Fair Value Accounting and the Minimum Capital Test September 21, 2006 Toronto Jane Voll, Vice-President and Chief Economist & Grant Kelly, Director, Policy Development and Assistant Chief Economist

Agenda Fair Value Accounting Status update on the MCT Outstanding concerns regarding the MCT

Fair Value Accounting OSFI guidelines: Regulatory capital treatment of certain items under the new financial instruments standards Guideline D-10: Accounting for financial instruments designated as “Held for Trading” (Fair Value Option)

Fair Value Accounting Industry position on OSFI’s guidelines: Insurance risk should not be classified as “financial” risk. Concern over the timeline Permanence of assets Tax impacts Impact on hedging own credit risk, loans and receivables P&C insurance cycle is volatile OSFI guideline D-10 should be open to P&C insurance

Fair Value Accounting Aggregate industry statistics (2005): BV bonds $51.1 billion (MV $51.8 billion) BV portfolio excl real estate $60.9 billion (MV $63.4 billion) Bonds BV yield 4.83% (MV yield 4.76%) Bond investment income $2.5 billion Liabilities net of reinsurance $35.5 billion * Source: IBC with data from MSA.

Fair Value Accounting IBC member survey: Average duration of bonds: 4.05 years (Max 11.1 years; Min 0.3 years) Average duration of claims liabilities: 2.81 years (Max 5.0 years; Min 0.25 years) MV/BV Bonds: 100.8% (Max 103.6%; Min 98.0%) * Sample of 21 companies/groups (51% of aggregate industry bonds; 57.5% of liabilities). Results are weighted based on portfolio.

Fair Value Accounting IBC member survey: Investment split for co’s that selected an investment option*: 24.4% HFT; 75.3% AFS; 0.3% HTM % of surveyed co’s that selected 100% HFT: 9.5% % of surveyed co’s that selected 100% AFS: 42.9% % of surveyed co’s choosing a mixed of investment categories: 23.8% * 16 out of 21 companies/groups sampled.

Fair Value Accounting IBC recommendations/comments to Dept of Finance Canada: No amendment to the definition of specified debt obligations “SDO’s” as market to market properties (142.2(1) (b) of the Income Tax Act “ITA”) If Finance considers a transition period for the expected income tax reserve change, a 3-4 year period would be appropriate and reasonable. Maintain the current methodology for calculating balances of the Canadian Investment Fund and related values for investment property in Part XXIV of the ITA regulations. Matching (P&C vs life)???

Agenda Fair Value Accounting Status update on the MCT Outstanding concerns regarding the MCT

Status update on the MCT IBC recommendations to CCIR on the MCT Review: Canadian P&C regulatory capital requirements remain significantly higher than other nations with similar or higher risk profiles Capital factors for P&C insurers are higher than other FI’s. Margins on margins

Status update on the MCT IBC recommendations to CCIR on the MCT Review (con’t): Penalty (margin) on cessions to sister companies should be eliminated, since these companies are already regulated under OSFI Regarding group vs legal entity supervision, the MCT should recognize group level transferability of capital within a group Canadian standards will need to evolve to incorporate both standard tests and internal modeling for risk and solvency assessment

Status update on the MCT 3 stages to MCT review: 1) Immediate: Changes to the test for ) Medium term: Asset factor review (IBC survey) 3) Long Term: Internal modeling for capital/risk management

Outstanding concerns with the MCT Margins on Margins Asset factors (risk sensitivity) Solvency requirements vs international

Thank you