Chapter 5 - Regulation in the Insurance Industry

Introduction

Consumer protection is at the heart of all government regulation. Therefore, the focus of insurance regulation is solvency, market conduct of insurance companies, and affordability and availability of insurance. Affordability and availability are of particular concern for mandated products such as automobile insurance. This section outlines why the insurance industry is so heavily regulated and how this benefits the insured.

Good Corporate Governance

The insurance industry must both comply with government legislation and practise good corporate governance. Certain regulations create arduous processes for insurers: Management must spend valuable time and resources meeting immediate regulatory requirements rather than focusing on projects that will produce more durable success for the corporation. Too much emphasis on rules and regulations can stifle entrepreneurial activity and good management practices.

An unintended consequence of regulatory compliance is its disproportionate effect on smaller companies that do not have the scope of resources to draw from that larger companies have. Regulators have said that they must seek a balance between principles and rules. A regulator that enforces too many rules may lose sight of concerns that really matter. It is encouraging to see that regulatory authorities within Canada have considered or may be considering a change from a prescriptive rules-based regulatory approach to a principles-based regulatory approach. A principles-based regulatory approach is based on broadly stated, high-level principles, rather than detailed rules of compliance.

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The Insurance Bureau of Canada (IBC) is a national industry association representing the vast majority of Canada’s home, car, and business insurance companies, and it works to coordinate efforts to deal with regulatory pressures. The IBC liaises with government, industry-related bodies, and other associations to identify regulatory issues. One goal of the IBC is to secure legislative efficiency and harmonization and to promote self-regulation when possible for the insurance industry. It analyzes relevant federal legislation and provincial/territorial legislation with national implications. It also develops industry positions, briefs, and responses to regulatory issues.

Globalization and Regulation

The effects of globalization are also felt at the regulatory level and thus it is prudent to understand how regulation is handled internationally. The IBC maintains relationships with relevant foreign and international regulatory bodies, including the National Association of Insurance Commissioners (the US standard-setting organization and regulatory support organization) and the International Association of Insurance Supervisors. The International Association of Insurance Supervisors has given attention to worldwide convergence of solvency regulation. It has turned its attention to finding a common structure and common standards for solvency assessment. The insurance industry can better position itself if it understands how its legislation may be influenced by international initiatives.

A Made-in-Canada Issue

In Canada’s federal, provincial, and territorial mix of legislation, when rules impose conflicting requirements or overlapping requirements or requirements that change among the provinces and territories, it becomes confusing and costly for the insurance industry. Because the provinces and territories have so many individual needs, the luxury of uniform legislation has not been feasible. Harmonization, an exercise requiring skill and finesse, is the approach that allows provinces and territories to maintain their individuality while still providing a common base of operation for the country.

Not all regulation causes adverse effects. But all regulation typically causes an insurance company’s management to pause and review its current position, the direction it had been pursuing under the former regulations, and the direction it should now pursue because of changed regulations. Insurance capital does not recognize national or provincial/territorial borders. It flows to where it can see the best returns. The cost of working within a particular regulatory environment can be more or less attractive to insurance capital; this needs to be a consideration of governments and their regulatory regimes.

A Risk-Based Regulatory Model

There has been widespread movement on a global scale by insurance regulators to advance a principle- or risk-based regulatory model. This approach to regulatory legislation and supervision contemplates that regulators will work with insurance companies to have them ultimately solve their own problems.

The risk-based model of insurance regulation starts with a healthy insurance market, where consumers’ needs are met by products that are readily available and affordably priced and where both insureds and claimants are treated fairly according to societal expectations.

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Changing the communication model between regulator and insurance company is a focus of risk-based supervision. Governments must clearly state their goals and key policy objectives to the insurance industry. Everyone should understand the framework of regulation and how it is to be applied. In this way, insurance companies can align themselves to meet those goals and still compete within the framework. Key objectives of risk-based regulatory models include the following:

• Informed and empowered consumers

• Timely and fair claims management

• Meaningful choice for insurance consumers

• Low system costs

• Market stability

Risk-based regulation and supervision also aims to moderate the insurance premium rate cycle. Governments have gained instant political credibility by imposing price freezes on insurance rates—but at the expense of long-term market stability. Price regulation that delays market pricing tends to worsen the effect of the insurance premium rate cycle on consumers. In a risk-based system, regulators evaluate the actual goal of consumers: a stable marketplace where consumers are treated fairly. See In Practice—Government Actions on Automobile Insurance.

