Canada
Financial Sector Assessment Program-Insurance Core Principles-Detailed Assessment of Observance

This Detailed Assessment report, a part of the 2013 Financial Sector Assessment Program (FSAP) of Canada, assesses Canada’s regulatory regime and supervisory practices against the international standards. The IMF report suggests that the Office of the Superintendent of Financial Institutions (OSFI) should be empowered to take supervisory measures at the level of the holding company. It highlights that while OSFI requires Federally Regulated Insurers (FRI) FRIs to develop internal capital targets, requirements to develop an Own Risk and Solvency Assessment are scheduled to be implemented in 2014.

Abstract

This Detailed Assessment report, a part of the 2013 Financial Sector Assessment Program (FSAP) of Canada, assesses Canada’s regulatory regime and supervisory practices against the international standards. The IMF report suggests that the Office of the Superintendent of Financial Institutions (OSFI) should be empowered to take supervisory measures at the level of the holding company. It highlights that while OSFI requires Federally Regulated Insurers (FRI) FRIs to develop internal capital targets, requirements to develop an Own Risk and Solvency Assessment are scheduled to be implemented in 2014.

Executive Summary

The insurance sector in Canada is mature and diversified. Assets held by federally regulated insurers (FRIs) are limited by comparison with those of banks, accounting for only 21 percent of total financial system assets. The number of FRIs has been reducing through consolidation from 290 in 2008 to 264 as at end-2012. The life and health (L&H) industry accounted for about 83 percent of the assets held by FRIs and is dominated by three large internationally active insurance groups with significant operations in the US, Asia and Europe, who held just under 76 percent of total life industry assets in 2012. The property and casualty (P&C) industry is less concentrated, with foreign-owned branches having significant market share. The number of provincially incorporated insurers (240) has been decreasing, offset by growth in captive insurers (all 23 are based in British Columbia). Assets held by provincial insurers (Can$75.4 billion) represent about 11 percent of the assets held by FRIs as at end-2011, of which provincial insurers in Québec accounted for 80 percent (Can$60 billion). The insurance sector is served by a wide range of intermediaries, comprising approximately 154,000 insurance agents and 44,000 to 45,000 brokers as at end-2012

The performance of the L&H industry has been dampened by the global financial crisis and the ongoing volatile financial markets. Total assets held by L&H FRIs reached Can$602 billion as at end-2012. The market share of annuities products, comprising largely segregated fund policies, fell to 52 percent in 2012 (Can$4.7 billion gross premiums) from 61 percent in 2010. Group business recorded a 21 percent increase (to Can$2.6 billion) while individual business remained steady (Can$ 1.7 billion). L&H FRIs have been repricing their products in recent years in response to the low interest rate environment and have also been removing or weakening product guarantees, transferring more risks to policyholders. In the absence of growth, profitability has been declining, compounded by the protracted low interest rate environment.

The P&C industry is much smaller and writes almost exclusively domestic risks, with motor insurance as the dominant line of business. Total assets of P&C FRIs as at end-2012 were Can$124.6 billion. Growth in the sector has been modest; premiums rose by 10 percent in 2012 (Can$43.7 billion). Ontario automobile insurance is the single largest P&C product, accounting for about 25 percent of the premiums of the P&C industry. While operating results have been strong, declining investment returns have stimulated a focus on improving underwriting discipline. The mortgage insurance market has insured loans in-force of Can$730 billion with written premium of Can$2.2 billion in 2012 and is dominated by the state-owned Canada Mortgage and Housing Corporation (with about 70 percent market share).

The solvency position of the L&H industry has been eroded since 2010, while the overall solvency of the P&C industry has remained stable. At the aggregate level, both sectors report solvency ratios that are well above the regulatory minimum. The key exposures of L&H FRIs are to continuing low interest rates, volatile equity markets and slow economic growth, while P&C FRIs have to confront difficult investment market conditions and increased frequency and severity of natural catastrophes.

Federal and provincial authorities share responsibilities for supervising the insurance sector in Canada. OSFI is responsible for the prudential supervision of FRIs and Canadian branches of foreign insurers. Insurers incorporated in a province are subject to the solvency oversight of that province’s insurance supervisor. The provincial supervisors are also responsible for licensing and supervising the conduct-of-business (CoB) of insurers, including FRIs, operating in their provinces. There are various supervisory coordination mechanisms at both the federal and provincial levels.

The Canadian regulatory regime for FRIs has a high level of observance with the ICPs, supported by robust prudential supervision by OSFI. OSFI’s risk-based Supervisory Framework facilitates structured and comprehensive supervisory risk assessments and the industry has a high regard for the professionalism of OSFI supervisors. The supervisory intervention process is transparent and supports timely intervention to address emerging concerns. OSFI has adequate supervisory resources and technical capacity to conduct effective supervision. Minor gaps in the regulatory regime have been addressed by OSFI through its guidelines and supervision. While OSFI has been conducting active supervision of groups in practice, the transparency of its different approaches to supervising insurance groups should be improved. It is recommended that the authorities adopt a transparent and consistent regulatory regime for group-wide supervision, based on a clear definition of the group, which includes prudential and market conduct requirements at the group level as well as a consistent approach to group-wide supervisory work. Going forward, it is advisable that OSFI be empowered to take supervisory measures at the level of the holding company.

