2007 General MeetingAssemblée générale 2007

Montréal, Québec

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

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PD 16

Other Stakeholders in ERM

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Speakers

• Donald Chu– Director, Financial Institutions Ratings,

Standard & Poor’s

• James C. Baillie– Director and Chair, Risk Review

Committee, Sun Life Financial

• Allan Brender– Special Advisor, Capital Division, OSFI

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OSFI’s View of ERM

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Regulatory Influence on ERM

• Historically, ERM developed within the banking sector, primarily due to the effects of the Basel Accord

• OSFI encourages the development of ERM within the Canadian insurance sector

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OSFI’s Mandate

• Supervise institutions and pension plans to determine whether they are in sound financial condition and meeting minimum plan funding requirements respectively, and are complying with their governing law and supervisory requirements;

• Promptly advise institutions and plans in the event there are material deficiencies and take or require management, boards or plan administrators to take necessary corrective measures expeditiously;

• Advance and administer a regulatory framework that promotes the adoption of policies and procedures designed to control and manage risk;

• Monitor and evaluate system-wide or sectoral issues that may impact institutions negatively.

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Some Principles in OSFI’s Supervisory Framework

• The level and frequency of supervisory scrutiny will depend upon the risk assessment of the institution. Institutions that are well managed relative to their risks will require less supervision. Not all areas within an institution need to be reviewed every year.

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Some Principles in OSFI’s Supervisory Framework

• Supervision will include reviews of major risk management control functions such as Financial Analysis, Compliance, Internal Audit, Risk Management, Senior Management and Board Oversight. OSFI’s supervisory process uses, where appropriate, the work of the institution’s internal management and control functions.

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Some Principles in OSFI’s Supervisory Framework

• …. The degree of intervention will be commensurate with the risk profile of the institution …

• Ratings will be provided to the institution after each on-site review …

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ERM in OSFI’s Regulatory Framework

• The regulatory framework consists of the collection of regulations and guidance attached to the legislation that is administered by OSFI

• Many of these regulations and guidelines refer to an institution’s ERM

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ERM and Capital

• ERM is a financial institution’s first line of defense– Manage and control risk; prevent trouble

from happening

• Capital is an institution’s second line of defense– Hold sufficient financial resources to meet

the costs of trouble when it develops

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ERM and Capital

• A recent development in capital requirements is the introduction of advanced approaches more tailored to an institution’s specific circumstances– Basel II– MCCSR Advisory Committee

(MAC)– Solvency II

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ERM and Capital

• When would a regulator agree to the introduction methods for the determination of required capital that are likely to lead to reductions in required capital?

• ANSWER: When the institution has a strong ERM culture and program that reduces the likelihood of difficulties occurring and controls their costs

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Internal Models and Capital Requirements

Current requirements with respect to banks’ trading blocks and segregated fund guarantees are prototypes

• Risk management• Board resolutions and reporting• Model approvals• Use test

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Hedging

• Hedging of financial risks can be a significant component of ERM– OSFI encourages hedging

• Recognition of hedging in capital requirements– As opposed to banking, the term of risks in

insurance often exceeds the term of available hedging instruments

– Recognition must be for a hedging policy and not just for hedges in place

– The regulator needs assurance the institution will implement its hedging policy appropriately

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Do Institutions Properly Recognize their Risks?

• Credit derivatives• CMOs• Asset Backed Commercial Paper• Securitized instruments

• Reliance only on “credit” ratings may be insufficient

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The Bottom Line

The primary component of OSFI’s mandate is:• Supervise institutions and pension plans to determine whether

they are in sound financial condition and meeting minimum plan funding requirements respectively, and are complying with their governing law and supervisory requirements

Solid ERM culture and practices increase the probability an institution’s financial condition will remain sound, thereby easing the supervisor’s task and increasing the security of policyholders and depositors

Questions and Discussion