IFRS Seg Fund Treatment to Strain Insurer Capital?

In a prior post I discussed IFRS and the Assets-to-Capital Multiple with respect to banks and their mortgage securitization habits, but I’ve just realized there’s another nuance lying in ambush behind the thickets of regulation.

The OSFI Draft Advisory on Conversion to International Financial Reporting Standards (IFRSs) by Federally Regulated Entities (FREs) states:

With respect to life insurance entities, current CGAAP specifically requires that segregated funds should be accounted for separately (off balance sheet). However, IFRSs do not specifically address accounting for segregated funds. As a result, most segregated funds are expected to require consolidation treatment because of the “control” tests in IAS 27 and SIC 12. Most life insurers are, therefore, expected to report their segregated fund assets and liabilities on balance sheet through a one-line reporting format rather than commingled with other asset and liability categories.

OSFI is not issuing any additional accounting guidance or clarification in this area at this time.

OSFI will consider the accounting treatment of segregated funds if it becomes apparent that life insurers intend to commingle assets and liabilities, rather than use the expected one-line reporting format.

With respect to segregated funds, risk based capital requirements already exist and OSFI requires that the current treatment continue. Therefore, although segregated funds will appear on the balance sheet, they would not attract asset specific capital charges outside of the existing Segregated Fund Risk charge.

This is interesting in light of recent OSFI speeches by Julia Dickson:

As OSFI regulates non-operating insurers acting as holding companies, we are considering updating our current regulatory guidance for these entities to promote a more integrated and consistent approach to determining regulatory capital requirements. For example, OSFI’s MCCSR tests could be used to evaluate the group’s consolidated risk-based capital – and a test similar to the asset-to-capital multiple (ACM) test could be used to evaluate leverage.

… and her speech-tester, Mark White:

For example, OSFI’s Minimum Continuing Capital and Surplus Requirements (MCCSR) tests could be used to evaluate a financial group’s consolidated risk based capital – and an ACM like-test could be used to evaluate leverage.

These speeches were reported on PrefBlog in the posts OSFI Looking Closely at Lifeco Consolidated Capital and OSFI to Address Double-Leverage?, respectively.

If we look at, for instance, the Manulife 4Q09 Report we see that total capital is $33.2-billion, and total funds under management are $440-billion, which includes the general fund of $187-billion and seg-funds (on balance sheet, but not included in “Total Assets”) of about $192-billion.

After consolidation – particularly if mutual funds, etc., are consolidated – we could see reported total assets change dramatically:

MFC 4Q09
CAD Billions
Total Assets as Currently Reported 205
Seg Funds 192
Other Funds under Management 64
Potential Total Assets 461

Capital of 33.2 implies an ACM of about 14x; not only have we not been particularly thorough in digging up off-balance sheet committments, but it should also be remembered that a big chunk of these AUM are equities and should logically be constrained by a lower ACM than the banks’ loan-based accounts.

Life could well get interesting in the next few years!

5 Responses to “IFRS Seg Fund Treatment to Strain Insurer Capital?”

  1. prefhound says:

    I’m missing something here (due to gaps in my education, I suppose).

    Seg Funds are segregated. What exactly is the commitment of the sponsoring insurance company? Does the commitment vary depending on whether the seg fund holds money market (reputational “guarantee”) or equity?

    If the funds are not segregated, but mutual funds (e.g. IGM) how is this different?

  2. jiHymas says:

    Well, the IAS 27 Summary states:

    Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

    … and since it’s controlled, it must be consolidated.

    Price Waterhouse observes:

    Caution to non-experts: Special Purpose Entities (SPEs) are one of the most problematic and judgemental areas in accounting today. This publication addresses broad issues – real-life examples are never as straightforward.

    and provides a booklet. Their flow-chart has as one of its questions “Is there a retained majority of the residual or ownership risks?”; the answer will be “Yes” for seg funds; and if the answer is “Yes”, then consolidation is required.

    I don’t understand the logic and I’m not even going to try! OSFI can afford to spend millions on accountants and

    OSFI is not issuing any additional accounting guidance or clarification in this area at this time

    I’m just a poor dumb Portfolio Manager and if OSFI says they’re going to be consolidated then … it’s their call, even regardless of IFRS!

  3. prefhound says:

    well, I can understand why you’re confused. Is it your opinion that seg funds leave a “retained majority of the residual or ownership risks” with the sponsoring firm while mutual funds don’t?

  4. jiHymas says:

    Seg funds are easy. They will by their nature have some kind of minimum return guarantee that covers 50%+ of invested principal, so that’s a “retained majority of the ownership risks”.

    Money Market Funds are less clear, since there is no explicit guarantee of the principal by the sponsor. However, the implicit guarantee definitely exists, has been honoured many times in the States and has been recently honoured in Canada (National Bank / ABCP). You will recall I have argued for consolidation of MMFs on the books of regulated sponsors in the past.

    Other funds … well, I’m just kinda hoping!

  5. […] It is not clear whether or not this draft advisory will include leverage caps on assets including seg funds. […]

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