The requirements on valuation of technical provisions and assets provide a comprehensive framework of standards. They include a consistent economic basis for valuation across the balance sheet and margins for adverse deviation. While the approach to valuation of liabilities is principles-based and provides for significant discretion to be exercised by the Appointed Actuary (AA), it is underpinned by professional and regulatory requirements applying to the AA and a sound framework of oversight, peer review and audit requirements. The approach has been adapted where areas of weakness were highlighted by the financial crisis and OSFI’s supervisory work.

OSFI has robust capital adequacy requirements for L&H and P&C business, although there are gaps and inconsistencies in their application, at both group and solo legal entity levels. Separate capital frameworks apply to L&H and P&C business, capturing all material risks as well as requiring FRIs to hold capital for risks not covered by the standard requirements. OSFI allows firms to use internal models in limited areas, but applies a full model approval process and ongoing monitoring. A distinguishing feature and a strength of OFSI’s regime is its application on a consolidated basis to each operating FRI. However, OSFI’s approach to the application of group capital requirements varies across groups, reflecting the limitations on its powers over unregulated holding companies. Furthermore, its focus on consolidated capital adequacy is not matched by the application of a full framework of capital or disclosure requirements to all Canadian solo legal entity FRIs within groups. There is scope for strengthening OSFI’s approach in the area of investments. While OSFI already requires FRIs to develop internal capital targets, requirements to develop an Own Risk and Solvency Assessment are scheduled to be implemented in 2014.

CoB regimes across provinces are being harmonized and this should continue while ensuring adequate supervisory resources for effective CoB supervision. The CoB regime adopted by AMF is in line with international best practice and it has adequate resources to conduct effective risk-based CoB supervision. Constrained by limited resources, FSCO has adopted both a reactive and industry-wide targeted approach to supervising the FRIs based in Ontario (the vast majority of the total) and large numbers of insurance intermediaries. It is essential that FSCO be equipped with adequate resources and financial capacity to deal with the size and diversity of the Ontario marketplace.

There is scope for strengthening the legal capacity and operational autonomy of the supervisors. OSFI has not been delegated powers to make directly binding rules. Its use of guidelines to set out detailed standards confers considerable flexibility, for example in responding to emerging risks, and its guidelines are treated by regulated entities as authoritative. Nonetheless, the authorities should consider the scope to strengthen regulation by empowering the supervisors to issue enforceable rules by administrative means rather than through legislation. In the case of OSFI and AMF, relevant laws should be updated to separate the provisions governing prudential decisions of the supervisors, for example on changes of control, from the national interest issues which the executive authorities must take into consideration; and in the case of FSCO, to limit the circumstances under which the provincial government can issue a policy statement to FSCO. Consideration should be given to exempting the supervisors from the government’s fiscal controls and administrative guidance so as to strengthen their financial autonomy. There should be provisions in law requiring public disclosure of the reasons for a removal of the President and CEO of AMF and the Superintendent of FSCO, in line with international standards.

Assessment of Insurance Core Principles

A. Introduction and Scope

1. This report assesses Canada’s regulatory regime and supervisory practices against the international standards established by the International Association of Insurance Supervisors (IAIS), as part of the 2013 Financial Sector Assessment Program (FSAP) of Canada. The assessment was conducted by Su Hoong Chang (IMF) and Ian Tower (external expert engaged by the IMF) and from 12 to 28 June 2013.

2. The assessment is benchmarked against the IAIS Insurance Core Principles (ICPs) issued in October 2011, as revised in October 2012. The ICPs apply to all insurers, whether private or government-controlled. Specific principles apply to the supervision of intermediaries. The scope of the assessment covers: a) the prudential supervision exercised by the OSFI at the federal level based on materiality considerations1 i.e. prudential oversight of insurer by provincial authorities is not covered; and b) the conduct-of-business regimes of the Financial Services Commission of Ontario (FSCO) and the Autorité des Marchés financiers (AMF) in Québec, on a sampling basis. The institutional arrangements for financial sector regulation and supervision are outlined in Section C.

B. Information and Methodology Used for Assessment

3. The level of observance for each ICP reflects the assessments of its standards. Each ICP is rated in terms of the level of observance as follows:

  • a) Observed: where all the standards are observed except for those that are considered not applicable. For a standard to be considered observed, the supervisor must have the legal authority to perform its tasks and exercises this authority to a satisfactory level.

  • b) Largely observed: where only minor shortcomings exist, which do not raise any concerns about the authorities’ ability to achieve full observance.

