Personal Property
Chapter 3
Personal Property
Learning Objectives When you finish this study, you should be able to meet the following objectives: • Discuss the role of federal and provincial insurance regulators and their oversight of broker
licensing and handling of complaints against members of the insurance industry in Alberta. • Explain how regulation influences the insurance industry. • Explain the role and functions of the Office of the Superintendent of Financial Institutions
(OSFI) in insurance regulation. • Describe the purpose of the Canadian Council of Insurance Regulators (CCIR).
Contents Role of the Insurance Regulator
A Risk-based Regulatory Model Information for Regulators Scope of Regulation Provincial Regulators Alberta Provincial Regulation Licensing Levels in Alberta Errors and Omissions Insurance Requirements and Brokers Complaint Handling Conduct of Intermediaries Regulating Automobile Underwriting Rules Regulating Pricing OSFI: The Federal Regulator Insurance Company Solvency Financial Consumer Agency of Canada
Canadian Council of Insurance Regulators (CCIR) The Future of Regulation
Role of the Insurance Regulator
The approach generally taken in our business environment has been to let the market carve its own path: One expects that a dynamic, innovative sector will arise from vibrant competition. However, where most other sectors of our economy have been left to find market-based solutions to their problems, insurance has been treated somewhat differently.
The property and casualty (p&c) insurance industry is one of the most highly regulated business segments at both federal and provincial levels. This is in addition to the more generally applicable regulation which applies to all companies. Even municipal government regulation is felt by the insurance industry.
Understanding the political context of regulatory activity is essential for a healthy private insurance sector. Relationships must be struck with regulators at all levels to ensure that viable solutions are implemented for the good of consumers and the insurance industry. In fact, some insurance people have become politically active through the party of their choice to create an opportunity for a voice.
The minister responsible for the portfolio encompassing insurance necessarily has a political agenda because he or she must report to the public on progress made where complaints have been raised. There will always be pressure on the minister to offer short-term solutions to identified problems.
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When their money is at stake or when insurance is not available, consumers tend to be vocal with their displeasure. This inevitably resounds with politicians. Media tends to fuel and worsen any situation, leading consumers to insist that 0 m government take action. Hostility and posturing are the unfortunate possible i results of confrontational behaviour, and these types of reactions have tended to stall any meaningful results for consumers and for the insurance industry.
Consumer protection is at the heart of all government regulation! Therefore, the focus of insurance regulation is solvency, market conduct, and affordability of insurance and its availability. Its affordability and availability are of particular concern for mandated products such as automobile insurance. 2
Definition solvency A business entity’s ability to meet its long-term financial commitments. 2
The insurance industry must strike the right balance between complying with government legislation and practising good corporate governance. Certain regulations have created arduous processes for insurers: Management must spend
valuable time and resources on meeting immediate regulatory requirements and than focus on projects that will produce more durable success for the corporation. Too much emphasis on rules and regulations can stifle entrepreneurial activity and good management practices. An unintended consequence of regulatory compliance issues is its perhaps disproportionate effect on smaller companies who do not have the scope of resources that larger companies have.
Regulators have said that they must seek a balance between principles and rules. A regulator that is too involved in looking at too many rules may lose sight of concerns that really matter.
A large segment of the insurance industry coordinates its efforts to deal with regulatory pressures through the Insurance Bureau of Canada (IBC).
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The effects of globalization are also felt at the regulatory level and thus it is prudent to understand how regulation is handled internationally. The BC maintains relationships with relevant foreign and international regulatory bodies, which includes the National Association of Insurance Commissioners (an American insurance regulator) and the International Association of Insurance Supervisors. The International Association of Insurance Supervisors has given attention to worldwide convergence of solvency regulation. It has turned its attention to finding a common structure and common standards for solvency assessment. The insurance industry can better position itself if it understands how legislation may be influenced by international initiatives.
In the federal and provincial mix of legislation, rules that impose conflicting requirements or overlapping requirements, or requirements that change from province to province, can be confusing and costly for the insurance industry. Because the provinces have so many individual needs, the luxury of uniform legislation has not been feasible. Harmonization, an exercise requiring much more skill and finesse, is the approach that allows provinces to maintain their individuality while still providing a common base of operation for the country,
Not all regulation causes adverse effects. But all regulation typically causes management to pause and review its current position, the direction it had been pursuing under the former regulations, and the direction it should now pursue as a result of changed regulations.
A Risk-based Regulatory Model
There has been widespread movement on a global scale by insurance regulators to advance a principle- or risk-based regulatory model. This approach to regulatory legislation and supervision contemplates that regulators will work with insurance companies to have them ultimately solve their own problems.
Example
An automotive company set up a small insurance company to deal with its own executive automobiles. The insurance regulator would consider the position of this company within the larger context of the industry as a whole. That insurance company, if it failed, would only affect a few people and it would not create much political upheaval, nor would it represent a systemic problem within the insurance industry.
