Cambridge, Ontario June 1, 2011 CHECK AGAINST DELIVERY. For additional information contact:

Transcription

1 Remarks by Superintendent Julie Dickson Office of the Superintendent of Financial Institutions Canada (OSFI) to the 2011 Property and Casualty Insurance Industry Forum Cambridge, Ontario June 1, 2011 CHECK AGAINST DELIVERY For additional information contact: Brock Kruger Communications and Consultations

2 Remarks by Superintendent Julie Dickson Office of the Superintendent of Financial Institutions Canada (OSFI) to the 2011 Property and Casualty Insurance Industry Forum Cambridge, Ontario June 1, 2011 Introduction Thank you for inviting me to speak here again this year. I look forward to speaking at this conference and was sorry to have missed last year. Some significant changes and events have taken place since the last time I spoke here. These have all offered opportunities to learn and to improve our understanding and management of risk. Tonight I am going to briefly review the results for 2010 and then discuss key areas of risk and capital. The Bigger Picture But first let me say a few words about the recent financial crisis and its implications. OSFI and our counterparts around the world are attempting to identify and apply the lessons learned from the financial crisis. These lessons are being used to strengthen supervisory regimes and craft regulatory policies to help avoid a future financial crisis and to limit the spread and impact if one does happen. We are receiving significant and helpful input from financial institutions as we do this work. I have said before that I think the crisis has lessons for all financial institution sectors, even P&C, even though the epicenter of the crisis was not in the P&C sector. Now before you get nervous, let me be clear. We understand the substantial differences which separate the insurance sector from the banking sector, and the life sector from the P&C sector. For example, insurance companies in general do not engage in the types of highly leveraged and interconnected activities that caused the recent crisis. You enjoy steady policyholder demand for your products. Policyholders cannot immediately demand payments, which means there can be no run on the bank. While reading the 2009 report from the Insurance Bureau of Canada (IBC), I took note of the argument that P&C insurance is the oxygen of our economy. Without oxygen, nothing thrives. You clearly see the interconnectedness of what you do and the rest of the Canadian economy. As the report noted, homebuilders depend on insurance. Banks that lend money for mortgages need it. Businesses 1

3 need insurance to thrive. To quote the report, without insurance, life as we know it would be impossible. 1 So even if P&C companies may be very different from banks in terms of the risks and the consequences for the financial system should something go wrong, the P&C sector is incredibly important. That is why OSFI takes lessons learned from the financial crisis primarily a banking crisis and looks to see whether it makes sense to apply such lessons in other sectors, such as P&C. It is also why we are of the view that the bar for insurance regulation and supervision needs to be raised globally. We have no international agreement on key aspects of regulation in this sector such as a common capital standard. We have not even agreed that full consolidated supervision is required. These are things that we continue to push for globally. Review of the P&C Industry in 2010 Now let me turn to the industry s performance in The industry reported $2.4 billion in net income consistent with the net incomes reported in 2009 and Investment income continues to be the main driver of net income and generated $3.6 billion in earnings, while underwriting income remained largely break-even. In 2010, the combined ratio remained steady at 101 per cent also consistent with the results in 2008 and The major underwriting challenge continues to reside with personal auto in particular Ontario Automobile insurance (Ontario- Auto), which I will speak to later. Industry return on equity was 6.8 per cent, a reduction from 7.6 per cent in While the overall return on equity has not fallen to the levels at the low end of the cycle in 2002 (1.4%), they are well down from the levels reported in 2006 (20.3%), and from an average of 10.5 per cent for the past 10 years. Although several Federally Regulated Financial Institutions (FRFIs) have shown excellent results, industry Returns on Equity could be higher with continuing and improving underwriting practices and standards. From a capital perspective, the industry combined MCT/BAAT 2 ratio was per cent at year end. I will have more to say about capital later. With investment income driving results, the question is once again asked: Is an insurance company s core business picking investments, or is it providing insurance? I would suggest that underwriting insurance should be where your comparative advantage is Facts of the General Insurance Industry in Canada. Link to report: 2 The Minimum Capital Test (MCT) and the Branch Asset Adequacy Test (BAAT) are used to assess the solvency of property and casualty insurers. 2

