Canadian Underwriter
News

New federal requirements could put upward pressure on levels of capital to hold: CEO


April 23, 2014   by Angela Stelmakowich, Editor


Print this page Share

The Office of the Superintendent of Financial Institutions’ (OSFI) Own Risk and Solvency Assessment (ORSA) guideline will demand a new level of focus by insurers to adequately assess their risk profile, but could put upward pressure on the levels of capital to hold, Karen Gavan, president and CEO of Economical Insurance, suggested during a luncheon address in downtown Toronto Tuesday.

OSFI’s ORSA guideline requires companies to understand how much capital they need to ensure their solvency, Gavan told attendees of the Insurance Bureau of Canada’s 18th Annual Financial Affairs Symposium.

“While companies have lived under the regulatory capital regime for decades now, this new standard requires companies to really look at the actual risks they are taking,” she said.

But there are industry concerns over ORSA’s introduction, Gavan suggested. “One of the key issues and sources of tension is the higher the surplus requirement, the lower the return on equity (ROE),” she added.

“The MCT (minimum capital test) factors are average aggregate factors that apply to the industry as a whole. However, when each company individually assesses the capital for their unique business, we may find that MCT is either higher or lower than our individual assessment at the risk level,” she explained.

“Consequently, I think we will see continued upward pressure on the levels of capital to hold, as regulatory capital will likely set a floor from which only incremental capital is held,” Gavan told symposium attendees. “While companies want to hold a prudent amount of surplus, the regulatory perspective is to hold a prudent amount ‘plus plus’ to completely mitigate any risk of insolvency.”

Gavan noted that while mutual companies are generally not concerned about ROE, “they will need to hold higher levels of surplus as they are completely reliant on internally generated capital from earnings.”

For stock companies, however, she emphasized that ROE “is critical to provide a reasonable return to their investors.”

Another source of tension is the foreign capital risk charge, Gavan pointed out. “The challenge we face in equity investing in Canada is that the TSX is dominated by financial services and natural resources sectors, so investing solely in Canadian equities will serve to increase concentration risk,” she suggested.

“I am concerned that this capital charge will drive the industry to much higher risk concentrations if companies choose to invest only in Canada to avoid the foreign capital risk charge,” Gavan said. While she said she agrees there should be some charge for foreign capital exchange risk, there should also be a diversification benefit that partially offsets the risk charge.

“In the end, insurers must be able to attract investors to our marketplace in order to have access to capital to enable the industry to grow, invest, develop and become stronger for Canadians,” Gavan told symposium attendees. Overcapitalizing the industry depresses those returns and “prevents companies from attracting and deploying the capital they’ve generated in support of go-forward strategies. That’s an unintended consequence of the layered-on capital regime.”


Print this page Share

Have your say:

Your email address will not be published. Required fields are marked *

*