In Practice

Government Actions on Automobile Insurance

When the COVID-19 pandemic began in early 2020, driving behaviour changed overnight. At some points of the pandemic, many people were driving less or not at all. This had a positive impact on the short-term performance of automobile insurers, as less driving resulted in fewer claims. Several governments worldwide responded to this new driving reality by requiring automobile insurers to rebate premiums collected to customers. The post-pandemic return to more typical driving patterns, combined with supply chain and inflation pressures, resulted in more negative impacts on insurers’ performance. Certain governments, including Alberta and California, froze automobile insurance rates for many consumers (Alberta in 2023 and California in 2020).

Previously, in the late 1980s, the Ontario government froze automobile rate increases. Premium growth deteriorated as claims costs increased, causing a significant gap between income and costs. This put extra pressure on the Facility Association
 and resulted in the placement of thousands of drivers into the pool who perhaps did not really belong there.

Such government actions as these have forced many insurers to re-assess their ability to provide automobile insurance while still being able to maintain solvency requirements.

The risk-based model considers the effect that a company failure would have on consumers and the economy. Very large and very small insurance companies would have different effects on the financial system and on policyholders—with correspondingly different political implications. Example—Regulation in Industry illustrates this in practice.

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Example—Regulation in Industry

An automotive company sets up a small insurance company to deal with its own executive automobiles. The insurance regulator considers the position of this company within the larger context of the industry as a whole. The insurance company, if it fails, will only affect a few people and it will not create much political upheaval, nor will it represent a systemic problem within the insurance industry.

The risk-based model operates on the theory that different insurers face different risks depending on the nature of their book of business, their growth rate, their investment management philosophy, and a number of other factors. Therefore, the amount of capital required to support those risks should be based on the rating of the level of risk attached to all risk factors rather than on an arbitrary basis such as the premium-to-surplus ratio.

Regulators operate under the typical constraints that any business has—they must operate within a budget and according to a business plan. Although the government has initiated charge-back systems to the insurance industry for certain functions, the regulator’s resources are concentrated on riskier institutions whose practices are likely to materially affect their existence and whose demise would have a greater impact.

Information for Regulators

Using the risk-based approach, regulators monitor and analyze key indicators to exercise appropriate stewardship over the system as a whole.

Regulators develop information about the insurance business and its business practices to understand what creates difficulty for companies. Regulators consider a company’s significant activities, such as the lines of business written and the risks inherent to such business. Is writing such business a high or low risk? Business functions, such as underwriting and claims settlement, are reviewed to determine whether risks are being mitigated. Can the organization’s internal controls and corporate governance be relied upon? Business processes such as information technology must be reviewed in the context of the particular business. The insurance company’s approach to risk management activities is considered and includes a review of its reinsurance arrangements.

Regulators monitor the following information:

• Reliable statistics on the frequency and severity of claims

• Trends in loss cost developments

• Average length of time that a claim is open

• Incidence and cost of fraudulent and other illegal activity

• Changes in average private passenger premiums

• The Consumer Price Index (CPI)

• Strategic planning effectiveness to respond to changing consumer needs

• Technology roadmap including data security

• Premiums for specific demographic profiles

• Insurance costs as a percentage of the total costs of running an automobile and of disposable income

• Reinsurance costs as a percentage of premium

• Profit or loss from a residual market mechanism (like the Facility Association), if applicable

• Capital bases of insurers operating in the province or territory and other financial diagnostics

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Inadequate premium rates inevitably affect profitability. Eventually regulatory capital requirements will falter if rates are not corrected. Sometimes a dynamic tension arises between the federal solvency regulator with an agenda to raise rates and the provincial or territorial regulator more concerned with reduced or stable pricing.