4 All told, insurers have to be focused on improving underwriting results, not only because it is your core business, but because the prognosis for investment returns is not clear. We are encouraged by a number of events that suggest recovery, albeit a slow recovery, in underwriting results. But continued vigilance is required. Indeed, a continued low interest rate environment, would mean that investment income would contribute less to overall net income in future years. If companies are facing low investment returns and lackluster underwriting results, then the industry will be confronting two significant negatives. In speaking about a low interest rate environment, insurers should be aware that betting on the direction of interest rates with mismatched assets and liabilities is a risk that OSFI believes should be capitalized against. Auto In terms of auto insurance, uncertainty has lessened and our risk assessment is more favorable for the automobile insurance industry in general. All indications are that the real issue and uncertainty resides with Ontario auto in the Greater Toronto Area (GTA). In Ontario, while we are encouraged by larger rate increases taken by individual companies, it is absolutely critical not to let rate adequacy slip away should loss development in the coming months continue the trends of the past. It is anticipated that the reforms introduced in September 2010 will have a positive impact for deteriorating Ontario auto personal accident results, but uncertainty remains as to how these reforms will ultimately play out and the full effects may not be known until later this year at the earliest. What is clear is that the reforms alone will not restore profitability in this line of business in the near term. Rate increases, together with progress in curtailing fraudulent claims, are required if the industry is to continue to provide the services it offers Ontario drivers. While recent measures to curtail fraud are encouraging, there is no short-term solution to deal with the escalating losses residing in the GTA. Individuals, institutions, the government and the police must continue to be vigilant in curtailing fraud if they want to ensure the Ontario auto line returns to profitability. Homeowners The pricing action taken over the past two years apparently across the board to correct for weather-related exposures, the undervaluation of construction and contents costs, has moved this line into profitability in

5 Significant steps have been taken to rebalance pricing and risk but the great unknown continues to be susceptibility to weather occurrences. From the perspective of insurance companies, climate change is real. We have seen a number of domestic catastrophic events or near catastrophic events that total in the $1 billion range in each of the past two years, and this could put this line of business in unprofitable territory when coupled with the low interest rate environment. Commercial Property lines While small-to mid-size commercial property lines are profitable, the performance of large commercial lines does give us cause for concern. Market conditions have been soft in the larger lines for a number of years with premiums not keeping pace with inflation since let alone any allowance for general economic or business growth. The industry was fortunate in 2010 not to have experienced significant losses or impacts on overall results. Commercial Liability Lines Competitive pressures in selected lines (such as Errors and Omissions insurance) are a cause of concern. The gradual increase in the direct loss ratio since 2007 has put this line into marginal profitability. If the pattern of rate increases and increases in claims continues into 2011, this line will no longer be profitable. OSFI has elevated its monitoring activities to address these concerns. Risk Management Practices OSFI has been emphasizing for some time the need for the industry to look beyond obvious insurance and investment risks. We have been conducting a cross-sector review of risk management practices at some of the larger companies, and while our work is not yet complete or representative of the entire property and casualty industry, I thought that you would be interested in hearing about some of our preliminary findings. So far, our review has shown that the industry is moving in the right direction on risk management. Many of the financial institutions we reviewed have come a long way in supporting good risk management practices. Executives are assigning risk management roles to senior management, boards are increasingly providing clear mandates and objectives, and risk officers are being given the appropriate authority to carry out the mandate. There is often evidence of a good link between risk management practice and capital management processes and between other significant activities like investments and underwriting. We also found that in most cases there is regular reporting of issues to boards and senior management. These positive findings are what will create the building blocks for these companies to manage enterprise-wide risk well and not just insurance and investment risk. 4

