OSFI's Dickson Highlights Insurance Holding Company Regulation

In a speech delivered to the Canadian Reinsurance Conference, Julie Dickson, head of the Office of the Superintendent of Financial Institutions, remarked on insurance holding company regulation:

Another example of how life insurance and life reinsurance regulation is changing is evidenced by recent announcements by the Australian Prudential Regulatory Authority (APRA). APRA has made it clear that non-operating holding companies of life insurers should be subject to a similar regime to that which applies to life insurers themselves, and to banks and Property and Casualty (P&C) insurers. This means that the holding company is subject to some of the same regulatory requirements as the underlying risk-taking institution or institutions.

This is a significant change, as this approach is not the norm in many countries.

We think OSFI’s risk based capital rules are ahead of many existing systems in Europe but Solvency 2 is staking out new ground and we are watching it, as well as what other regulators are doing, like Australia.

… which is somewhat less emphatic than her statement on the issue last November.

She also mentioned accounting standards:

Finally, major accounting changes are also in the works. The International Financial Reporting Standards (IFRS) Phase II is not yet finalized but there is already considerable discussion of the potential impacts. One theme I see developing internationally seems to argue that if we can’t all agree on accounting changes, then there should be two sets of books – one that pleases the accounting standard setters and one that pleases everyone else (regulators and companies, assuming they can agree).

Historically there have been instances of having two sets of books – a statutory set and a GAAP set. This is a backwards step in OSFI’s view. A key aspect of the Canadian system is that all financial institutions report based on GAAP, and OSFI uses those same reports. Without such a system, how does management know what they are managing to? Why should regulators use different statements than shareholders and policyholders, when our interests ultimately converge? Will there be less transparency rather than more if two sets of statements are produced and used?

The debate over which set of books get used is something of a red herring – I don’t care which set is used for the media to report headline number, as long as there are adequate disclosures in the notes. All the good stuff’s in the notes anyway – to the occasional chagrin of pseudo-quants who pick all their numbers off Compustat!

There are also hints of a new regulatory regime for reinsurance:

The aim of the proposed regulatory changes is to better align the risk charges in capital between the P&C sector and the Life sector. Currently, the Life sector has a minimum capital charge based on gross requirements to account for the fact that a company could cede all its business and end up with no capital to cover its operational risk, whereas the P&C sector has a charge for counterparty credit risk. As transactions taking place between ceding and assuming companies are similar in nature (although the risks are different) OSFI is proposing to have similar risk charges for the two industries.

As a result, the P&C sector can expect to bear a minimum capital charge on the MCT, whereas the Life sector can expect to see the introduction of counterparty risk charge in the MCCSR. The scope and scale of the charges will be discussed with industry over the course of the year.

There are also changes coming with reinsurance credits:

As a result of the global financial crisis, one of the key lessons learned for regulators was that the amount and quality of collateral are very important to reflect the risk in financial transactions. As OSFI is an integrated regulator, this is our perspective and we will apply the same thought process to insurance.

From OSFI’s point of view, we can understand how lifting collateral requirements would be a benefit to certain global reinsurers, but we believe that regulators and supervisors would need to be assured that the security offered by a strong financial institution at the time of signing of the treaty would still be there to meet the obligations of the policyholders many years in the future. Consequently, we are still of the strong opinion that collateral must be posted by non-registered reinsurers to secure the benefits of the Canadian ceding company and its Canadian policyholders.

It should be noted that, to the extent that insurers do not meet OSFI’s minimum expectations on sound reinsurance practices and procedures, capital credit for reinsurance arrangements may not be granted.

And at the same time, reinsurance of longevity risk got a boost:

We understand that insurers have assumed both mortality risk and longevity risk to meet the needs of their clients, however, until recently reinsurers have chosen not to reinsure longevity risk in a material way.

We understand that reinsurers have argued that there is not enough tangible evidence of the predictability of longevity risk to mirror the experience which the reinsurers have had with mortality risk. Up to now, that has been the prevailing view of reinsurers, especially in North America. However, as a regulator, we are watching with interest the developments in Europe with respect to the reinsurance of longevity risk. In its simplest form, we can see how longevity risk serves as a natural, if imperfect, hedge to mortality risk.

We can see that there is clearly a need for longevity reinsurance, especially when that longevity risk is sourced from private pension plans.

That’s good news for JPMorgan – they’ve been flogging LifeMetrics for years.

She mentioned adverse selection as an element in the pricing of annuities:

OSFI is weighing the merits of these potential longevity transactions, but this growth opportunity for reinsurers comes with significant risk management challenges:
  • Annuities are particularly prone to the risk of mis-pricing and uncertainty regarding adverse selection (that is, annuitants living longer than their life expectancy).
  • Asset/liability mismatch is difficult considering the long term nature of this business, and these risks.

Adverse selection as it relates to annuities was discussed in the April 2010 PrefLetter, on sale now at a selected high-end website near you!

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