The availability of sound statistical data and good communication with regulators can improve a potentially adversarial regulatory process and make it less costly. The General Insurance Statistical Agency (GISA) is a not-for-profit organization named by regulators as the statistical agent for participating regulators. GISA contracts with IBC to collect data from insurers and compile exhibits. Costs are recovered through assessments to insurers and charging deficiency fees.

Jurisdictional Scope of Regulation

The Office of the Superintendent of Financial Institutions (OSFI) is the federal regulator responsible for monitoring the solvency of federally incorporated insurers as well as Canadian branches of foreign-owned insurers. Each federally incorporated insurer must be licensed to operate in each province and territory where it writes business, as well as being licensed for each class in which business is written.

Insurers can choose to register with the provincial/territorial or federal regulators. Either level of regulator may grant a licence to an insurer, but the level the insurer chooses to register with affects how it can operate. The federal regulator is responsible for regulating the solvency of federally chartered insurers, and the provincial and territorial regulators share this responsibility for insurers registered in their particular jurisdiction. Because most premium volume is written by federally regulated insurers, provincial and territorial governments rely on the federal regulator to perform solvency reviews.

Reinsurers are regulated less closely than primary insurers because regulators emphasize protection of the consumer. Reinsurers sell to primary insurers—that is, other insurance companies—which are presumed to be sophisticated buyers and able to protect their own interests. Reinsurers are not required to be licensed to operate in Canada. However, federal legislation places certain limitations on the percentage of an insurer’s risks that can be placed with an unregistered reinsurer in Canada. This affects an insurer’s legislative requirements regarding its minimum capital levels. If a provincially registered reinsurer chose to do business with an out-of-province insurer, the insurer would be subject to the rules governing an unregistered reinsurer.

OSFI: The Federal Regulator

The Office of the Superintendent of Financial Institutions is the primary regulator of federally chartered Canadian and foreign property and casualty (P&C) insurance companies in Canada. Its mission is to protect the interests of depositors, policyholders, pension plan members, and creditors of financial institutions from undue loss, and to advance and administer a regulatory framework that contributes to public confidence in a competitive financial system. OSFI supervises and regulates all banks and all federally incorporated or registered trust and loan companies, insurance companies, cooperative credit associations, fraternal benefit societies, and pension plans. Activities of OSFI can be divided into regulatory and supervisory functions.

• Regulatory functions include developing and interpreting legislation and regulations, issuing guidelines, and approving requests as required under the financial institutions legislation.

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Supervisory functions include assessing the safety and soundness of the institutions under its mandate. That entails evaluating a company’s risk profile, financial condition, risk management practices, and compliance with applicable laws and regulations.

To ensure that careful provision is made for the future of insurance company operations, OSFI stresses profitability, adequacy and quality of capital and earnings, adequacy of reserves for policy liabilities, adequacy of reinsurance protection, the quality of assets, and internal controls. Through its oversight, OSFI identifies potential problems early and intervenes when necessary to help an insurer overcome possible failure. OSFI performs the following activities to achieve its goals:

• Outlines its views of best practices or risk management measures

• Informs the public of items of general interest

• Publishes warnings for the financial sector

• Presents internally and externally generated consultation papers of interest to its stakeholders

• Continuously monitors insurers’ financial condition and operating performance

• Verifies compliance with statutory and other regulatory requirements

• Conducts periodic on-site examinations as required by statute

OSFI is also responsible for the following regulatory functions of financial institutions in Canada:

• Incorporating new Canadian companies

• Issuing orders to Canadian and foreign companies to carry on business

• Reviewing and assessing applications involving

  • corporate reorganization;

  • changes of ownership;

  • acquisition of other financial institutions;

  • changes in classes of insured risk; and

  • withdrawals from the Canadian insurance market.

