MCT Capital Required: Insurance Risk (Unregistered Reinsurance)

Tony88passTony88pass
in OSFI.MCT

Hi Graham,

I have a question on this formula:

CapReq(UnregRe)
= (UEP + O/S) x 15% – max(0, -D) (if < 0 then set to 0)

If D<0 and -D>(UEP+O/S)*15%, it means the collateral is greater than the reinsurer's exposure so insurer doesn't need capital required, it's in line with the formula above and makes sense to me (If the Unreg Reinsurer defaults, the insurer will even benefit from it by keeping the collateral)

If D>0, then it means even without considering the margin the collateral is short to cover the reinsuer's exposure, after including the margin, the collateral will be short by [(UEP+O/S)*15%+D], so to my understanding this should be the capital required, overall the above formula should be (UEP+O/S)*15%+D in my opinion

Can you let me know your thought?

Thanks,
Tony

Comments

  • grahamgraham
    edited June 2021

    Hi Tony,

    Before addressing your question, one thing to notice is that "D", which is:

    • D = (UEP + O/S recoverable + Reinsurance Receivable)
    •        - (Reinsurance Payable + NOD + LOC)

    will either reduce capital available (if D>0), or reduce capital required (if D<0).

    • when D>0, that means collateral is not sufficient to cover reinsurer recoverables/receivables and capital available must be reduced. (No adjustment is made to capital required.)
    • when D<0, collateral is sufficient so the required margin of (UEP + O/S) x 15% can be reduced by the magnitude of D to a minimum of 0. (No adjustment is made to capital available.)

    So even if D=0 and the collateral perfectly covers the exposure, you still require a margin of (UEP + O/S) x 15% for unregistered reinsurance. To reduce this margin, the collateral must exceed the exposure. This corresponds to D<0.

    Take a look at this exam problem for an example of this calculation:

    Back to your question:

    • Part of what you stated is correct but I don't think the formula you gave is correct when D>0. When D>0 the term max(0, -D) = 0 so D plays no role in adjusting the capital required for unregistered reinsurance.
    • Maybe you just got D and -D mixed up because the formula you gave: (UEP+O/S)*15%+D is correct for when D<0. (And with the condition that this value for margin required for unregistered reinsurance cannot be less than 0.)
  • Tony88passTony88pass
    edited June 2021

    Hi Graham,

    Based on the formula:

    CapReq(UnregRe)
    = (UEP + O/S) x 15% – max(0, -D) (if < 0 then set to 0)

    Isn't that the capreq can't exceed (UEP+O/S)*15%? So it's a topline instead of a baseline?

    I read the relevant section in the paper, it calls (UEP+O/S)15% margin required, from a MfAD stand point, does the regulator think the A/R could potentially go up so requires you to add buffer of that amount? Otherwise if D=0, the collateral is enough to cover the A/R, why still need the additional "(UEP+O/S)15%"? This part makes me confused

  • grahamgraham

    Please see edited answer above your last post.

  • Tony88passTony88pass

    Thanks Graham, it makes lots of senses now!

  • cornedovcornedov

    Hi @graham , I was taking a look at that past exam question you linked above and two thinks popped out to me.

    1) How do we know Capital Available given is post deductions? One common error in the examiners report was making a deduction to Capital Available for unregistered reinsurance. Is there anything in the question that indicates this is CA after all adjustments? As a rule of thumb should we assume that when Capital Available is given that no adjustments are necessary? Or would the best approach be to state an assumption and work from there.

    2) it appears that the calculation for unregistered reinsurance must be done per reinsurer here. Does this mean we could have both a deduction to capital available and deduction to capital required for unregistered reinsurance at the same time?

    Ex: Insurer A has (A+B+C)-(D+E+F+G+H) = 20, meaning we deduct from capital available but insurer B has (A+B+C)-(D+E+F+G+H) = -20 so we deduct from capital required?

    I'm wondering if this has changed under IFRS17 where we are measuring groups of reinsurance contracts and may not have this information broken down by reinsurer.

  • grahamgraham

    1. Capital Available Post-Deductions

    One point of confusion is whether the provided Capital Available (CA) is after all necessary adjustments, specifically concerning unregistered reinsurance. From the examiner’s report for Question 15, it was noted that some candidates incorrectly adjusted Capital Available for unregistered reinsurance. This suggests that Capital Available was given directly in the exam and was meant to be used without further deductions.

    While the exam question might not have explicitly stated that CA was provided after adjustments, the examiner's comment implies that no further deductions were expected to CA.

    Rule of thumb: Unless explicitly stated otherwise, assume that the provided CA is post-adjustment. However, it's always a good idea to state this assumption clearly in your solution and proceed based on that.

    2. Unregistered Reinsurance Calculations and Impact on Capital

    The calculation for unregistered reinsurance is expected to be done per reinsurer as noted in the examiner's report. One common error was calculating this on a combined basis rather than for individual reinsurers.

    To answer your question directly: Yes, you could have both a deduction to Capital Available and a deduction to Capital Required for unregistered reinsurance simultaneously. For example:

    • Insurer A could have a deduction from Capital Available due to a lack of collateral for unregistered reinsurance.
    • Insurer B might lead to a reduction in Capital Required through the reinsurance margin calculation.

    Regarding IFRS 17, the situation could change since it emphasizes the measurement of reinsurance contracts in groups, rather than by individual reinsurer. This could make it challenging to apply the same detailed per-reinsurer adjustments as before.

    Summarize briefly:

    In short, both adjustments could happen simultaneously under the older framework, but with IFRS 17, contract aggregation might shift this process to a more portfolio-level assessment. I don't think there is clear guidance on this in the syllabus material. You may just have to take your best guess on what to do in any given exam question but if you briefly your reasoning, you should be ok.

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