The risk-based model operates on the theory that different insurers face different risks depending on the nature of their book of business, their growth rate, their investment management philosophy, and a number of other factors. Therefore the amount of capital required to support those risks should be based on the rating of the level of risk attached to all risk factors rather than on an arbitrary basis such as the premium-to-surplus ratio.
Random choice
Regulators operate under the typical constraints that any business has: They must operate within a budget and according to a business plan. Although, the government has initiated charge-back systems to the insurance industry for certain functions. The regulator’s resources are necessarily concentrated on riskier institutions whose practices are likely to materially affect their existence and whose demise would have a greater impact.
Information for Regulators Using the risk-based approach, regulators monitor and analyze key indicators to exercise appropriate stewardship over the system as a whole.
To understand what would create difficulty for companies, regulators develop information about the insurance business and its business practices. When developing such information, regulators consider the following:
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Are the company’s significant activities like the lines of businesses written and the risks inherent to such business? Is writing such business a high or low business risk? Are the business functions, such as underwriting and claims settlement, being reviewed to determine whether risks are being mitigated? Can the organization’s internal controls and corporate governance be relied upon? Are the business processes like information technology reviewed in the context of the particular business?
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What is the insurance company’s approach to risk management activities and its reinsurance arrangements?
Keeping the above considerations in mind, regulators monitor the following:
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Reliable statistics on the frequency and severity of claims Trends in loss cost developments Average length of time that a claim is open Incidence and cost of fraudulent and other illegal activity Changes in average private passenger premiums Consumer Price Index (CPI) Premiums for specific demographic profiles Insurance costs as a percentage of the total costs of running an automobile and of disposable income Reinsurance costs as a percentage of premium (reinsurance is discussed later in this study) Profit or loss from a residual market mechanism (like the Facility Association, discussed later in this study), if applicable Capital bases of insurers operating in the province and other financial diagnostics
Inadequate premium rates inevitably affect profitability. Eventually, regulatory capital requirements will falter if rates are not corrected. Sometimes a dynamic tension arises between the federal solvency regulator who has an agenda to raise rates and the provincial regulator who is more concerned with reduced or stable pricing.
The availability of sound statistical data and good communication with regulators can improve a potentially adversarial regulatory process and make it less costly. The General Insurance Statistical Agency (GISA) is a not-for-profit organization named by regulators as the statistical agent for participating regulators. GISA contracts with IBC to collect data from insurers and compile exhibits. Costs are recovered through providing assessments to insurers and charging deficiency fees.
Report
Scope of Regulation
Insurers can choose to register with the provincial or federal governments. Either level of government may grant a licence to an insurer, but the level of government the insurer chooses to register with will affect how it can operate.
The responsibilities of the federal government include monitoring the solvency of federally incorporated insurers, as well as Canadian branches of foreign-owned insurers. The provincial government’s responsibility includes monitoring the solvency of insurers registered in their particular jurisdiction.
Because most premium volume is written by federally regulated insurers, provincial governments rely on the federal regulator to perform solvency reviews.
Each federally incorporated insurer must be licensed to operate in each province and territory where it writes business, and must also be licensed for each class in which business is written.
The scope of regulation for reinsurers is discussed below: • Reinsurers are regulated less closely than primary insurers because regulators
emphasize protection of the consumer. • Reinsurers sell to primary insurers—that is, other insurance companies—which
are presumed to be sophisticated buyers and able to protect their own interests. • Reinsurers are not required to be licensed to operate in Canada. However,
federal legislation places certain limitations on the percentage of an insurer’s risks that can be placed with such a non-approved reinsurer. This in turn affects
an insurer’s legislative requirements regarding its minimum capital levels. • If a provincially registered reinsurer chose to do business with an out-of
province insurer, the insurer would be subject to the rules governing a nonapproved reinsurer.
Provincial Regulators
Provincial regulators exercise controls, similar to those of the federal regulator, over those insurers who are incorporated and licensed to operate only in a given province.
Each province has its own insurance legislation-or, in Quebec, the Civil Code of Quebec-that sets out the authority and responsibilities of the regulator.