OSFI continues to update how it regulates Canadian financial institutions and formally releases guidelines and advisories. Guidelines are best or prudent practices that OSFI expects federally regulated financial institutions to follow. The guidelines set standards for industry activities and behaviour. The P&C insurance companies then design their models and processes to satisfy the guidelines. The guidelines are categorized:

• Capital adequacy requirements

• Prudential limits and restrictions

• Accounting and disclosure

• Sound business and financial practices

As evidence of OSFI’s role as a principle- and risk-based regulator, Guideline E-19—Own Risk and Solvency Assessment became effective January 1, 2018. The assessment is known as ORSA and is designed to reflect an insurer’s self-assessment of risks proportionate to the nature, scale, and complexity of the company’s business and risk profile.

OSFI also looks at outsourcing of business activities by insurers, which may include policy administration, claims handling, accounting, and underwriting. OSFI’s concern is that an insurer’s dependence on third parties could increase the insurer’s risk profile. Insurers are asked to evaluate and provide contingencies for their outsourced activities, which include the following:

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Evaluating the risk of outsourcing

• Carrying out a due diligence study

• Creating a business continuity plan in case a third party cannot perform outsourced activities

• Establishing a process for monitoring and managing the outsourced activities

No one can guarantee that a company will not fail within the insurance community. But OSFI has set parameters to demonstrate the conditions under which a failure would be acceptable. In this context, expectations of politicians must be managed so that they are aware that an institution may fail occasionally.

Currently, OSFI assigns a relationship manager to each institution. Relationship managers get to know the people in the companies to which they have been assigned, and they get to know how these companies operate. Financial downturns can thus be identified very early to begin proactive interventions. Effective early action can contribute to confidence in the financial system, affirming to Canadians that the confidence they have in the system is warranted.

Provincial and Territorial Regulators

Exhibit—Provincial and Territorial Regulatory Authorities of the Property and Casualty Insurance Industry contains a list of departments and regulatory bodies assigned responsibility for insurance in each jurisdiction.

Each province and territory has its own insurance legislation—or, in Quebec, the Civil Code of Québec—that sets out the authority and responsibilities of the regulator. Provincial and territorial insurance legislation is mainly concerned with market conduct issues, policy wordings including statutory conditions, affordability, and availability. Much provincial and territorial legislation has resulted from lost public confidence in the insurance industry to deliver its products at reasonable rates. Not only are insurers subject to legislation but so are independent insurance adjusters, agents, and brokers.

The responsibilities of provincial and territorial insurance regulators include the following, among others:

• Approving classes of business

• Approving policy forms

• Controlling an insurer’s advertising

• Enforcing underwriting eligibility criteria

• Licensing and supervising adjusters, brokers, and agents

• Licensing insurers to operate in its jurisdiction

• Monitoring each insurer’s compliance with provincial and territorial insurance legislation

• Monitoring the solvency of provincially and territorially incorporated insurers

• Overseeing claims settlement practices

• Overseeing the electronic marketing of insurance

• Overseeing the ethical, operational, and trade practices of insurers

• Reviewing insurance contract wordings

Because insurers must be licensed for classes of insurance to be written in their province or territory, legislation allows regulators to determine if an insurer has the necessary expertise to carry on such business.

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Exhibit

Provincial and Territorial Regulatory Authorities of the Property and Casualty Insurance Industry

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Controlling an insurer’s advertising includes controlling how an insurer’s name appears in advertisements, on the policy contract, and in correspondence (usually the insurer’s name must appear as it does in its licence). The regulator also oversees insurers to ensure that advertising and other business practices are fair.

Certain policy wordings are governed by minimum standards of coverage set out in legislation. This applies to insurers but not to reinsurers. This can create awkward situations for insurers who may be left without reinsurance protection for certain exposures. For example, the property fire policy is subject to statutory minimum coverage requirements that do not permit insurers much leeway to limit fire coverage offered to consumers. However, reinsurers who are not subject to the legislation can restrict coverage on reinsurance policies.

Regulating Automobile Underwriting Rules

In some provinces and territories, rate- and product-related filing requirements are imposed on automobile insurance writers to ensure that customers are treated uniformly and therefore more fairly. When an insurer declines an applicant, does not renew a policy, or limits coverage in some way, the reasons must conform to those underwriting rules that have been filed and approved. In general, companies must comply with anti-discrimination laws and public policy. An insurer has latitude in setting its underwriting rules, but rules cannot conflict with the legal statutes governing such matters. Regulators and insurers must work together now more than ever as underwriting becomes more data-driven and more data is available through such means as usage-based insurance (UBI), telematics, Internet of Things (IoT), smart cars, driver-assisted vehicles, and ridesharing services.