  • c) Partly observed: where, despite progress, the shortcomings are sufficient to raise doubts about the authorities’ ability to achieve observance.

  • d) Not observed: where no substantive progress toward observance has been achieved.

4. The assessment is based solely on the laws, regulations and other supervisory requirements and practices that are in place at the time of the assessment in June 2013. Ongoing regulatory initiatives are noted by way of additional comments. The authorities have provided a full and well-written self-assessment, supported by anonymized examples of actual supervisory practices and assessments, which enhanced the robustness of the assessment. Technical discussions with and briefings by officials from OSFI, FSCO and AMF also enriched this report; as did discussions with industry participants.

5. The assessors are grateful to the authorities for the full cooperation and thoughtful logistical arrangements, particularly the helpful co-coordination of various meetings with industry participants. The assessors also benefitted from the valuable inputs and insightful views from meetings with insurers as well as industry and professional organizations.

C. Overview—Institutional and Macroprudential Setting

Institutional Framework and Arrangements

6. The responsibilities for financial sector supervision in Canada at the federal level are undertaken by a number of agencies: a) the Department of Finance (DoF) is responsible for the overall stability of the financial system and financial sector legislation at the federal level; b) the Bank of Canada (BoC) provides liquidity to the Canadian financial system, oversees key payment, clearing and settlement systems, and assesses risks to financial system stability; c) OSFI exercises prudential regulation and supervision of federally regulated financial institutions (FRFIs), including federally regulated insurers (FRIs); d) the Canada Deposit Insurance Corporation (CDIC) insures deposits of member institutions and is the bank resolution authority; and e) the Financial Consumer Agency of Canada (FCAC) has the mandate to strengthen oversight of consumer protection measures, expand consumer education activities, and enforce consumer related provisions in statutes covering FRFIs. The Minister of Finance (Minister) has overarching authority over federal financial sector legislation, including the governing legislation that establishes the mandates and powers of financial sector regulatory agencies and is supported by the DoF in fulfilling this mandate.

7. Supervisory coordination amongst the federal agencies is facilitated by various collaborative mechanisms:

  • a) The Financial Institutions Supervisory Committee (FISC) facilitates consultation and the exchange of information between OSFI, CDIC, BoC, FCAC and the DoF. It is chaired by the Superintendent of Financial Institutions;

  • b) The Senior Advisory Committee acts as a discussion forum for financial sector policy issues, including macroprudential oversight and financial stability issues. It is chaired by the Deputy Minister of Finance with the same membership as the FISC although other government agencies may be invited, where appropriate;

  • c) The Heads of Agencies Committee acts as a forum for exchange of information and views and coordinate actions on issues of mutual concern, such as hedge funds and OTC derivatives. It is chaired by the BoC Governor and includes the DoF, OSFI, the four largest provincial securities regulators and the Chair of the Canadian Securities Administrators (CSA).

8. Federal and provincial2 supervisors share responsibilities for supervising the insurance sector. The insurance regulatory system in Canada reflects the cooperative federalism that characterizes the Canadian approach to government. OSFI is responsible for prudential supervision of insurers incorporated under the federal Insurance Companies Act (ICA), which are referred to as federally regulated insurers (FRIs) in this report. Insurers that are incorporated in a specific province are subject to the solvency oversight of that province. OSFI also regulates the solvency and soundness of licensed Canadian branches of foreign insurers. The relevant provincial supervisors supervise the market conduct of all insurers (including FRIs) operating within their provinces.

9. OSFI exercises prudential regulation and supervision of FRIs. Its primary activities are to: protect the rights and interests of depositors, policyholders, pension plan members and creditors of financial institutions (FIs); and contribute to public confidence in a safe and sound financial system. OSFI’s mandate does not include consumer-related issues or the securities industry. OSFI also works closely with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), which is responsible for ensuring compliance with Canada’s Proceeds of Crime (Money Laundering) and Terrorist Financing Act.

10. While some provincial supervisors delegated prudential supervision of insurers incorporated in their jurisdiction to OSFI in the past under supervisory memoranda of understanding (MoUs), this practice has discontinued. Historically, provincial supervisors harmonized their solvency standards with those of OSFI, to minimize regulatory arbitrage. Over the past two decades, OSFI has updated its solvency regime for FRIs, in line with evolving international regulatory and market developments. However, the declining number of provincially incorporated insurers raised pertinent costs-and-benefits considerations for some provincial supervisors faced with a need to invest significant resources to continuously update and maintain their solvency regimes in line with international standards. While some provinces, especially those with a significant mass of provincial insurers (e.g., Québec) have chosen to retain their autonomy in prudential supervision, a number of provinces3 are considering other policy options. All the MoUs have expired and OSFI no longer conducts on-site examination of provincially incorporated life insurers and fraternal benefit societies.