The following is a list of provinces and the government departments or regulatory bodies assigned responsibility for insurance:
Table 2.1: List of Provincial Regulators
Province
British Columbia
Government Department or Regulatory Body Financial Institutions Commission Insurance Council of British Columbia Superintendent, Insurance and Financial Institutions Alberta Finance Alberta Insurance Council Superintendent, Insurance and Financial Institutions
Alberta
… Table 1.2: List of Provincial Regulators Province
Government Department or Regulatory Body Saskatchewan
Saskatchewan Financial Services Commission Financial Institutions Division Superintendent of Insurance
Manitoba
Manitoba Consumer and Corporate Affairs Manitoba Insurance Council Superintendent, Financial Institutions Regulation
Ontario
Financial Services Commission of Ontario Superintendent of Financial Services
Quebec
L’inspecteur général des institutions financières Bureau des services financiersAutorité des marchés financiers Surintendante de l’encadrement de la solvabilité
New Brunswick
Department of Justice · Superintendent of Insurance Department of Environment and LabourSuperintendent of Insurance
Nova Scotia
Prince Edward Island
Community Services and Attorney General
Newfoundland
Department of Government Services and Lands Superintendent of Insurance
Northwest Territories Nunavut
Department of Finance Superintendent of Insurance Consumer and Safety Services Department of Community Services Superintendent of Insurance
Yukon Territory
In Alberta the government departments or regulatory bodies assigned responsibility for insurance are the following: • Alberta Finance • Alberta Insurance Council • Superintendent, Insurance and Financial Institutions
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Provincial insurance legislation is mainly concerned with market conduct issues; policy wordings, including statutory conditions; affordability; and availability. Much provincial legislation has been the result of lost public confidence in the insurance
industry to deliver its products at reasonable rates. Not only are insurers subject to legislation but so are independent insurance adjusters, agents, and brokers.
The responsibilities of provincial insurance regulators include the following, among others: • Monitoring each insurer’s compliance with provincial insurance legislation • Monitoring the solvency of provincially incorporated insurers • Licensing insurers to operate in its jurisdiction • Licensing and supervising adjusters, brokers, and agents • Approving classes of business • Controlling an insurer’s advertising • Reviewing insurance contract wordings • Approving policy forms • Enforcing underwriting eligibility criteria • Overseeing claim settlement practices • Overseeing the electronic marketing of insurance • Overseeing the ethical, operational, and trade practices of insurers
Because insurers must be licensed for classes of insurance to be written in the province, legislation allows regulators to determine if an insurer has the necessary expertise to carry on such business.
Controlling an insurer’s advertising includes controlling how an insurer’s name must appear in advertisements, on the policy contract, and in correspondence (usually, the insurer’s name must appear as it does in its licence). The regulator also oversees insurers to ensure that advertising and other business practices are fair.
Certain policy wordings are governed by minimum standards of coverage set out in legislation. This applies to insurers but not to reinsurers. This can create awkward situations for insurers who may be left without reinsurance protection for certain exposures.
Alberta Provincial Regulation There are a number of entities that work to regulate the insurance industry in Alberta: • The Office of the Superintendent of Insurance • The four Insurance Councils • The Alberta Automobile Insurance Rate Board)
Office of the Superintendent of Insurance
The Office of the Superintendent of Insurance regulates and creates policy for the insurance market in the province of Alberta to ensure that Albertans have affordable access to the insurance coverage they require. This is achieved by monitoring the effectiveness of the market, and responding to the needs of the province and its citizens.
Four Insurance Councils
There are four Insurance Councils:
- Alberta Insurance Council 2. Insurance Adjusters’ Council 3. General Insurance Council 4. Life Insurance Council
The Alberta Insurance Council is the financial arm of the councils and provides investigation and administrative services to the other councils. The Alberta Insurance Council also provides administrative services to the Continuing Education Accreditation Committee appointed by the Minister of Finance.
The Insurance Adjusters’ Council, General Insurance Council, and Life Insurance Council are the regulatory bodies responsible for licensing and discipline of insurance agents, brokers, and adjusters in the province of Alberta.
The councils are formed under the Insurance Act and they derive their authority under a delegation from the Minister of Finance for the province. The Alberta Insurance Council and the Ministry of the Treasury Board and Finance work together to ensure consumers are protected and companies, insurance adjusters, and insurance agents operate at the highest standards.
Concerns and complaints regarding insurance companies previously handled by the Alberta Insurance Council are now being dealt with by the Office of the Superintendent of Insurance. Issues, concerns or complaints regarding insurance agents or licensed independent adjusters will continue to be dealt with by the Alberta Insurance Council. The Chairperson of each council sits on the Alberta Insurance Council. The General Council has representation from various sectors within the industry, such as independent brokers, direct writers, insurers and representatives from the public.
Alberta Automobile Insurance Rate Board (AIRB)
The primary role of this board is to regulate insurer rating programs for basic and additional coverage for private passenger, miscellaneous private passenger, and
commercial vehicles. The AIRB conducts an annual review to establish guidelines for automobile rating factors to be used when reviewing individual insurers’ rating programs and the premium level for basic coverage. The AIRB also seeks consumer feedback on the experience in obtaining automobile insurance coverage. Insurers must file requests for changes in automobile insurance premiums and receive approval for the same. The AIRB guidelines are also used to determine the appropriate premium level for the grid rating program. The grid rating program caps premiums for basic coverage.
Licensing Levels in Alberta
In Alberta the licensing process requires candidates pass exams of 100 multiplechoice questions, 70 of which they must get correct to receive their licence for the chosen level. See Table 2.2: Broker Licensing Levels in Alberta for a description of the three levels of broker licences in Alberta.
