November 1, 2003 by Lawrie Savage of Lawrie Savage & Associates Inc.
Over the past 10 to 15 years, there has been a monumental shift in the approach to the supervision of financial institutions as countries around the world have moved to adopt risk-based supervisory techniques and much higher standards of corporate governance. In the realm of solvency supervision Canada has been a leader of this movement, with major revisions to the Insurance Companies Act in 1992 (along with many additional changes since then) and the adoption by the Office of the Superintendent of Financial Institutions (OSFI) of risk based supervisory techniques.
However, in the field of “market conduct” Canada has seen very little of the new approaches. Provincial insurance acts have been slow to change, and when changes have occurred they have tended to add to the myriad of rules and regulations rather than streamlining and simplifying, as is possible with corporate governance, risk based methodologies.
The new principles are straightforward and highly logical. Described below is an overview. First, we can presume that in adopting increasingly complex, rule-based regulatory regimes, governments are attempting to achieve certain public policy goals. Precisely what those goals are, however, is seldom articulated.
With the “new approach”, we require governments to spell out exactly what it is they want to achieve. Second, with clearly specified public policy goals, we use corporate governance to make boards of directors and senior managers responsible under the law for putting in place systems within their companies which will reasonably assure that these goals are achieved by their organizations. Third, the government establishes a framework (the OSFI “supervisory framework” is a good example of this) which clearly explains how companies will be assessed in terms of their overall achievement of the public policy goals. The assessment process must be as objective as possible and highly transparent so that everyone knows the basis on which they will be judged.
Finally, rather than working to, in effect, “micro-manage” the system by attempting to check or control a vast number of transaction-oriented items, the government adopts fully risk based methodologies, which means monitoring the system for indicators of higher than usual risk and then focusing resources on those areas. The concept here is to prevent problems from arising rather than to attempt to fix problems that already exist. This is analogous to public health policy: We know that it is highly beneficial from a cost perspective if we can keep the population in good health rather than attempting to rehabilitate people who are already sick. In insurance terms, the idea is that regulators assess the risk that individual companies may not be able to meet the public policy objectives that have been agreed to, and they then work with those companies to reduce the risk of non-achievement of objectives.
Let us move to a more concrete example. Suppose that one of the public policy goals in market conduct stipulated by regulators is that companies must have systems in place to reasonably ensure that claims are settled without unreasonable delay in a way that fully responds to the coverage provided in the insurance contract. There would be a monitoring system in place to provide information on this parameter to the regulators.
Public complaints are a highly effective source of information about company behavior and we already have sophisticated systems in place for dealing with public complaints. By extending those systems slightly, the regulators could quickly see if there are companies having a disproportionate number of justified complaints in the area of claims settlement. For the sake of argument let us say that, of the several hundred companies in the marketplace, there are a few companies that do seem to have a disproportionate number of complaints along these lines. These companies would find themselves to be assessed as higher than normal risk in terms of meeting the policy objective for timely claims settlement and the regulators would then focus on the management and boards of these companies to assess their procedures and to see what changes might be necessary. Companies judged not to be meeting the standards (as set out in measurable terms in the market conduct supervisory framework), and not making progress to meeting the standards, could be exposed to significant penalties.
The approach outlined in the above would in effect be a move from a “red tape system” to a “smart tape system”. What are the benefits?
The new approach replaces a huge number of specific rules and regulations with a few supervisory tools. Instead of forcing all companies to submit to considerable filing and other paper burden requirements, regardless of their risk profile, attainment of public policy objectives becomes a matter of competitive behavior. If my company can meet all of the public policy objectives in a more cost efficient way than your company, or if it can do so in a way that provides higher levels of service to its customers, then my company has a competitive advantage and will tend to become larger and more profitable than your company.
Following from that, we also have in place a system which should operate for less cost (especially taking account of industry cost of compliance) and much greater effectiveness, because companies are focusing on what is important. If companies are working to attain specific goals, their methods may change over time as the marketplace and public needs change.
Thus, we also have a malleable system that adapts to changing circumstances rather than a rigid system which requires compliance with a huge array of rules and regulations – many of which no longer serve a purpose because the reasons they were originally adopted have long since disappeared. Finally, we have a system which will tend to be far more harmonized across provinces – because there is little that needs to be harmonized compared to the present system, and much of what does need to be harmonized will be in terms of administrative practice rather than law.
The IBC is currently initiating talks with the various provincial regulators to discuss the new approach and how it might be implemented in the Canadian market. Much work remains in terms of working out the details of how the new system would operate. However, similar principles of market conduct supervision have been successfully implemented in countries such as New Zealand, and they are recommended by the International Association of Insurance Supervisors (IAIS) – the world organization for standard setting in insurance supervision. The governments of Canada, Quebec and Ontario are members of IAIS.