11. The provincial supervisors are responsible for licensing and supervising the conduct-of-business (CoB) of insurers operating in their provinces4. The scope and approach adopted for CoB supervision of insurers and intermediaries in each province vary. In some provinces, insurance brokers and agents are regulated in the same manner and by the same supervisor while in other provinces, SROs may be given delegated powers to supervise certain categories of intermediaries.5

12. This assessment does not cover the FCAC in view of its limited role in supervising the insurance sector. FCAC is an agency of the federal government and falls under the purview of the Minister. It was established by Parliament in 2001 under the Financial Consumer Agency of Canada Act to consolidate6 and strengthen oversight of consumer protection measures in FRFIs, and to expand consumer education. FCAC focuses on the lending activities of FRFIs and administers the consumer provisions7 under the ICA. It also monitors FRFI’s compliance with voluntary codes of conduct and public commitments.

13. Coordination amongst provincial supervisors is facilitated by the Canadian Council of Insurance Regulators (CCIR). The CCIR is a long-established inter-jurisdictional association of insurance regulators (i.e., federal, provincial and territorial authorities) with the mandate to promote an efficient and effective insurance regulatory system in Canada. OSFI participates in the meetings of the CCIR as an observer. CCIR is also a member of the Joint Forum of Financial Market Regulators (JFFMR), a mechanism through which pension, insurance and securities regulators co-ordinate, harmonize and streamline the regulation of financial products and services in Canada. The other JFFMR members are the Canadian Association of Pension Supervisory Authorities, the CSA and the Canadian Insurance Services Regulatory Organizations (CISRO).8

Market Structure and Industry Performance

Industry Structure and Recent Trends

14. The insurance sector in Canada is small relative to the banking sector. Assets held by insurers accounted for only 21 percent of financial system assets. Domestic banks own six life-and-health (L&H) FRIs and 12 property and casualty9 (P&C) FRIs, as part the conglomerate groups. The insurance subsidiaries are not considered material in the context of the banks’ overall business. Only one very small P&C FRI was part of a financial conglomerate headed by a securities firm.

15. Insurance penetration and density10 for the Canadian L&H industry and the P&C industry has seen modest increases. Over the past 5 years, L&H insurance penetration has increased modestly from 3.1 percent to 3.2 percent and insurance density increased slightly Can$1,687 (from Can$1,548). This is comparable to the average penetration and density for advance markets of 3.6 percent and US$1, 543 as at end-2011. The penetration and density ratios of the P&C industry as at end-2012 were 2.37 percent and Can$1,234, respectively. The P&C ratios are significantly lower than the average ratios for advanced markets of 5.0 percent and US$2,168, respectively, as at end-2011.11 Reinsurance penetration and density is low at 0.63 percent and Can$330, respectively, in 2012. The number of domestic employees in the Canadian insurance industry is approximately 254,400 as at end-2011.

16. The number of FRIs has been consolidating while there is a shift in the composition of provincial insurers (Table 1). As at end-2012, there were 264 FRIs, down from 290 in 2008, with P&C FRIs accounting for 57 percent of FRIs, despite the higher reduction in numbers. The P&C industry is much smaller than the L&H industry and accounted for 17 percent of total industry asset in 2012. In addition, 80 foreign insurers had been licensed to operate as branches in Canada. The reduction of L&H and P&C provincial insurers were offset by increase in captive insurers12 and other types of insurers. All the 23 captive insurers are based in British Columbia. Although the number of provincial insurers is comparable to FRIs, assets held by provincial insurers (Can$75.4 billion) represent about 11 percent of the assets held by FRIs as at end-2011. Provincial insurers in Québec had the largest provincial asset base at more than Can$60 billion.13

Table 1.

Insurance Market Structure as at end-2012

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(1) Reinsurers were included under P&C in 2008Source: OSFI

17. The L&H industry is dominated by three large internationally active insurance groups with significant operations in the US, Asia and Europe. Together, Manulife Financial Corporation (MFC), Sun Life Financial Inc. (SLF) and The Great West Life Assurance Company (GWL) held just under 76 percent of total life insurance assets in Canada in 2012, at the legal entity level. MFC had the highest asset base at the consolidated level and it is the only top-3 insurance group with larger foreign than domestic operations. Domestically, with the benefits of economies of scale and pricing powers, these groups enjoy competitive advantages against their smaller domestic and foreign peers.

18. In recent years, SLF and MFC have retrenched their US operations significantly, particularly in the variable annuities business.15 The low interest climate has affected the competiveness of Canadian insurers in the US as they are required to hold higher technical provisions compared with their US peers owing to differences in valuation bases. Overall, 48 percent of the consolidated assets of the top-10 insurance groups are attributable to domestic operations, while 69 percent of gross premium is generated through domestic operations. The largest foreign market for the top 3 insurance groups is the US, accounting for 37 percent of assets and 17 percent of premiums in 2012, followed by Europe (11 percent of assets and 12 percent of premiums). While assets held in respect of their Asian operations were relatively low at 9 percent of total assets, it is viewed as a potential growth market, representing 19 percent of premiums written in 2012.