Table 2.2: Broker Licensing Levels in Alberta
Broker Level
Authority
Level 1 Broker
Level 2 Broker
- Would primarily work in the office in the role of
front-counter customer service representative Could also work in a support role for Level 2 and
Level 3 Brokers • Work must be supervised by superior level • Would work as producer of new business and
manage existing business Could be involved in personal lines and
commercial • Would work without supervision but would not
act in the capacity of a manager or operator of a brokerage firm
Level 3 Broker
- Would have broad technical insurance knowledge
and may act in the capacity of a manager or operator of a brokerage firm
Errors and Omissions Insurance Requirement and Brokers
Despite the best efforts of brokers and agents, they may become involved in a lawsuit because their client does not have coverage for a loss or because, due to their actions, an insurer has been required to pay a loss that it did not intend to. Such a lawsuit could arise out of allegations of either:
an error (doing something wrong); or, an omission (not doing something that should have been done).
The brokers and agents best defence against this type of claim is:
Documentation Communication Acting within the scope of their authority and competence
It is a statutory requirement that all brokers/agents carry a minimum of $2 million of errors and omissions coverage and file proof of the same at the required intervals.
Complaint Handling
In the province of Alberta, the Alberta Insurance Council (AIC) and the industryspecific councils are responsible for the certification of:
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Agents Brokers Adjusters
The AIC handles the complaints process for all individuals and businesses which hold certificates of authority issued by the AIC. The process typically involves the following steps: 1. The AIC, through its investigative role, deals with complaints from many
sources. 2. Disciplinary proceedings are advanced when, following an investigation, it is
determined that there is sufficient evidence that a certificate holder has not
complied with the requirements of the act or the regulations made under the act. 3. Complainants are always requested to provide a written summary of the nature
of the complaint and all relevant facts and supporting documentation to the AIC. 4. An investigator will determine whether or not there are reasonable and
probable grounds to conclude that a section of the Insurance Actor
regulations has been breached. 5. The decision made will determine whether or not disciplinary proceedings
will be commenced. 6. Decisions made can be appealed by following a set procedure. It includes a
hearing by an appeal panel, which would hold an in-person hearing and provide all parties with a written decision.
Conduct of Intermediaries
What happens in other parts of the world affects our environment. The reaction to the announcement made by New York’s Attorney General about widespread bid rigging in the insurance industry caused Canadian regulators to look closely at intermediaries in Canada. This triggered consumer groups in Canada to question ordinary business practices here that were not related to the issues raised in the United States.
In a chain reaction, regulators in Canada began an investigation into marketplace activities. The survey that Canadian regulators conducted satisfied them that the only action necessary in our environment was defining a positive statement of principles. Certain principles were articulated by regulators to govern relationships between consumers, insurers, and brokers and agents. Regulation of broker and agent conduct is in the provincial domain.
Regulating Automobile Underwriting Rules
In some provinces, rate and product-related filing requirements are imposed on automobile insurance writers to ensure that customers are treated uniformly and therefore more fairly. When an insurer declines an applicant, does not renew a policy, or limits coverage in some way, the reasons must conform to those underwriting rules that have been filed and approved. In general, companies must comply with anti-discrimination laws and public policy. An insurer has latitude in setting its underwriting rules, but rules cannot conflict with the legal statutes governing such matters.
Insurers must also adhere to the statutory conditions included in the provincial legislation to govern such matters between insurer and insured as, among others, cancellation for non-payment of premium or written reasons for non-renewal.
Regulators have been sympathetic at times to the problems they sometimes cause insurers, especially when consumers are affected adversely.
Regulating Pricing
Certain provincial governments have initiated studies to review the profitability of insurance companies in non-mandatory lines of insurance to judge whether the profits realized by insurance companies are reasonable. The feasibility of initiating rate regulations was the goal. Such government action seems heavyhanded and would probably not be tolerated by any other business sector in our economy. Government intervention in mandatory insurance products has opened the door for some governments to question profit levels of insurance overall..
Example During a review of underwriting rules by the Ontario insurance regulator, insurers were faced with increased numbers of risks forced to deal with the Facility Association for insurance. Insurers asked for flexibility in their filed underwriting rules so that they might write risks that had previously been declined. The flexibility was allowed by the regulator, but all exceptions and their reason had to be documented. A procedure was implemented to report exceptions and their reasons to the provincial regulator.
OSFI: The Federal Regulator
The following section will build on the discussion of the Office of the Superintendent of Financial Institutions (OSFI). As previously mentioned, OSFI is the primary regulator of federally chartered Canadian and foreign property and | casualty insurance companies. Its mission is to protect the interests of depositors, policyholders, pension plan members, and creditors of financial institutions from undue loss, and to advance and administer a regulatory framework that contributes to public confidence in a competitive financial system. OSFI supervises and regulates all banks, and all federally incorporated or registered trust and loan companies, insurance companies, cooperative credit associations, fraternal benefit societies, and pension plans.
Activities of QSFI can be divided into regulatory and supervisory functions.
