Life Insurance Capital Adequacy Test (LICAT)

Overview

Life Insurance Capital Adequacy Test (LICAT) replaced MCCSR capital framework on January 1, 2018 to regulate and monitor the solvency position of federally regulated life insurers. The Office of the Superintendent of Financial Institutions (OSFI) stated that the LICAT framework was driven by the need to better align risk measures with economic realities, such as the global financial crisis back in 2008 and international developments in financial reporting (e.g., IFRS 17), actuarial methodology and capital standards (e.g., Solvency II).

LICAT contains a mix of factor-based approaches, OSFI-prescribed shock assumptions, and reliance on computed capital requirements derived from life insurance companies' own risk models in the case of exposures related to segregated fund products. This hybrid approach allows for greater risk sensitivity and a more principles-based approach to certain risk components. The framework is more robust and risk sensitive compared to MCCSR and contributed to improved policyholder and creditor protection.

Under the LICAT Guideline, the solvency buffer (the base for calculating regulatory solvency ratios) is calculated by aggregating insurance risk, credit risk, market risk, segregated fund guarantee risk and operational risk components. The solvency buffer is also adjusted for diversification and discretionary product features.

With International Financial Reporting Standard 17 - Insurance Contracts (IFRS 17) becoming effective on January 1, 2023, OSFI has been working with the industry to revise existing capital frameworks from IFRS 4 to IFRS 17. In adapting to IFRS 17, OSFI aims to minimize industry-wide capital impacts through testing and the calibration of industry results. In 2018, OSFI issued a preliminary draft LICAT Guideline, updated for IFRS 17 and conducted a questionnaire/data collection exercise. In 2019, OSFI launched a consultation on the updated draft LICAT Guideline, accompanied by a Quantitative Impact Study (QIS). OSFI issued a revised draft LICAT 2023 Guideline on June 21, 2021, reflecting industry feedback collected over the past three years. An advisory to the LICAT guidelines on smoothing technique for determining interest rate risk requirements for participating business accompanied the release. Details of the revisions can be found on OSFI's website, which also includes the following roadmap milestones:

June 2021 Nov 2021 - Mar 2022 Aug 2022
Publish on OSFI's website:
» Revised draft LICAT / MCT / MICAT 2023 guidelines
» Draft regulatory capital forms
» QIS #3 and sensitivity tests
Potential directed consultations and data calls for calibration and transition purposes Publish on OSFI's website:
» Final LICAT / MCT / MICAT 2023 guidelines
» Final regulatory capital forms

Source: LICAT, MCT and MICAT review for IFRS 17

OSFI is also developing a new approach to determine capital requirements for Segregated Fund Guarantee (SFG) risk, which follows a separate project plan. One objective of the new standard approach is to improve the risk sensitivity of SFG capital requirements. Accordingly, unlike updates being made to other areas of the LICAT framework for IFRS 17, the new approach for SFG risk will include changes in OSFI's capital policies. Under the new approachs, capital requirements will be calculated by applying shocks to SFG liabilities. Internal models that were previously used to calculate SFG capital requirements will no longer be permitted for this purpose under the new approach. OSFI has delayed the introduction date of the new standard approach for determining regulatory capital requirements for segregated fund guarantee business to January 1, 2025. In the interim period, the current methodology is being retained and adapted to accommodate IFRS 17.

How does Moody's Analytics support LICAT?

The intent of the LICAT methodology is to design component calculations that reflect more closely the risk within each company's actual inforce portfolio according to both its composition and to the company's risk management practices. Therefore, modelling the methodology at a full seriatim level using AXIS will be very important for the management and investigation of LICAT impact.

AXIS already has the capability of calculating each of the proposed stress testing components of LICAT by using the existing projection functionality within both Asset and Liability Cells, using various techniques to apply adjusted assumptions reflecting the required shocks, and extracting the appropriate reserve or asset market value calculations from existing CY Reporting options. This overall approach is referred to as the "Direct Method" in AXIS terminology and User Guides. Users can automate the process by using Batch testing features to shock assumptions and capture both detailed cashflows and present values required.

The recommended solution lies in the powerful Solvency Capital Requirement (SCR) Table to streamline the calculation of different LICAT risk components. This approach is known as the "SCR Method" in AXIS terminology and User Guides. It is especially helpful under the context of IFRS 17, where each Liability Cell has one IFRS 17 reserves section. The SCR table provides a powerful way to control and aggregate all the required LICAT component calculations for a fully integrated projection of required capital going forward that can realistically model the impact of LICAT on required and free surplus for pricing or various ALM projections.

In both liability and asset modules, you can create a new Solvency Capital Requirement (SCR) composite table in the Required Surplus section of a Cell. This composite table and the tables nested inside allow you to specify different assumption shocks for various solvency buffer components. AXIS will calculate the impact on the projected cash flows as defined by a selected Reserve Section of the Cell which must be dedicated to this purpose, based on the SCR table shocks at the valuation date and at all future reporting dates. At the higher levels, you can use the "SCR aggregation" Formula Table to incorporate risk diversification.

For clients already familiar with the AXIS SCR functionality under IFRS 4, functionality under IFRS 17 can be accessed in the same manner albeit with a beta feature code. The beta feature code allows Moody's Analytics to notify clients about new and upcoming LICAT 2023 features, as they are still under active development. Information on Access to Functionality, AXIS LICAT User Guide and Sample Datasets can be found within this Microsite.