6 Notwithstanding these positive comments, our review found that defining and communicating risk appetite and tolerance can be improved. (Let me quickly add that OSFI has found similar weaknesses in other sectors.) Risk management should be an enterprise-wide exercise and engrained in the business culture of the organization. One of the indicators of a strong risk management culture is an elevated role for the Chief Risk Officer (CRO). This role is different in many institutions; some CROs carry too many other responsibilities that may distract them from their core role, and in some cases not all risk management policies reside with the CRO. Some CROs do not have enough independence, and we found that some may not have the profile, influence or stature on the executive team that we would expect. When our work is complete, we will be sharing our findings with industry. Stress Testing By now, most of you will have seen our 2011 industry stress test, which is based on a prolonged no growth, low interest rate environment. This is similar to the experience in Japan over the last 20 plus years. In such an environment, certain classes of business, such as disability and property, would likely experience higher losses, so an underwriting profit is absolutely critical as there would be virtually no investment income. As well, in the scenario of no growth in the real economy, the overall insurance market would be unlikely to grow and could even shrink. This would likely put pressure on expense ratios and could result in a rate decline as companies compete for market share. The stress test scenario also included the occurrence of three small catastrophes over a five-year period, reflecting the increase in the number of natural catastrophes over the last few years. These scenarios were designed to test the retention of insurers rather than the maximum limits of their catastrophe reinsurance treaties. Last year, we received a number of comments on the short time frame that was provided to complete the stress test. So this year we have given companies a full two months to respond. In addition, to assist you in your resource planning, we want to make it clear that OSFI will be requiring companies to provide results on a common stress test on an annual basis. Catastrophes Recent events in Japan, New Zealand, Chile and Haiti have certainly focused the world s attention on the risk of earthquake. 5

7 These catastrophes remind us that Canada is not immune to earthquake risk and experts believe that major earthquakes are likely to occur in Quebec, some parts of Ontario and British Columbia at some points during the next 40 years. One aspect of earthquake preparation concerns the ability of P&C companies that have sold earthquake insurance to meet their obligations to policyholders should such an event take place. In 1998, OSFI published Guideline B-9 on earthquake risk. We believe this guideline has resulted in most Canadian insurance companies being much better prepared for the financial consequences of a major earthquake than they were prior to the introduction of the guideline. Still, there are a number of areas where companies could improve risk management for earthquake exposure. OSFI has been discussing improvements to the guideline with the IBC and industry representatives. Later this year we expect to issue a revised draft guideline for industry comment. The proposed changes will be evolutionary rather than revolutionary. This statement is substantiated by the fact that many companies have already instituted risk management practices that will be incorporated into the new guideline. These include companies requiring stronger risk management at the board level, demonstrating better understanding of model risks, improving the quality of data, and broadening the range of exposures and costs. Review of Capital Requirements OSFI regularly reviews the Minimum Capital Test (MCT) to ensure it continues to accurately reflect industry risks. We have been consulting with the industry to improve the capital test to make it more risk based. We released a revised draft MCT guideline on May 10, 2011, for comment by June 24. This is likely to impact companies differently based on their risk profile. We did not enter into this exercise with the view that capital for the industry is inadequate. The overall objective is to better align risks and the capital required. The draft guideline reflects a reassessment of some risk margins (interest rate, credit), with better incentives to look at both sides of the balance sheet before investing. In the future, we will reassess other margins, for example, unpaid claims. This process may take longer than some in the industry would like or be too fast for others, but OSFI s approach to these reforms must deal with the entire industry and not just individual companies. Our objective is to ensure that we are making meaningful changes in a timeframe that allows for the industry to adjust, while not falling behind international developments. 6

8 As we reassess the risk margins, OSFI will also be developing expectations for the process used by insurers to assess their own capital adequacy, and providing further clarification for the setting of internal capital levels. Conclusion Having a strong, profitable and innovative insurance sector is critical to Canadians. We are encouraged by the risk management measures companies are taking, but the bar must continue to rise. The external environment which can drive investment results is subject to much uncertainty. Continuing soft markets in the large commercial lines, unfolding developments in Ontario auto insurance reforms, and recent escalating trends in catastrophic events demand that companies stay ahead of the curve and maintain underwriting discipline. Companies can be harmed by the same old things inadequate pricing, rapid growth, insufficient capital and under-reserving as well as by some new dangers over-reliance on models and changing weather/catastrophic patterns. Both types of threats are always present. Dealing with these risks is important given the important role of P&C companies in the economy. Thank you. 7