Regulatory functions include developing and interpreting legislation and regulations, issuing guidelines, and approving requests as required under the financial institutions legislation. Supervisory functions include assessing the safety and soundness of the institutions under its mandate. That entails evaluating a company’s risk profile, financial condition, risk management practices, and compliance with applicable laws and regulations.
To ensure that careful provision is made for the future of insurance company operations, OSFI stresses profitability, adequacy and quality of capital and earnings, adequacy of reserves for policy liabilities, adequacy of reinsurance protection, the quality of assets, and internal controls. Through its oversight, OSFI identifies potential problems early and intervenes when necessary to help an insurer overcome possible failure. OSFI is involved in the following activities to achieve its goals: • Outlines its views of best practices or risk management measures • Informs the public of items of general interest
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Publishes warnings for the financial sector Presents internally and externally generated consultation papers of interest to its stakeholders Continuously monitors insurers’ financial condition and operating performance Verifies compliance with statutory and other regulatory requirements Conducts periodic on-site examinations as required by statute
OSFI is also responsible for the following regulatory functions:
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Incorporating new Canadian companies Issuing orders to Canadian and foreign companies to carry on business Reviewing and assessing applications involving • corporate reorganization; • changes of ownership; • acquisitions of other financial institutions; • changes in classes of insured risk; • withdrawals from the Canadian insurance market.
OSFI also looks at outsourcing of business activities by insurers which may include policy administration, claims handling, accounting, and underwriting. OSFI’s concern is that an insurer’s dependence on third parties could increase the insurer’s risk profile. Insurers are asked to evaluate and provide contingencies for their outsourced activities summarized as follows:
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Evaluate the risk of outsourcing Carry out a due diligence study Create a business continuity plan in case a third party cannot perform outsourced activities
Establish a process for monitoring and managing the outsourced activities
No one can guarantee that a company will not fail within the insurance community. But OSFI has set parameters to demonstrate the conditions under which a failure would be acceptable. In this context, expectations of politicians must be managed so that they are aware that an institution may fail occasionally.
Currently, OSFI assigns a relationship manager to each institution. Relationship managers get to know the people in the companies to which they have been assigned and they get to know how these companies operate. Financial downturns can thus be identified very early to begin proactive interventions. Effective early
ONS
action can contribute to confidence in the financial system affirming to Canadians that the confidence they have in the system is warranted.
Insurance Company Solvency
A company is considered to be solvent when it is capable of honouring all its debts even if it were closed down immediately. Regulators must be satisfied that every insurer has funds that are readily available to pay expenses and claims. Financial institutions provide financial security to businesses and consumers and to ensure this role is fulfilled, regulators closely monitor their solvency.
The regulator becomes much more actively involved when it identifies a problem with an insurer. Threats to an insurer’s financial viability or solvency may lead OSFI to put the company on a regulatory watch list or to meet with senior management or the external auditor to outline concerns and discuss remedial actions. Such further actions could include the following: • Restricting business operations (i.e., limiting the amount of premium written) • Increasing the frequency and scope of on-site examinations
Calling for additional capital to be invested in the company Discussing contingency plans with relevant compensation funds and provincial insurance regulators (Such plans could involve taking control of the company.) 4
Government also tracks insurers’ accumulations of exposure and limits written in earthquake zones, such as in Quebec and British Columbia. Such insurers must document procedures outlining to OSFI how they plan to manage their earthquake risk (including limits of coverage) and how their financial resources would cover their calculated probable maximum loss (PML). These insurers are required by OSFI to reserve against potential liabilities arising from a major earthquake. How an insurer’s earthquake exposure is reinsured is also prescribed by OSFI.
Guidelines have been developed for tracking and managing earthquake exposures. Computer models have been developed that estimate the PML that might arise from a major earthquake.
In addition, insurers must have contingency plans for such matters as claims management, emergency communication links, the availability and adequacy of claims adjusting staff, and off-site systems backup in place to handle an earthquake event.
Regulatory Assessment Measures
Regulators assess whether reported liabilities are realistic for a company’s claims, unearned premium, and other amounts owing.
Guidelines that regulators have established include the following:
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Reserves Receivables Investment risk Assessing foreign parent companies On-site OSFI reviews
Reserves
Premium reserves and claims reserves are subject to annual review by a qualified actuary. Premium reserve is a test of the adequacy of premium rates and the claims reserve is a test of the adequacy of reserves held to pay outstanding claims and claims which have been incurred but not reported (IBNR).
Receivables The collectability of accounts receivable and reinsurance recoveries (credit risk) are reviewed. For example, regulators do not allow an insurer to treat accounts receivable outstanding for more than 65 days as assets for the purpose of calculating capital and surplus.
Investment Risk The manner in which insurers may invest their assets is subject to regulation to ensure the safety of the capital and the appropriate level of liquidity.
Assessing Foreign Parent Companies When assessing foreign subsidiaries, branches, or reinsurers, the financial strength of the parent and the quality and type of home country regulation are considered. Some such parent companies are much larger than any Canadian company, however, the regulator would still review rating agency reports, financial reports, and newspaper clippings to determine whether the condition of the parent company and assess its profitability.