Insurers must also adhere to the statutory conditions included in the provincial and territorial legislation to govern such matters between insurer and insured as, among others, cancellation for non-payment of premium or written reasons for non-renewal. Regulators have been sympathetic at times to the problems they sometimes cause insurers, especially when consumers are affected adversely. See Example—Request for Flexibility.

Example—Request for Flexibility

A review of underwriting rules by the Ontario insurance regulator resulted in an increased number of risks being transferred to the Facility Association for insurance. Insurers asked for flexibility in their filed underwriting rules so that they might write risks that had previously been declined.

The flexibility was allowed by the regulator, but all exceptions and their reasons had to be documented. A procedure was implemented to report exceptions and their reasons to the provincial regulator.

Regulating Pricing

Certain provincial governments initiated studies to review the profitability of insurance companies as well as the broad availability of coverage in non-mandatory lines of insurance to judge whether the profits realized by insurance companies are reasonable. The feasibility of initiating rate and coverage availability regulations was the goal. Such government action seems5-12heavy-handed and would probably not be tolerated by any other business sector in the economy. Government intervention in mandatory insurance products has opened the door for some governments to question profit levels of insurance overall.

Regulating the Use of AI

As more data is being collected than ever before, many insurers are scaling up their use of artificial intelligence (AI) and big data analytics (BDA) to support risk assessment, fraud prevention and detection, and process efficiency. Although the use of AI and BDA is innovative and exciting, bringing benefits to both insurers and insureds, known and unknown risks will emerge that need to be monitored and regulated. For example, AI algorithms can be biased, which can lead to unfair discrimination toward consumers. Regulators must ensure that appropriate consumer protection regulations on insurers’ use of AI and BDA is put into place.

Introduction

The insurance industry operates in a dynamic regulatory environment. In some jurisdictions the ever-changing regulations call for insurers to move quickly within their operations to ensure compliance. And inevitably, the cost of compliance is high.

Canada’s property and casualty (P&C) insurance companies must consider the needs of multiple stakeholders, the key ones being consumers, shareholders, and regulators. Changes in the regulation of insurance will likely be dictated, as they have always been, by the will of the governments involved. If the governments find that the industry is healthy and consumers are satisfied, there may be no increase in regulation. If it is unhealthy and the public dissatisfied, if insolvencies occur, or if too many insurers see a downgrade of their ratings, then regulation and supervision may be increased.

In other countries, some regulators choose a less intrusive route to serve consumers without government intervention. When an insurance company is behaving in a way that may be offensive to some consumers, the regulator discloses such behaviour to the public. Other regimes provide lists to consumers to show market practices of insurers. If an insurance company is engaging in a practice that a consumer finds offensive, the consumer has the option to boycott that company. The choice is then left with the consumer.

There may be other options to ensure that consumers are well served by the insurance industry. It is clear, however, that everyone benefits when insurance companies are well run and profitable. This section explores the scope of regulation in Canada and how this affects the insurance industry.

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Canadian Council of Insurance Regulators

Insurance issues are becoming increasingly complicated and increasingly cross-jurisdictional due to factors like globalization and technological change. The Canadian Council of Insurance Regulators (CCIR) is an association composed of regulators (officials and not ministers) from each province and territory and the federal level. The CCIR cannot enact legislation, but members can make recommendations to their respective governments on related issues. The CCIR is a means for insurance regulators to share information and find common solutions.