19. The P&C industry is less concentrated than the L&H industry, with foreign-owned insurers having significant market share. It comprises local subsidiaries of the large global groups, subsidiaries of the large Canadian banks as well as mutual/co-operative organizations. The top-10 P&C FRIs produced 46 percent of total industry premium in 2012.

20. Branches or subsidiaries of large global reinsurance groups dominate the reinsurance sector. The scale of the reinsurance industry in Canada is small; assets held by reinsurers totaled only Can$29 billion or 3 percent of the assets of direct insurers. For better focus, the following market analysis is limited to the L&H and P&C industries, excluding reinsurers.

21. The insurance sector is adequately served by a wide range of intermediaries. As at end-2012, there were approximately 154,000 insurance agents (or approximately one for every 225 Canadians), up from 133,000 in 2008. Over the same period, the number of insurance brokers increased from approximately 44,000 to 45,000. Brokers have diverse business models comprising: a large number of small, often family-owned, “main street” brokers; larger regional brokers; and the largest international brokerage groups. In recent years, managing general agencies16 (MGAs) have gained almost half the market share for L&H distribution channel (please refer ICP 18).

Assets and liabilities

22. The investment portfolios of L&H FRIs are diversified, with moderate exposure to real estate (Table 2). Excluding the segregated funds, FRIs’ investments in real estate (directly and through mortgage loans) accounted for 20 percent of their assets as at end-2012, a decline from the 25 percent recorded as at end-2008. Allocation to fixed income securities has been consistently above 65 percent of investment portfolios (excluding the segregated funds) in the last five years. L&H FRIs also invested in alternative asset classes, e.g., some Can$20 billion was invested in private placement debts although direct exposures to Europe were modest. Nonetheless, sensitivity to market risks (especially equity risk) arising from their legacy segregated fund guarantees17 is a concern, particularly for insurers who did not adequately hedge their equity exposures. The L&H insurance groups wrote more than half of their segregated fund portfolios outside of Canada, with assets totaling Can$422 billion at the consolidated level as at end-2012, a significant 32 percent increase from 2008 (Can$320 billion).18

Table 2.

Composition of Assets—L&H FRIs

(Legal Entities)

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Prior to 2011, “in Canada” data was not collected for conglomerates.

Source: OSFI

23. The investment profile of the P&C industry is conservative, heavily weighted in fixed income securities (Table 3). Government and corporate bonds constituted more than 85 percent of the investments of P&C FRIs for the last five years. In addition, almost the entire debt security portfolio was invested in Canadian debt securities. They have negligible exposures to the real estate sector.

Table 3.

Composition of Assets—P&C FRIs

(Legal Entities)

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Source: OSFI

24. While L&H FRIs have negligible off-balance sheet activities, some P&C FRIs are active in securities lending. L&H FRIs engaging in securities lending to generate fee income generally hold collateral with market values that exceed the value of securities lent. They also engage in limited amounts of repurchase and reverse repurchase transactions. With the bulk of their investments held in securities, 27 P&C FRIs are active in securities lending and a total of Can$2.4 billion of securities were lent in 2012. A small number of P&C FRIs use derivatives in hedging programs. Canadian P&C FRIs have not participated in insurance linked securities (ILS). However, some parent entities have participated in the ILS market for Canadian perils but the Canadian FRIs are not taking credit on the balance sheet for these ILS.

25. Asset transfers between parent banks and insurance subsidiaries (both L&H and P&C) are permitted for capital management purposes. OSFI monitors these transactions to ensure that these are consistent with the capital framework. Some bank-owned FRIs invest in bank parent-originated National Housing Act Mortgage-Backed Securities. This program is overseen by CMHC and the pool of assets is guaranteed by CMHC.19 While P&C FRIs reported negligible intra-group balances as at end-2012, the L&H FRIs held Can$85.6 billion in intra-group assets.

26. L&H FRIs have been increasing their technical provisions, despite the steady decline in premium revenue while the technical provisions for P&C FRIs remain stable (Tables 4 and 5). The significant increase in technical provisions (26 percent excluding segregated funds) in 2011 was mainly due to the adoption of IFRS requiring technical provisions to be reported on a gross basis, and from a rapid decline in fixed income yields. Non-participating policies20 account for the bulk of the technical provisions for traditional policies. The amounts reported under segregated fund policies reflect the assets deposited in the segregated funds, while some Can$10 billion in provisions for the embedded guarantees are included as technical provisions for non-participating policies. Given recent market volatilities, OSFI has been closely monitoring the adequacy of technical provisions for the segregated fund portfolios.