Canada is one of few countries that supervise the property and casualty insurance industry on a safety and soundness basis. Even fewer supervise and regulate reinsurance companies. However, Canadian regulators tend to work very closely with foreign regulators. Foreign branches must have sufficient assets to cover
their liabilities. The larger the foreign branch the more closely operational issues are reviewed.
On-site OSFI Reviews
S When OSFI conducts an on-site review it measures an insurer’s inherent risk. TL OSFI would review, among other characteristics of the insurer, the following:
Insurance risk The product and its pricing are examined to determine whether the insurer’s exposure was greater than its pricing or whether there was an unhealthy trend developing in that direction.
Underwriting of risks The insurer’s exposure through risk selection and approval, the retention and transfer of the risk (reinsurance), and the effect of claim reserving and settlements are reviewed.
Legal and regulatory compliance The insurer’s legal and regulatory compliance is reviewed including a check as to whether the insurer conforms to ethical standards.
Dishonesty or error detection Controls to detect dishonesty or errors in data or disaster recovery plans are reviewed. 20
Regulation of Investments
Choosing investments for an insurance company is a matter for the board of directors and management. However, the types of investments insurers are permitted to hold are subject to regulation and assets are verified to ensure that they are real and that they are worth the amount reported.
Property and casualty insurers must establish internal policies on investment concentration for their portfolios—that is, on the extent of their investments in various sectors of the economy and types of financial instrument such as stocks and bonds. Regulation describes that a “reasonable and prudent person” standard would apply to a portfolio of investments and loans to avoid undue risk of loss and obtain a reasonable return. This approach gives more freedom to investors but also places significant responsibility on both insurers and regulators to ensure that funds are prudently invested. Management controls in place ensure investment policies are followed. 2
OSFI applies limitations on real estate and equity holdings to encourage the purchase of safer, more stable products such as guaranteed investment certificates (GICs) and bonds. The more conservative investments provide lower returns to insurers, and this may affect investment returns that insurers might realize. This in turn can affect an insurer’s ability to make a profit to offset underwriting losses that may occur, especially in a soft market.
Financial Regulatory Tests
A risk-based capital standard is used to rate the adequacy of an insurer’s capital. OSFI applies tests to the balance sheet with emphasis on the insurer’s assets, liabilities, and capital to make its assessments.
Managing capacity is critical to a company’s success. A company can enhance its solvency and capacity by adding capital through retained earnings or the sale of shares; or it can make strategic use of reinsurance. Reinsurance is used to reduce an insurer’s liabilities by bringing net premiums written to a level that can be supported by the insurance company’s equity (capital and surplus) position.
Measuring Capacity
Regulators impose minimum capital requirements on insurers and that limits their capacity to write business. Capacity is the function of both capital available and extent of exposure that insurers are prepared to accept.
The level of capital and surplus must be sufficient to cover expenses, commissions, premium taxes, and claims which are incurred prior to policy premiums becoming earned. The insurer must be capable of weathering bad >
adstand cycles in which premium income and investment income are insufficient to cover the cost of claims and expenses. 5.
The guidelines regulators use to measure the capacity of insurers include the following: • The ratio of net premiums to equity (capital and surplus) is measured. For
an average mixed portfolio of business the premium to equity ratio might be
2.5:1. If the ratio went as high as 3:1, the regulator would be concerned. • The maximum single exposure, being a maximum percentage of equity that
can be put at risk on a single exposure, is assessed. For example, an insurer might be restricted to a net retention on a single risk of not more than 2% of its equity.
The percentage of reinsurance ceded on an insurer’s total portfolio business is limited by OSFI guidelines to ensure that the insurer retains a significant financial interest in the outcome of its underwriting decisions and will, therefore, operate in a responsible way. u
Measuring Solvency OSFI uses the minimum capital test (MCT) to measure solvency. A single harmonized asset test applies to all Canadian insurers operating in Canada, whether they are licensed federally or provincially. A similar test using MCT principles applies to branches of foreign property and casualty insurers. The MCT framework more closely relates capital requirements to the degree of risk that an insurance company assumes similar to risk-based requirements for deposit-taking institutions and life insurers. This test is intended to give regulators early warning of an insurer’s potential solvency problems.
Definition The minimum capital test requires that insurers have assets worth at least a certain multiple of the amount of their liabilities as well as a margin of additional assets.
OSFI communicated with insurers to determine the amount of capital required to support insurers’ premium volumes. They discussed business risks with them and asked them to conduct “stress tests” of their financial positions in different hypothetical scenarios. That involved assessing their solvency at different premium volumes and proportions of exposure from various lines of insurance, among other variables. It was ultimately up to each insurer to determine the level of capital it needed to offset the credit, market, legal, regulatory, operational, strategic, compliance, and insurance risks in its business.
