In , OSFI introduced an Alternative Method for determining regulatory capital requirements for segregated fund guarantees in order to mitigate the impact of significant short-term changes in segregated fund guarantee requirements and recognize that segregated fund guarantees are generally long-term contracts.

    Under the Alternative Method, the regulatory capital requirement is higher for contracts with less than five years to maturity and lowerf or contracts with more than five years to maturity. The ultimate goal is to develop a methodology that measures risk appropriately, aligns capital and hedging incentives, and encourages the establishment of solvency buffers well before an adverse economic event occurs. In , OSFI initiated a comprehensive review of the methods used to determine regulatory capital requirements for segregated fund guarantee risk.

    It was initiated to determine what the gaps were in the existing methodology and what could be done to address them. From this work, OSFI decided to develop regulatory capital requirements for segregated fund guarantee risks using principles that are market consistent. For example, a market consistent principle would be to use market values where they exist and are credible.

    The result will be a more market consistent approach to determining regulatory capital requirements. Under a more market consistent approach, supervisory target capital levels may be more volatile, particularly for unmitigated positions. The approach also has the potential for regulatory capital requirements to be higher than under the current framework.

    Recognizing that development of the new approach based on market consistent principles would take several years to complete, OSFI decided to update the calibration criteria for the investment return models used to determine segregated fund guarantee requirements to be applied only to business written after January 1, The revised model calibration criteria are based on 80 years of equity return experience, including return experience since and during the s. Implementation of the new approach is expected to occur in , with parallel results being produced during It is sometimes argued that the capital of a life insurance company is sufficient if it covers all the obligations a company has to its policyholders and creditors.

    Implicit in this view is the fact that the insurance company may not have enough resources to continue to be viable but because of the long-term nature of its obligations to policyholders, it could discharge its obligations over time run-off or transfer them to another company. In contrast, a much larger proportion of the obligations of banks can be withdrawn in the very short term; that is, a bank is more exposed to a short-term failure than a life insurance company.

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    Regulatory capital requirements exist to ensure that sufficient quantity and quality of assets are available to provide for an orderly transfer of the remaining obligations to another insurer or to run-off the remaining obligations should insolvency occur gone concern. A going concern approach requires a different level and quality of capital instruments. Traditionally, stakeholders in the life insurance industry have placed a greater focus on total capital rather than tier 1 capital.

    The greater emphasis on total capital is justified for the protection of policyholders and senior creditors because the traditional life insurance business is not vulnerable to liquidity runs from policyholders. Excessive gone concern capital levels could result in an inability to earn an acceptable return on capital or increase the probability of insolvency through substantial fixed charges against earnings interest on subordinated debt.

    Insufficient total capital levels could result in losses to policyholders and senior creditors in times of stress. OSFI believes that high quality capital instruments should form a substantial part of the capital resources of an insurer when times are good. This provides the company, and OSFI, with the flexibility to respond in a constructive way in times of stress.

    OSFI will consider these elements in developing guidance for the level and quality of available capital in the revised regulatory capital requirements. The review of the definition of capital component is necessary to incorporate lessons learned during the recent financial crisis.

    Would a “public plan option” at least be a step in the right direction?

    These relate to the quality of certain capital instruments during periods of stress, the appropriateness of deductions and adjustments made to regulatory capital. The review provides an opportunity to consider each available capital element and assess its contribution to two goals: financial strength and protection of policyholders and creditors. Revisions will provide increased transparency with respect to the meaning and purpose of both total protection of policyholders and senior creditors and tier 1 financial strength capital elements.