Operating performance and solvency position

27. The demand for L&H products has been affected by developments in the financial markets (Table 6). Notably, the market share of annuities products, the bulk of which are segregated fund policies, has declined from 61 percent in 2010 to 52 percent. Only group business recorded a 21 percent increase in premium volume (to Can$2.6 billion) while individual business remained steady at around Can$ 1.7 billion. New product initiatives for the last five years have featured price increases and the removal or weakening of guarantees. Product re-designs have resulted in a transfer of investment risks from insurers to policyholders, and some FRIs have attempted to re-establish participating insurance as a major product line, albeit with limited success. In the absence of growth, profitability of L&H FRIs has been declining, compounded by the protracted low interest rate climate. In addition to the impact on their investment performance, the record low interest rate level also resulted in the need to increase insurers’ technical provisions, with significant impact on their profitability.

Table 4.

Trend in Technical Provisions—L&H FRIs

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Prior to 2011, “in Canada” data was not collected for conglomerates.

Source: OSFI
Table 5.

Trend in Technical Provisions—P&C FRIs

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Source: OSFI
Table 6.

Gross Premiums by Major Lines of Business in 2012—L&H FRIs

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Source: OSFI

28. The P&C industry writes almost exclusively domestic risks; with motor insurance as the dominant line of business (Table 7). Growth has been modest; gross written premiums rose by 10 percent in 2012 (Can$39.7 billion in 2011) after a slight drop of 3 percent in 2011. Ontario automobile insurance is the single largest P&C product, accounting for about 25 percent of the premiums of the P&C industry. While operating results have been favorable, declining investment returns has motivated a refocus on underwriting discipline. In 2011, the overall results for automobile insurance improved, largely due to reforms introduced in Ontario in September 2010, partly offset by higher third party liability claims. In addition, extreme weather and natural catastrophes had dampened results as the industry experienced its third straight year of catastrophe-related insurance claims above Can$1 billion.

Table 7.

Premiums by Major Lines of Business in 2012—P&C FRIs

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Source: OSFI

29. The state-owned Canada Mortgage and Housing Corporation (CMHC)22 is currently one of the largest FIs in Canada. In Canada, federally regulated lenders are required to insure residential mortgage loans with loan-to-value (LTV) ratio of greater than 80 percent against default by either the CMHC or by a private mortgage insurer.23 Non-federally regulated lenders may choose to insure residential mortgages through CMHC or the other private mortgage insurers in order to access CMHC securitization programs. The mortgage insurance market has insured loans in-force of Can$730 billion with a written premium of Can$2.2 billion in 2012 and is dominated by CMHC (about 70 percent market share) and Genworth Financial Mortgage Insurance Company Canada (25 percent). Canada Guaranty Mortgage Insurance Company also underwrites mortgage insurance in Canada. With the increase in home ownership and rising housing prices, CMHC’s assets increased more than twelve-fold between 2000 and 2010. CMHC is the only insurer permitted to insure commercial mortgages. The federal government guarantees 90 percent of a private insurer’s residential mortgage loans in the event of insolvency. The federal government requires CMHC and the two private mortgage insurers to observe specific underwriting parameters. The private mortgage insurers are subject to OSFI’s prudential regulation. The National Housing Act establishes authorities for OSFI to examine and report on CMHC’s commercial operations to determine whether CMHC is carrying on its activities in a safe and sound manner and to access CMHC’s books and records. As CMHC is a Crown corporation, OSFI does not have legal authorities to take enforcement actions in the case of CMHC. OSFI is required to report the results of its examinations, including any recommendations, to the CMHC’s responsible Minister, the Minister of Finance and CMHC’s board of directors at least once per year.24

30. The solvency position of L&H industry has been eroded since 2010 while the overall solvency of P&C industry has remained stable (Table 8). The solvency regimes applicable to L&H and P&C FRIs are different, including the solvency control levels (described in ICP 17). All L&H and P&C FRIs meet the minimum ratios of 120 percent and 100 percent, respectively. OSFI’s has set a supervisory target of 150 percent for both classes of FRIs. The capital resources of fraternal benefit societies are well above the supervisory target of OSFI, as they have no external access to capital, either through equity investment or debt issuance.25 The two largest fraternal benefit societies constitute approximately 90 percent of the fraternal industry, both have high capital ratios.

Table 8.

Solvency Position of FRIs

(End-period)

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Source: OSFI

Key risks and vulnerabilities

31. L&H FRIs are exposed to protracted low interest rates, volatile equity markets and slow economic growth. Given the long term nature of L&H liabilities, FRIs who did not have adequate asset-liability management are vulnerable to the reinvestment risks arising from their legacy portfolios. As part of their de-risking efforts, some FRIs have withdrawn from certain products or redesigned their product features. Increased capital requirements for segregated fund products and enhanced supervisory monitoring have also played a role in influencing product design and pricing. Generally, pricing has also been raised to better reflect risks, which may create opportunities for new entrants into the market. Slow economic growth may also influence policyholders’ behavior adversely. However, policy surrenders have fallen due to rising premium levels (which increased the cost of policy replacement) and limited options for alternative investments. Wealth management products are seen as a growth area as insurers shift investment risks to policyholders, with more focus on fee-based income.