The MCT requires that an insurer’s assets exceed its liabilities by a specified ratio; that ratio may be higher for some insurers than for others. Over time, as insurers’ portfolios grow or shrink and the proportions vary among different lines of insurance, some insurers may find themselves to be overcapitalized and others, undercapitalized.
).
Overcapitalized insurers have a business problem: They will want to increase their premium volume to take full advantage of the capital at their disposal. Undercapitalized insurers must restore an acceptable balance between their premium volume and the capital they have to support it. Such insurers can: 1. reduce their premium writings, 2. take a different strategic direction on the type of business they write, 3. possibly cede more to reinsurers, 4. reduce the capacity they provide in certain lines of business, or 5. restructure their balance sheet to free up more capital. 9
Withdrawal from a province might be the right business choice for an organization but insurance companies must also comply with government notice requirements for such action or perhaps face a significant fine.
* Even if the number of policies being issued by the insurer does not change, rate
increases that increase an insurer’s premium volume will affect the amount of capital the insurer needs to comply with the MCT.
When capital becomes scarcer, it becomes more difficult for the insurer to accommodate certain lines of coverage. For example, an underwriter who provided high excess limits for directors’ and officers’ liability coverage may find on renewal that capacity has been cut and underwriters are unable to offer as much coverage as before.
MCT impacts the insurers risk selection. The variation in margins the MCT requires for loss reserves might incline an insurer to pursue lines of insurance for which lower margins and less capital are required. Writing riskier business requires more capital, while writing less risky business requires less capital.
It is probably sound for a business to aim at a capital level that provides a cushion above minimum requirements to cope with volatility in markets and economic conditions, innovations in the industry, consolidation trends, international development, and to provide for risks not explicitly addressed in the calculation of policy liability or the MCT. The MCT does not provide the optimum capital requirement. Regulators may decide to evaluate what a company’s optimum capital condition might be separately.
Loss reserves and unearned premium reserves are examples of the liabilities for which such calculations are performed. The margin required to be added for loss reserves varies for different lines of insurance; it tends to be higher for lines such as liability insurance and lower for lines such as property insurance.
The variation in margins required for loss reserves might suggest that an insurer should focus its marketing efforts in lines of insurance for which lower margins and less capital are required. However, other considerations affect the choice of target market: the insurer’s expertise in the line of insurance; an appropriate distribution network; and whether it is licensed to underwrite the line of business.
Reinsurance Recoverables and Solvency
A margin is added to the MCT for the risk that the insurer may be unable to recover on purchased reinsurance. Reinsurance recoverables would be in jeopardy if the reinsurer failed or the insurer’s actuaries miscalculated loss development and the corresponding ultimate losses so that the amount of reinsurance purchased was insufficiesnt to cover liabilities.
Insurers who use registered reinsurers have a smaller margin to add to their assets than what would be required for using an unregistered reinsurer. Thus the difference in margin requirements between licensed and unlicensed reinsurers is a consideration for insurers in making their arrangements for reinsurance because it means a difference in the amount of capital an insurer must set aside to cover the risk of non-recoverable reinsurance. That difference in capital will in turn affect how much premium the insurer’s capital will support.
Financial Consumer Agency of Canada
The performance of the insurance industry is also judged according to how it treats consumers. The Financial Consumer Agency of Canada (FCAC) is an independent body established by the federal government to oversee consumer issues and expand consumer education in the financial sector. FCAC promotes a greater awareness of the financial system and the rights and responsibility of consumers. They help consumers to get information they need to become more informed about financial products and services. It operates on a risk-based compliance framework.
FCAC does the following activities:
Supervises financial institutions to determine whether they are in compliance with the consumer provisions applicable to them Promotes the adoption by financial institutions of policies and procedures to implement consumer provisions applicable to them Monitors financial institutions’ publicly available voluntary codes of conduct designed to protect the interests of customers and any public commitments made by financial institutions to protect customer interests Promotes consumer awareness about the obligations of financial institutions under the consumer provisions applicable to them Fosters understanding of financial services in cooperation with any other relevant organization
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FCAC’s mission is to improve Canada’s financial marketplace by doing the following: • Supervising financial institutions efficiently and effectively with respect to
fulfilling their obligations to consumers • Providing information to consumers to enable them to understand their rights
and to make informed financial decisions
FCAC is funded by the financial institutions it regulates. FCAC cooperates with other organizations, creates information programs, and operates a toll-free consumer help line and a Web site (http://www.fcac-acfc.gc.ca/) to achieve its ends.
Canadian Council of Insurance Regulators (CCIR)
Insurance issues are becoming increasingly complicated and increasingly crossjurisdictional due to factors like globalization and technological change. The Canadian Council of Insurance Regulators (CCIR) is an association composed of regulators (officials and not ministers) from each province and territory and the federal level. The CCIR cannot enact legislation, but members can make recommendations to their respective governments on related issues. CCIR is a means for insurance regulators to share information and find common solutions. It does operate a Web site at http://www.ccir-ccrra.org/.
