Notes on MFC-inspired OSFI Seg-Fund MCCSR Requirements

Moody’s discussion of original rules:

Canadian guaranteed seg funds, like guaranteed variable annuities in the U.S., expose their issuers to catastrophe risk – namely, the low frequency, but potentially high severity risk of a prolonged downturn in the equity markets, resulting in reduced seg fund asset values and potential losses on guaranteed benefit payments. In Canada, this risk is magnified by the prevalence of maturity guarantees, which, unlike death benefits, pay out with certainty at a specified contract maturity date (assuming no previous lapsation). We believe that significant individual guaranteed seg fund exposures exist, given the recent retreatof reinsurers from this market, and in the absence of effective hedging techniques.

In 1999, OSFI, with the collaboration of the Canadian Institute of Actuaries (CIA), began to seek a solution to the industry’s growing exposure to guaranteed seg fund risk from a capital and reserving standpoint. In August 2000, a special CIA task force produced a report9 with a recommended framework for establishing total minimum balance sheet requirements (i.e., capital plus reserves, rather than just capital or reserves). Following a review and modification by OSFI, the recommendations culminated in the introduction of a new Mandatory Minimum Continuing Capital and Surplus (MCCSR)10 guideline in December 2000. The new requirements are being phased into the MCCSR capital of Canadian seg fund providers with 50% of the new standards required at year-end 2000, and the full standards required by year-end 2001.

At that time, MFC had seg-fund AUM of $6,767-million. According to MFC’s 3Q08 Earnings Release, segregated funds at 2008-9-30 were $165,488-million, comprised largely of $101,301-million in the US and $29,851 in Canada.

OSFI’s Revisions to Segregated Fund Guarantee MCCSR Rules:

Minimum Capital Dependent on Expected Payment Date: Currently SFG capital is established based on a confidence level of CTE(95) over the term of a contract, regardless of whether the payments are expected to be due next quarter or in 30 years. OSFI believes that the confidence level and the capital requirement should reflect the proximity of the expected cash flows. Therefore, cash flows would be grouped into 3 categories according to expected dates and the following minimum confidence levels would apply: i) due in 1 year or less, CTE(98); ii) due between 1 and 5 years, CTE(95); and iii) due after 5 years, CTE(90).

2. >5 Yr Capital Increases Towards Capital Based On CTE(95): To help ensure sufficient capital is methodically accumulated for cash flows beyond 5 years and to allow such capital to grow towards a CTE(95) capital requirement, a calculation will be performed to measure the amount (the “Adjustment Amount”) that would, if accumulated over the next 20 quarters (and no other changes occur – i.e. all parts of the equation remain the same), be required to adjust the actual >5 year capital at the end of the prior quarter (the “>5Yr Previous Q Required Capital”) to equal the capital required at the end of the current quarter measured at a CTE(95) confidence level (the “Current Q >5Yr CTE(95) Capital). The Adjustment Amount would equal 5% of the amount obtained when the >5Yr Previous Q Required Capital is subtracted from the Current Q >5Yr CTE(95) Capital.

Globe & Mail story Shaken Manulife goes to banks for loan:

During a conference call with analysts, Mr. D’Alessandro acknowledged he had asked the Office of the Superintendent of Financial Institutions, which regulates banks and insurers in Canada, to change certain capital rules as the firm faced the prospect of having to tap equity markets for an infusion

Conference call transcript:

As you can see on this slide in the box in the middle, we are expecting to close the third quarter in our target MCCSR range of 180% to 200% albeit at the lower end of that range.

As you can see, the required capital has increased and the primary driver of the increase in required capital is the impact of the equity markets on the segregated fund guarantees. Available capital has also increased through the notches by expected earnings but also by some capital re-positioning whereby we’ve moved excess capital from other components of the organization into Manulife.

I would just caution at this stage that the Q3 numbers are still estimated as we’re still preparing our final close of the books so all the Q3 numbers that you see in this report are preliminary.

Our segregated fund guarantee offerings are primarily in three jurisdictions: our US business, our Canadian business, and our Japanese business, and we have approximately $72 billion of net in force of guarantees.

MFC Slideshow, Impact of Equity Markets on Capital Position.

Update, 2008-11-12: Comparison of US & Canadian practice.

Discussion of Internal Models

Update, 2008-11-13: OSFI’s Framework for a New Standard Approach to Setting Capital Requirements.

Update, 2008-11-13:OSFI’s 2001-12-20 Letter to the OSC re Financial Reporting in Canada’s Capital Markets

subsection 22(6) of the OSFI Act requires that the Superintendent report annually “respecting the disclosure of information by financial institutions and describing the state of progress made in enhancing the disclosure of information in the financial services industry.” Prudential regulators, such as OSFI, take an interest in improving disclosure by financial institutions, not only to better serve the interests of their depositors and policyholders but also to promote the application of market discipline as a governance tool. As you are aware, this concept underlies Pillar 3 of the revised Basel Accord and also features in the international supervisory framework for insurance enterprises.

6 Responses to “Notes on MFC-inspired OSFI Seg-Fund MCCSR Requirements”

  1. […] and $326-million on equity-related issues. SLF does not yet know the effect of OSFI’s MCCSR Rule-Change on capital. They have $69.0-billion in segregated fund assets, compared to $16.6-billion in equity […]

  2. […] A massive change has been made to the MCCSR rules […]

  3. […] after getting into trouble with imprudent stock speculation – and partially bailed out by OSFI – is issuing common stock: Manulife Financial Corporation (MFC) will further strengthen its […]

  4. […] Readers will remember that Manulife got into difficulty with its seg-fund guarantees. The problem is that they are – as managers – ascribing a very low probability to those guarantees […]

  5. […] a matter of trust. In Canada, of course, we have OSFI with its demonstrated willingness to short-circuit Pillar 1 on the basis of a panicky ‘phone call, as well as contemptuous opacity towards the concerns of investors (Pillar […]

  6. […] nice to know they’re actually going to spend some time thinking about it rather than just taking dictation from well-connected companies … but OSFI has blown its credibility as an enforcer; all credit analysis must be performed […]

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