The CCIR’s focus is on improving the efficiency and effectiveness of the Canadian regulatory framework. Its overall goal is to simplify, coordinate, and harmonize the regulation of insurance in Canada:

The Canadian Council of Insurance Regulators is an inter-jurisdictional association of insurance regulators. The mandate of the CCIR is to facilitate and promote an efficient and effective regulatory system in Canada to serve the public interest.^[1]

Why is there a need for a body such as the CCIR? The CCIR is a Canada-wide communication tool that has successfully produced recommendations for common regulatory standards, developed positions on regulatory issues, given advice to policymakers in member jurisdictions when advice is requested, and considered model legislation for governments. It has accepted and advances the notion that regulators should listen first and act second, then include all stakeholders in a cooperative effort to find workable solutions.

The differences in legislation and regulation across the country add additional costs in compliance for those insurers that operate in more than one jurisdiction. This can be particularly challenging for insurers in smaller jurisdictions where there is less scale to absorb the additional costs of compliance. Simplification and harmonization of legislation and regulation improves the environment for insurers, ultimately reducing compliance costs.

The CCIR has been involved in

• harmonizing and streamlining licensing approvals and financial and corporate sector filings;

• fast-tracking licence approvals for insurers who are licensed in one Canadian jurisdiction and seeking authorization in another; and

• further streamlining financial and corporate filings, such as one-point filing with the primary regulator.

When an insurer must file with its various regulators in different formats, and potentially with different information required, it adds complexity, which adds cost—all of which ends up being passed down to the insurance consumer when they pay their premium.

Relationships have been reviewed between insurers and their intermediaries to ensure that consumer confidence is maintained in the insurance industry. They have used risk assessment questionnaires to examine and report on business practices. Other initiatives to reduce regulatory burden include developing a risk-based model for market conduct regulation to reduce the burden for good operators and focus regulatory attention on those who are not. The CCIR facilitated the development and adoption of the minimum capital test that established a coordinated approach to an industry practices review.

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Insurance Product Licensing

The CCIR announced a revised set of harmonized and flexible classes of insurance and definitions that would make it easier for insurers to develop and introduce new products into the marketplace.

As part of its harmonization project, the CCIR developed insurer guidelines to set out business practices to expedite the process of adding a new class of insurance to an existing licence or creating a new insurance product. These guidelines help regulators evaluate applications in a timely way and facilitate a coordinated regulatory approval from all affected jurisdictions.

The insurer must prepare a submission for regulatory approval when a new product is launched. Insurers must conform to CCIR’s insurer guidelines to support the application. An insurer must seek regulatory approval to write a new insurance product that does not fit into any of the existing classes of insurance or a product that is not included within its licensing limitations.

CCIR’s insurer guidelines include the following practices:

• The insurer should conduct a detailed analysis of its available underwriting expertise, its claims-handling capabilities, and other important functional areas to ensure that the new product can be fully supported.

• The insurer must establish appropriate controls and reporting to allow the insurer to accurately monitor the performance of the new product or class of business.

• The insurer must educate its distribution network about the new product or class.

• The insurer must prepare financial forecasts to demonstrate the viability of the product or class.

• The insurer must develop an exit strategy to minimize the effect of market dislocation.

Regulators assess whether the necessary resources and controls are in place to deliver new products to consumers. The guidelines and the involvement of regulators ensure that an insurer can support the product it intends to sell.

Insurance Company Solvency

Businesses and consumers expect financial security from financial institutions, and regulators closely monitor their solvency to ensure that this responsibility is fulfilled. A company is considered to be solvent when it is capable of honouring all its debts even if it were closed down immediately. Regulators must be satisfied that every insurer has funds that are readily available to pay its expenses and claims.

The regulator becomes much more actively involved when it identifies a problem with an insurer. Threats to an insurer’s financial viability or solvency may lead the Office of the Superintendent of Financial Institutions (OSFI) to put the company on a regulatory watch list or to meet with senior management or the external auditor to outline concerns and discuss remedial actions. Such further actions could include the following:

• Restricting business operations (that is, limiting the amount of premium written)

• Increasing the frequency and scope of on-site examinations

• Calling for additional capital to be invested in the company

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Discussing contingency plans (which could involve taking control of the company) with provincial/territorial insurance regulators and relevant compensation funds. See In Practice—Property and Casualty Insurance Compensation Corporation.