The CCIR’s focus is on improving the efficiency and effectiveness of the Canadian regulatory framework. Its overall goal is to simplify, coordinate, and harmonize the regulation of insurance in Canada, as shown by its mission statement:
Definition
The Canadian Council of Insurance Regulators is an interjurisdictional association of insurance regulators that works cooperatively with other financial services regulators and stakeholders to facilitate and promote an efficient and effective regulatory system in Canada to serve the public interest.
Why is there a need for such a body as CCIR? CCIR is a Canada-wide , communication tool that has successfully produced recommendations for common regulatory standards, developed positions on regulatory issues, given advice to policymakers in member jurisdictions when advice is requested, and considered model legislation for governments. It has accepted and advances the notion that regulators should listen first and act second, then include all stakeholders in a cooperative effort to find workable solutions. L
The differences in legislation and regulation across the country add additional costs in compliance for those insurers that operate in more than one jurisdiction. Simplification and harmonization of legislation and regulation improves the environment for insurers ultimately reducing compliance costs.
CCIR has been involved in (1) harmonizing and streamlining licensing approvals and financial and corporate sector filings, (2) fast-tracking licence approvals for insurers who are licensed in one Canadian jurisdiction and seeking authorization
in another, (3) further streamlining financial and corporate filings, such as onepoint filing with the primary regulator.
Example In 2003, the Insurance Bureau of Canada (IBC) worked with the CCIR to see provincial regulators get industry financial information directly from OFSI. This one-point filling project would eliminate duplicate filings and ease the administrative burden on the industry. Provinces reported that changes were needed in their legislation and regulations before this could occur.
Relationships have been reviewed between insurers and their intermediaries to ensure that consumer confidence is maintained in the insurance industry. They have used risk assessment questionnaires to examine and report on business practices.
Other initiatives to reduce regulatory burden include developing a risk-based model for market conduct regulation to reduce the burden for good operators and focus regulatory attention on those who are not.
CCIR facilitated the development and adoption of the minimum capital test that established a coordinated approach to an industry practices review.
Insurance Product Licensing
In 2002 the CCIR announced a revised set of harmonized and flexible classes of insurance and definitions that would make it easier for insurers to develop and introduce new products into the marketplace. This project led to an amendment in the schedule to the Insurance Companies Act in 2006. The number of classes of insurance were reduced from 50 to 16 (15 in Quebec) and the licensing process for insurers was streamlined. The classes of “fire insurance” and “loss of employment insurance” were retained until amendments could be made to the Insurance Companies Act to remove them.
The insurer must prepare a submission for regulatory approval when a new product is launched. Insurers must conform with the CCIR’s insurer guidelines to support the application.
An insurer must seek regulatory approval to write a new insurance product that does not fit into any of the existing classes or a product that is not included within its licensing limitations.
As part of its harmonization project, the CCIR developed insurer guidelines to set out business practices to expedite the process of adding a new class to an existing
license or creating a new insurance product. These guidelines help regulators evaluate applications in a timely way and facilitate a coordinated regulatory approval from all affected jurisdictions.
The insurer guidelines include such practices as the following: • The insurer should conduct a detailed analysis of its available underwriting
expertise, its claims-handling capabilities, and other important functional
areas to ensure that the new product can be fully supported. • Appropriate controls and reporting must be established to allow the insurer to
accurately monitor the performance of the new product or class of business. • The insurer must educate its distribution network about the new product or
class of business. • Financial forecasts to demonstrate the viability of product or class must be
prepared. • An exit strategy must be developed to minimize the effect of market dislocation.
Regulators assess whether the necessary resources and controls are in place to deliver new products to consumers. The guidelines and the involvement of regulators ensure that an insurer can support the product it intends to sell.
The Future of Regulation The insurance industry operates in a dynamic regulatory environment. In some jurisdictions, the ever-changing regulations call for insurers to move quickly within their operations to ensure compliance. And inevitably, the cost of compliance is high.
Canada’s property and casualty insurance companies must consider the needs of multiple stakeholders, the key ones being consumers, shareholders, and regulators. Changes in the regulation of insurance will likely be dictated, as they have always been, by the will of the governments involved. If the governments find that the industry is healthy and consumers are satisfied, there may be no increase in regulation. If it is unhealthy and the public dissatisfied; if insolvencies occur; or if too many insurers see a downgrade of their ratings, then regulation and supervision may be increased.
In other countries, some regulators have chosen another less intrusive route to serve consumers without government intervention. When an insurance company is behaving in a way that may be offensive to some consumers, the regulator discloses such behaviour to the public. Other regimes have provided lists to consumers to show market practices of insurers. If an insurance company is engaging in a practice that a consumer finds offensive, the consumer has the option to boycott that company. The choice is then left with the consumer.
There may be other options promoted to ensure that consumers are well served by the insurance industry. It is clear, however, that everyone benefits when insurance companies are well run and profitable.
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