On December 14, 2023, the Office of the Superintendent of Financial Institutions (Canada) (OSFI) published adjustments and clarifications to the 2024 Minimum Capital Test (2024 MCT), the capital guideline applicable to federally regulated property and casualty insurers, effective January 1, 2024.
At a high level, the adjustments and clarifications impact the calculations for unexpired coverage for reinsurance contracts held in the 2024 MCT (collectively, the Amendments).
OSFI notes that the Amendments will be incorporated into the PC4 Instructions and may also be incorporated into a future version of the Minimum Capital Test. The Amendments are effective immediately and are described in further detail below.
Background
Chapter 4 of the 2024 MCT relates to insurance risk, which is divided into four parts: (i) liability for incurred claims; (ii) unexpired coverage; (iii) unregistered reinsurance; and (iv) earthquake and nuclear catastrophes.
With respect to liability for incurred claims and unexpired coverage, margins are added to cover a potential shortfall due to the uncertainty that insurance contract liabilities will be sufficient to cover future claims.
The margin for unexpired coverage is calculated by class of insurance, by multiplying the greater of: net unexpired coverage; and 30% of net premiums received in the past 12 months, by the applicable risk factors. Net unexpired coverage is calculated by subtracting unexpired coverage for reinsurance contracts held from unexpired coverage for insurance contracts issued.
Generally, the higher the net unexpired coverage, the higher the margin required to be maintained in respect of that unexpired coverage by the insurer in Canada.
1. Amendment to General Measurement Method calculation
Section 4.2.2.2 of the 2024 MCT relates to unexpired coverage for reinsurance contracts held (Unexpired Coverage). The first calculation method determines the Unexpired Coverage based on the general measurement method (GMM).
The GMM calculation has been amended to clarify that the estimate of future cash flows for reinsurance contracts held excludes premium and reinsurance commission cash flows that are due. Premiums and reinsurance commission cash flows and risk attaching proportional reinsurance contracts held are considered due, therefore are zero.
OSFI stated that the estimate of future cash flows does not include the risk adjustment for non-financial risk. Estimates of future cash flows for reinsurance contracts held and future reinsurance contracts held refer to the portion of such contracts that covers the unexpired portion of underlying insurance contracts issued. These cash flows include expected losses recoverable, net of expected future reinsurance costs.
2. Amendment to Premium Allocation Approach calculation
The second calculation method is the premium allocation approach ("PAA"). The PAA calculation has been amended to clarify that, with respect to expected premiums payable for reinsurance contracts held net of associated reinsurance commissions receivable, the premium payable and commissions receivable mean those that are not yet due. Similar to the amendment to the GMM calculation, premiums payable and associated reinsurance commissions receivable on risk attaching proportional reinsurance contracts held are considered due, therefore the amount of expected premiums payable for these contracts is zero.
Depending on the insurer's method used to calculate unexpired coverage for reinsurance contracts held, the Amendments may lead to increases or decreases in the margin requirement.
Conclusion
Since the Amendments may impact the calculation of margins for liability for incurred claims and unexpired coverage for federally regulated property and casualty insurers, we strongly recommend that federally regulated insurers discuss the Amendments with their appointed actuary.
Dentons Canada's Corporate and Regulatory Insurance Group would be pleased to assist with any questions related to the above-noted changes to the Minimum Capital Test or any other inquiries regarding the application of OSFI's Minimum Capital Test Guideline .
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