LIFE INSURANCE CAPITALLIFE INSURANCE CAPITALMarket and Credit Risk QISMarket and Credit Risk QIS

Sylvain St-Georges, FSA, FCIA

November 19, 2009

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QIS – MARKET AND CREDITQIS – MARKET AND CREDIT

Introduction Market Risk Credit Risk Participating Products Closing Comments

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INTRODUCTIONINTRODUCTION

Main purpose: Test the practicality of the methods Estimate the potential impact

Approach based on shocks Actual requirements will require

calibration

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MARKET RISKMARKET RISK

Interest Rate Risk Equity Risk Real Estate Risk Pass Through Products Risk Currency Risk Liability Market Options Risk Asset Market Options Risk

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Interest Rate RiskInterest Rate Risk

Cash Flows Risk Free Interest Rates Interest Rate Shock Method Additional Scenarios

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Cash FlowsCash Flows

CALM cash flows No reinvestment Asset – fixed cash flows Asset – non-fixed cash flows Off-CALM assets and liabilities

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Risk Free Interest RatesRisk Free Interest Rates

Spot rates for Government of Canada Bonds

Provided rates for Canada and U.S.A. Rates for the first 30 years

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Interest Rate Shock MethodInterest Rate Shock Method

Economic impact of a sudden change in interest rates at time zero

Discount cash flows after 30 years to the year 30 using a flat 6% rate

Discount cash flows from years 0 to 30 to the year 0 using the prescribed interest rates

Net PV = Asset PV – Liability PV Buffer = Net PV of the base scenario

- min(Net PV of the test scenarios)

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Interest Rate Shock MethodInterest Rate Shock Method

Tests (estimated 99.5% percentile) Potential upward or downward change in 30

day T-bill rate over one year Potential upward or downward change in 30

year spot rate over one year Linear interpolation of shocks between

these two rates Shocks based on a simplified Cox-Ingersoll-

Ross model fitted to historical data

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Interest Rate Shock MethodInterest Rate Shock Method

Universal Life Products Guaranteed credited rates considered CFs consistent with the scenario interest

rates, for example, account values No adjustments due to anticipated

changes in lapse rates and expense charges (considered in insurance risk)

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Additional ScenariosAdditional Scenarios

Additional information to assist in calibrating the metrics

Shocks based on a 95% confidence level

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Equity RiskEquity Risk

Common shares (preferred shares included in the credit risk component)

Immediate shock (at time 0) Equity index stocks – 20% decline Managed equity portfolio – 30% decline

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Real Estate RiskReal Estate Risk

Immediate shock (at time 0) 20% decline

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Pass Through Products RiskPass Through Products Risk

Existing capital requirements New threshold of CF<70% Use of the CF based requirement is

optional

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Currency RiskCurrency Risk

Immediate shock (at time 0) Shock applied to the net mismatch of

CFs in each currency 20% rise or decline in currency’s value

against the Canadian dollar

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Liability Market Options RiskLiability Market Options Risk

Risk related to minimum interest rate guarantees reflected in the interest rate risk solvency buffer

Risk related to segregated fund guarantees is based on deterministic shocks

Additional segregated fund scenario requested for supplementary information

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Liability Market Options RiskLiability Market Options Risk

Risk related to segregated fund guarantees – maximum of these two scenarios:

Equity market falls 30% and bond market falls 20% (no recovery)

Equity index is assumed to increase 100% over 44 months, then drop to 75% of its starting value and fixed income market drops 20% in the 45th month (no recovery)

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Asset Market Options RiskAsset Market Options Risk

Products described in section 3.7 (Assets replicated synthetically and derivatives transactions) of MCCSR guideline

Current requirements

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CREDIT RISKCREDIT RISK

Short Term Investments Public Bonds Private Bonds Asset Backed Securities Mortgages Preferred Shares Other Items

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Short Term InvestmentsShort Term Investments

Current requirements Current factors consistent with factors

established for public bonds

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Public BondsPublic Bonds

Factors set up by rating and remaining term to maturity

Factors established using the Basel Foundation IRB approach, except

99.5% confidence level (instead of 99.9%) A modified maturity adjustment appropriate for

longer duration of bonds held by Canadian life companies

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Public BondsPublic Bonds

0-1 1-2 2-3 3-4 4-5 5-7 7-10 10+Standard

BaselCurrent

AAA 0.25% 0.25% 0.50% 0.50% 1.00% 1.05% 1.18% 1.25% 1.60% 0.25%

AA 0.25% 0.50% 0.75% 1.00% 1.25% 1.35% 1.60% 1.75% 1.60% 0.50%

A 0.75% 1.00% 1.50% 1.75% 2.00% 2.20% 2.70% 3.00% 4.00% 1.00%

BBB 1.50% 2.75% 3.25% 3.75% 4.00% 4.15% 4.53% 4.75% 8.00% 2.00%

BB 3.75% 6.00% 7.25% 7.75% 8.00% 8.00% 8.00% 8.00% 8.00% 4.00%

B 7.50% 10.00% 10.50% 10.50% 10.50% 10.50% 10.50% 10.50% 12.00% 8.00%

Other 15.50% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 12.00% 16.00%

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Private BondsPrivate Bonds

This category also includes leases and other loans

Factors based on the inferred rating from other issues by the same issuer

If it is not possible: factors are an average of the Public Bond BBB and BB factors for the equivalent term to maturity

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Asset Backed SecuritiesAsset Backed Securities

Calculated as a separate category of assets

To be grouped according to maturity and rating of the issue, on a similar basis as set out for Public and Private Bonds

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MortgagesMortgages

Commercial Mortgages Factor: 6% (current: 4%, Basel: 8%) Based on evidence from the 1990 real

estate downturn Single Family Residential Mortgages

Current factor Some data from the industry seems to show

numbers in line with the current factors

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Preferred SharesPreferred Shares

Current categorization Factors consistent with Public Bonds

factorsQIS Current

PFD-1 3.00% 1.00%

PFD-2 5.00% 2.00%

PFD-3 10.00% 4.00%

PFD-4 20.00% 6.00%

Other 30.00% 15.00%

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Other ItemsOther Items

Other items are: Miscellaneous Items Off-Balance Sheet Exposures Securities Lent

Current requirements

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PARTICIPATING PRODUCTSPARTICIPATING PRODUCTS

The “gross” reduction is based on the maximum reduction in present value of future dividends

The reduction included in the other components is subtracted from the “gross” reduction

The “net” reduction is applied to the market and credit risk components

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CLOSING COMMENTSCLOSING COMMENTS

Worksheets should be completed and returned by December 11, 2009

Submissions will be shared with Assuris and OSFI/AMF on a confidential basis

Interrogatories and Preparer Comments Responses to questions required Additional comments encouraged