32. P&C FRIs have to confront difficult investment market conditions and exposures to significant natural catastrophe. The 2012 OSFI standardized stress test on earthquake identified insured losses of up to $32 billion depending on the scenario.27 As the population grows in vulnerable areas, insured exposures have grown. Severe weather related claims have grown, approaching or exceeding $1 billion annually since 2009.28 Rate increases in property insurance have kept pace and loss ratios have been declining since 2009. Further, with a large number of foreign owned P&C FRIs, there are potential contagion risks from their related entities and parents.

33. Mortgage insurers are exposed to potential tail events that are inherently correlated to the housing market and macro-economic risks. It is generally recognized that mortgage insurers are more sensitive to mortgage defaults than the originating lenders because they bear substantially the losses arising from loan foreclosures, which would be amplified in a severe economic downturn or sharp decline in housing prices. As part of their credit risk management, mortgage insurers generally require that a borrower’s gross debt service-to-income ratio to be lower than 32 percent and total debt service not exceeding 40 percent of gross household income.29

D. Preconditions for Effective Insurance Supervision

Sound and sustainable macroeconomic and financial sector policies

34. Canada has a well-established framework of fiscal, monetary and other macroeconomic policies. The Government of Canada prepares and publishes an annual federal government budget within the context of a medium term fiscal strategy, which is currently to return to balanced budgets by 2015-6. It publishes a debt issuance strategy and a program for debt issues. The Bank of Canada has a monetary policy strategy based on inflation targeting, flexibly applied to take account of prevailing monetary and financial conditions, including at present the deleveraging of the banking sector in response to the financial crisis. The current target is an annual rate of 2 percent.

35. There is a comprehensive financial sector policy framework, which reflects a division of responsibility between federal and provincial authorities (Section C above). Financial sector policy and legislation are subject to regular review. All financial sector legislation includes provisions requiring review and renewal five years from enactment. Recent legislative changes have included the extension of OSFI’s responsibilities in 2012 to include reviewing and monitoring the safety and soundness of the commercial activities of CMHC, and reporting supervisory recommendations to CMHC’s responsible Minister, the Minister of Finance and CMHC’s board of directors.

A well-developed public infrastructure

36. The courts system and other legal infrastructure in Canada are highly developed and the independence of the judiciary is respected. There is a comprehensive body of business laws, including on insolvency and on contractual and property rights. All legislation must be passed by the Federal Parliament or provincial legislative assembly. The Constitution recognizes a strict separation at federal and provincial levels between the judiciary, parliament and government. The principle of judicial independence, i.e., freedom from legislative or executive interference, is secured in practice through provisions in law or in practice for security of tenure, financial security and administrative independence.

37. Canadian accounting and auditing standards are in line with international best practices. Accounting standards are made by the Accounting Standards Board (ASB), drawing on International Financial Reporting Standards (IFRS), which have applied to Canadian “publicly accountable profit-oriented enterprises” since the start of 2011. The ASB is involved in the International Accounting Standards Board’s standard-setting process. The Canadian Auditing and Assurance Standards Board (AASB) establishes auditing standards based on International Standards on Auditing. Oversight of the two bodies (including nomination of members) is undertaken on a public interest basis by bodies established by the Canadian Institute of Chartered Accountants (CICA): the Accounting Standards Oversight Council and the Auditing and Assurance Standards Oversight Council. CICA is a self-regulatory professional body. The Canadian Public Accountability Board (CPAB), established by CICA, OSFI and provincial securities regulators, oversees the quality of audit work of the larger auditing firms on the public financial statements of Canadian companies. CPAB is a member of the International Forum of Independent Audit Regulators.

38. There is a well-established framework of actuarial standards. The Actuarial Standards Board issues technical standards (Standards of Practice). The Canadian Institute of Actuaries (CIA) issues and enforces professional and ethical standards for its members. It had around 3,900 Fellows and 600 Associate members at June 2013. Only Fellows of the CIA who meet the additional requirements in OSFI guidelines are qualified to sign actuarial reports required by OSFI. The CIA is a self-regulatory professional body that is not subject to oversight. Its Rules of Professional Conduct are aimed at maintaining the quality, integrity, and professional standards of practicing actuaries and it has also established an internal disciplinary process. Disciplinary actions taken are published on the CIA’s website. Since 1992, it has received 173 complaints about members, undertaken investigations of 73 of these, of which 39 gave rise to charges being filed and 23 in Disciplinary Tribunal hearings. All but two cases led to findings of guilt. Some of the complaints were referred by foreign professional bodies.

