Creativity and Containment

Canada’s federal insurance regulator is planning to work closer together with its provincial counterparts to gain a better understanding of market conduct issues, according to the Superintendent of Financial Institutions Julie Dickson.

Dickson told people attending the Insurance Bureau of Canada (IBC)’s Seventh Regulatory Affairs Symposium in Toronto that OSFI planned to send a specialized property and casualty representative to future meetings of the Canadian Council of Insurance Regulators (CCIR). Last year, the CCIR, in tandem with the Canadian Insurance Services Regulatory Organizations (CISRO), developed and is now enforcing three general market conduct principles.

Noting “sanity is prevailing” currently in the Canadian primary insurance market, Dickson said a better-coordinated effort among regulators is needed in the area of market conduct to ensure the rhetoric about market discipline matches the reality. “The industry does need to remain vigilant,” she said.

With OSFI now appearing at the meetings of the CCIR, the council of provincial insurance regulators, all of the supervisors will get a better idea of what kind of market conduct is occurring, said Dickson. “It will be very helpful for OSFI and I hope it will be helpful for the market conduct regulators,” she said.

Dickson went on to name some areas in which insurers and reinsurers still need to improve. For example, in the area of risk management, she urged reinsurers and insurers to be absolutely clear in their documentation about what kinds of risks they are transferring. “Notwithstanding the economic reasons behind any insurance contract, it is essential for all parties to be fully aware of the intent and the terms and conditions in the contract,” Dickson said. “Common sense would dictate that the expectations are known to the parties prior to the contract incession, and also that the defined terms and conditions have been mutually agreed upon in writing. This is not always the case, however. We have seen situations where different interpretations have caused significant disputes and have ultimately factored into the liquidation of the ceding company involved. So for many groups of OSFI we [refer to this situation] in an attempt to compel companies to improve their documentation practices in order to eliminate the uncertainties related to coverage.”

Also, she noted, new accounting classifications have created “headaches” for some insurance companies, particularly those that do not have much in-house accounting experience. “The straight challenges we’re seeing on implementation of OSFI are coming on line D-10,” she said. “So if you are a company in this category, it would be advisable to seek out the help required now, as the complexity of recent accounting business is only the beginning.” She noted that as Canada moves towards international financial reporting standards, more time and effort would clearly be needed to determine the effects of the new standards prior to their implementation.

Finally, regarding earthquake risk, it has been more than 10 years since OSFI has required companies to report capacity set aside for claims related to earthquakes, Dickson noted. Decades ago, OSFI asked companies to set aside enough capital surplus to pay claims related to a 1-in-250 year earthquake. Over the next 25 five years, this capacity would be increased to a 1-in-a-500 year event, she said, adding that many of today’s companies are already setting aside enough capacity for this new level. “Most companies have realized it is not enough to fill in an earthquake form and call it a day,” she said.

REGULATION BY MARKETS

Contrary to the stereotype that the IBC endorses the establishment of private auto insurance rates exclusively by market forces, the IBC in fact believes “there is a need for government regulation of the market” to reduce market volatility, according to IBC vice president and chief economist Jane Voll.

But while government regulation of the insurance market is necessary, it should be done more at the level of setting thresholds to contain the rates, Voll said. She encouraged Canada’s insurance regulators to establish maximum acceptable boundaries for containing auto insurance pricing, within which market forces could determine the range of requested rate changes.

“Risk-based regulation is like a schoolyard,” said Voll. “When you have a high fence and all the kids are in the school yard, it’s okay for you to sit outside with a coffee on your teacher duty [while the kids play ball].

“But if kids go on the other side of the fence, and it’s not contained, they may run across to the other side of the street and play with a ball. In that case, you probably want to follow them and see what they’re doing and keep a very close eye and maybe put the coffee down.

“It’s about putting boundaries around competition. When the boundaries are strong, safe, secure and well-known, then the game can play.”

But while European and U.S. insurance regulators are increasingly using market forces as “a vehicle, a tool of the regulatory apparatus,” Voll said, “Canada has been going in the opposite direction.”

For example, Canadian regulators in the auto insurance sector are generally adhering to a file-and-approve method of setting auto rate changes, Voll observed. In a file-and-approve system, insurers file proposed rate changes to the regulator and the rates are not effective until regulatory approval. File-and-use systems, in contrast, are more flexible, because they allow insurers to file their rate changes with regulators and the changes become effective immediately upon filing.

The predominance of the file-and-approve regulatory method in Canada — in which government regulators, and not the market, dictates rate fluctuations — suggests insurance regulators don’t trust market forces to correct inconsistent or non-typical rate fluctuations, according to Voll.

“What do the markets say?” she asked. “Well, Economics 101 will tell you competition is the most ruthless regulator of profit and pricing. It sounds like a clich, but it’s true…Where the [regulators] were using market forces as a tool in their toolkit as a regulator, you find you have less price volatility for consumers when you rely on market forces.”

Voll presented slides showing it usually takes between three to seven months for auto insurance premiums to respond to trends in claims costs. But if the method for pricing a product is not competitive — and the regulator’s approval adds to the time it takes an insurer to adjust rates to costs — then in some cases it can take up to two years for an insurer to respond to rising costs with rate adjustments. Larger insurers, while they have the resources to adjust prices more quickly, can still take 20 months to adjust rates in a file and approve system, Voll noted. This will lead to larger and steeper price oscillations, as insurers try to make up for how long it has taken to catch up to claims costs.

CLOSING THE FILE

The insurance industry should not be holding on to policyholders’ records based solely on a concern about the potential for future claims litigation, a speaker from the office of the federal privacy commissioner told people attending the IBC’s Regulatory Affairs Symposium.

Elizabeth Denham, the director of research, analysis and stakeholder relations for the Office of the Privacy Commissioner of Canada, suggested as much when asked how long property and casualty insurance companies are entitled to hang onto records. The questioner noted that litigation often has a “long tail,” noting how long it took for residential school abuse claims to reach insurers’ desks. When personal injury claims involving residential schools are concerned, the statute of limitations for filing a claim may extend backwards for decades, the questioner noted.

But that’s no excuse for insurers to hold onto policyholders’ records beyond the point when the file became inactive, she noted. She observed that t
he appropriate length of time to hold onto a record would depend on the activity of the file.

“If a file is closed and the client is no longer your client, and after seven to 10 years, what are the reasons for maintaining those records? In case there may be litigation that’s unrelated to the coverage you are providing to this individual?” Denham asked. “You have to look at the coverage, the claim, the history, all of that. It is a complex area, but the law says that once you no longer require the record for business purposes, then it should be destroyed.”