The Life Insurance Industry and the Long Game

Julie Dickson of OSFI gave a speech titled The Life Insurance Industry and the Long Game, which gave some gentle hints to the industry, but was short on details regarding the potential for regulatory change:

Should rates continue at the current low level – below 3% on government bonds for a 30-year term – it will be a real game changer for the life insurance sector.

Since life insurers often lock in their assumptions for the expected rate of return when the product is priced, there is an implicit assumption that the life insurer will continue to earn the same average interest rate over the lifetime of the product. When interest rates fall life insurers must reinvest the renewal premiums on new investments at lower rates than originally priced, leading to a compression in the product margin.

As regulators, we want life insurers to maintain healthy solvency ratios and still deliver on their promises to policyholders. If insurers are moving risk from their balance sheets onto policyholders, policyholders need to understand the risks they are assuming – we would not want to see a repeat of the vanishing premium events of the early 1990s.

The low interest rate environment also puts pressure on life insurers to recognize that they must discount their liabilities at the prevailing rate of interest. Currently in Canada, actuarial practice allows life insurers to grade in the effects of a decreasing interest rate environment over 10 years. This is a prudent approach. But we are concerned that a few life insurers may not be moving quickly enough to recognize that a change in strategy is also required. Life insurers need to start making changes to their product portfolios today to mitigate the grading of these low interest rates into the ultimate reinvestment rate (URR) to value long term insurance liabilities.

Through fora like the G-20, the Basel Committee on Banking Supervision, and the Financial Stability Board, international agreements are moving from discussion to implementation. The banking industry has been the focus of the majority of the reforms to date, but the life insurance industry is never far from the discussions.

For example, we see the role of the Chief Risk Officer (CRO) as being of primary importance to both banks and insurers. The first line of defence is the business itself and it must own the risk in its operations. We see the CRO as being another line of defence for the board, shareholders, creditors, policyholders and other significant stakeholders (including regulators and supervisors) to ensure the effective management of risk within a financial institution – sort of like wearing a belt and suspenders, or a check on the front office. We expect the CRO to be independent, to work with the board to ensure there are independent processes and controls throughout the organization, and to serve the interests and concerns of significant stakeholders. Strengthening the role of the CRO is a significant change for some life insurers, but a necessary one.

On the process of stress testing, we know that the recent “simulated crisis” stress test that OSFI asked specific Canadian life insurers to undertake did cause some concerns for those companies, in particular the degree of detail we requested. At the same time, however, we were struck by some of the weaknesses in the operating capacity of companies to provide the material in a timely manner. We have had discussions with industry representatives to review these concerns and are in the process of making changes to the reporting requirements of the 2012 stress test.

An issue that is receiving considerable attention globally is capital. The right amount of regulatory capital needs to be carried for the right risk. As the regulatory capital regime in Canada evolves, the objective will be to ensure this happens. We also encourage insurers to continue to develop their capabilities: economic capital models need to be more than a multiple (or a fraction) of regulatory capital – they need to allocate the right economic capital to the right risk.

Leave a Reply

You must be logged in to post a comment.