On January 1, 2014, Office of the Superintendent of Financial Institutions (“OSFI”) implemented Guideline E-19: Own Risk and Solvency Assessment (ORSA) and companion Guideline A-4: Internal Target Capital Ratio for Insurance Companies. In this case, implementation meant that insurers were asked to, over a period of time, put in place the processes needed to meet the expectations of the Guidelines. They had until March 31, 2014, to let their OSFI relationship manager know when in 2014 their ORSA report would be available. Insurers looking for more insight into OSFI’s expectations may gain some valuable insight from their bank colleagues.
As the name suggests, an ORSA is a process through which an insurer identifies and assesses the set of unique risks to which the insurer is exposed. The companion Internal Target Guideline then requires that the insurer establish internal capital targets for the material risks identified by the ORSA. As an ORSA is meant to be forward-looking, the expectation is that the insurer will subject the results of the risk assessment to both stress and scenario testing.
Of course, ORSA is not unique to Canada. An ORSA is one of the key features of the new Solvency II capital regime being implemented in the European Union and the U.K. and has been adopted by the National Association of Insurance Commissioners in the U.S. What is unique to Canada is that OSFI is a consolidated industry regulator that implemented a similar process for banks in 2008, known as Internal Capital Adequacy Assessment Process or ICAAP.
Since implementing ICAAP in 2009, OSFI has sent two letters to the industry providing feedback based on its review of the banks’ annual ICAAP submissions, one covering the period between 2009 and 2011 and the other covering reports filed in 2013. The first letter sent in September, 2012 focused on the quality of the stress tests performed as part of the ICAAP. OSFI felt it necessary to remind the banks that it expected that stress tests used as part of the ICAAP would be consistent with OSFI’s Guideline E-18 on stress testing, a Guideline that also applies to insurers. Further, OSFI made two key observations about the tests. OSFI noted that, in order for stress testing to be meaningful, institutions needed to develop comprehensive, robust and forward-looking stress testing capabilities, using appropriate stress testing methodology and scenario testing selection that include extreme but plausible events, various types of material risks, and multiple perspectives (product, business and enterprise-wide). OSFI also noted that the board and senior management were expected to clearly demonstrate their accountabilities for ensuring an effective stress testing program and use of stress testing results for decision making and risk management.
In a second letter to the industry sent in January 2014, OSFI reminded the banks that they must be able to demonstrate that all major risks and material portfolios were addressed in their ICAAP, suggesting that the some banks may not have taken a comprehensive approach to identifying their risks. OSFI also stated that if an ICAAP suggested a capital target higher that previously adopted by the insurer, OSFI expected the insurer to either align the targets or to provide a clear rational for why the internal target could remain below the target identified by the ICAAP.
As 2014 unfolds, it will be interesting to see what comments OSFI may have on the first cycle of ORSAs. While there are key differences between the industries (there are only about 50 banks operating in Canada providing largely the same services compared with 130 insurers that offer widely varying products and services), we know from past practice that OSFI tries to ensure consistency in its expectations across all of the different financial services sectors. Insurers, therefore, should be mindful of OSFI’s ICAAP observations as they prepare their ORSA submissions.