39. A wide range of statistics is available to support insurance business and effective regulation. Social and economic statistics and data on the markets are issued by the Statistics of Canada and the BoC. Statistics on insurance risks such as mortality/longevity are issued by the CIA. OSFI makes available through its website and by arrangements with a third party database service extensive information based on the regulatory reporting of financial institutions that it regulates.

Effective market discipline in financial markets

40. Canada has well-developed arrangements promoting market discipline. General corporate governance requirements are set out in Canadian federal and provincial corporate statutes, including the Canada Business Corporations Act. The statutes prescribe certain requirements in respect of the structure of the board of directors, basic qualifications of directors and requirements for a minimum number of independent directors. Securities laws set out other requirements in relation to companies issuing securities, including requirements for disclosure of governance arrangements. The Toronto Stock Exchange sets governance and disclosure requirements as conditions of listing. Financial analysis is widely available from media, rating agencies, brokers etc. OSFI sets disclosure requirements on FRIs (ICP20).

Mechanisms for consumer protection

41. There is a variety of mechanisms for consumer protection, with CoB regulation undertaken by provincial authorities. Policyholder protection is effected through: market conduct requirements, complaints adjudication services; and the availability of policyholder compensation. There are national services for adjudicating on complaints against insurance companies (General Insurance OmbudService and the OmbudService for L&H insurance). There are also provincial mechanisms, some of which are outlined in this report in the assessment of ICP 19.

42. Policyholder compensation schemes cover all relevant policyholders of companies incorporated federally or by a provincial authority. For L&H insurance, the private not for profit body Assuris provides compensation in case of failure (defined as the issuance of a winding-up order). OSFI and provincial regulators require all insurers (excluding fraternal benefit societies) to be members of Assuris, which may levy assessments on the membership in case of a failure; it is also prefunded with $115 million. Assuris has powers to support a failing company ahead of failure and, with certain constraints, to transfer business to other insurers. Benefits are capped, for example at the greater of 85 percent or $200,000 for death benefits. In the P&C sector, membership of the compensation body Property and Casualty Insurance Compensation Corporation (PACICC) is required by provincial supervisory authorities rather than by OSFI as a condition of licensing. Compensation is subject to limits (for example, $300,000 for personal property). Federal Government powers to provide financial support to institutions in order to preserve financial stability apply to insurers.30

Efficient financial markets

43. Canadian markets offer a broad range of instruments to facilitate insurers’ asset-liability management. The Toronto stock exchange is the largest of several exchanges in Canada, and ranks amongst the top 10 global exchanges by daily turnover and total; market capitalization (US$2,010 billion at end-May 2013). There are liquid money and bond markets, with a range of instruments and maturities and active markets in derivatives. Insurers also have access to investments issued outside Canada. The payment and settlement systems infrastructure is comprehensive and are subject to oversight by the Minister, the BoC (in the case of the five systems designated as systemic) and provincial regulatory authorities (securities and derivatives).

Table 9.

Summary of Compliance with the ICPs

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E. Recommendations and Authorities’ Response

Table 10.

Summary of Observance Level

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Table 11.

Recommendations to Improve Observance of the ICPs

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Authorities’ responses to the assessment

44. The Canadian authorities wish to express their appreciation to the IMF and its assessment team for their assessment of the Canadian insurance sector. The Canadian authorities share the view that Canada has a high level of observance with the Insurance Core Principles (ICPs).

45. Canada is highly committed to the FSAP process and the insights that the IMF can provide with respect to a country’s financial sector through this process. Canada fully agrees that it is important to continually review and seek to improve the regulatory framework and supervision practices.

46. The IMF has made a number of observations and recommendations, which could further enhance the high degree of compliance with the ICPs.

47. These recommendations will be given consideration by the relevant federal and provincial authorities, having due regard to the various initiatives currently planned or underway, and taking into account the features of the Canadian regime that contributed to the performance of the Canadian insurance system during and post-crisis. It is noted that some recommendations are within the scope and mandate of regulators and others are subject to decisions by different levels of government.

48. Of note, are the recommendations from the IMF on Principle 23 (but carried throughout the assessment) related to group-wide supervision, which advises that there be a legislated definition of the scope of group-wide supervision, and that authorities empower supervisors to take necessary remedial and enforcement measures at the level of the holding company, in line with emerging best practices. For future assessments, the IMF may wish to consider bringing more clarity to the basis on which this principle is assessed, given that the ICP and the related standards appear to accept indirect authority over insurance groups, as opposed to direct legislated authority, as the current international standard. We also note that the principle itself is under review internationally.

49. The introduction of ICPs dealing with market conduct issues is relatively new. As a result there is a learning curve to understand how the IMF contemplates that specific standards should be implemented. As the ICPs and assessment techniques evolve, it will be important to balance consideration of process with consideration of outcomes achieved. Past experience has not demonstrated a history of significant unaddressed market conduct problems in Canada.

Detailed Assessment

Table 12.

Detailed Assessment of Observance of the ICPs

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