In Practice

Property and Casualty Insurance Compensation Corporation

The property and casualty (P&C) insurance industry funds a special program, approved by government regulators, to protect policyholders against the financial collapse of an insurer. The Property and Casualty Insurance Compensation Corporation (PACICC) is a non-profit organization that responds to claims of policyholders under most policies issued by P&C insurance companies when an insurer becomes insolvent.

Government also tracks insurers’ accumulations of exposure and limits written in earthquake zones such as those in Quebec, Ontario, and British Columbia. These insurers are required by OSFI to reserve against potential liabilities arising from a major earthquake. How an insurer’s earthquake exposure is reinsured is also prescribed by OSFI. Such insurers must document procedures and outline to OSFI how they plan to manage their earthquake risk (including limits of coverage) and how their financial resources cover their calculated probable maximum loss (PML).

Guidelines have been developed for tracking and managing earthquake exposures. Computer models have been developed that estimate the PML that might arise from a major earthquake. In addition, insurers must have contingency plans for such matters as claims management, emergency communication links, the availability and adequacy of claims adjusting staff, and off-site systems backup in place to handle an earthquake event.

Regulatory Assessment Measures

Regulators assess whether reported liabilities are realistic for a company’s claims, unearned premium, and other amounts owing. Regulators have established the following guidelines:

• Reserves—Premium reserves and claims reserves are subject to annual review by a qualified actuary. The premium reserve is a test of the adequacy of premium rates, and the claims reserve is a test of the adequacy of reserves held to pay outstanding claims and claims that have been incurred but not reported (IBNR).

• Receivables—The collectability of accounts receivable and reinsurance recoveries (credit risk) are reviewed. For example, regulators do not allow an insurer to treat accounts receivable outstanding for more than 65 days as assets for the purpose of calculating capital and surplus.

• Investment risk—The manner in which insurers may invest their assets is subject to regulation to ensure the safety of the capital and the appropriate level of liquidity.

Assessing Foreign Parent Companies

When assessing foreign subsidiaries or branches, or reinsurers, the financial strength of the parent and the quality and type of home country regulation are considered. In most cases, the parent companies are larger than the Canadian subsidiary; however, the regulator still reviews rating agency reports, financial reports, and news articles to determine the condition of the parent company and assess its profitability.

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Canadian regulators tend to work very closely with foreign regulators. Foreign branches must have sufficient assets to cover their liabilities. The larger the foreign branch, the more closely operational issues are reviewed.

On-Site OSFI Reviews

When OSFI conducts an on-site review, it measures an insurer’s inherent risk. It reviews, among other characteristics of the insurer, the following:

• Insurance risk—The product and its pricing are examined to determine whether the insurer’s exposure was greater than its pricing or whether there was an unhealthy trend developing in that direction.

• Underwriting of risks—The insurer’s exposure through risk selection and approval, the retention and transfer of the risk (reinsurance), and the effect of claim reserving and settlements are reviewed.

• Legal and regulatory compliance—The insurer’s legal and regulatory compliance is reviewed, including a check as to whether the insurer conforms to ethical standards.

• Dishonesty or error detection—Controls to detect dishonesty or errors in data and disaster recovery plans are reviewed.

• Other risks—OSFI provides guidance to insurers to assess their exposure to risk related to climate, cyber, and third-party risk, among others, and more recently it began reviewing insurers’ exposure to foreign interference threats and culture and behaviour risk (patterns of behaviour from employees that do not align with the insurer’s expectations and may increase financial and non-financial risk).

Regulation of Investments

Choosing investments for an insurance company is a matter for the board of directors and management. However, the types of investments insurers are permitted to hold are subject to regulation, and assets are verified to ensure that they are real and that they are worth the amount reported.

P&C insurers must establish internal policies on investment concentration for their portfolios—that is, on the extent of their investments in various sectors of the economy and types of financial instrument, such as stocks and bonds. Guideline B-1 describes that a “reasonable and prudent person” standard applies to a portfolio of investments and loans to avoid undue risk of loss and obtain a reasonable return. OSFI has issued other guidelines within its “Prudential Limits and Restriction” category to set the best and prudent standards for the insurers. This approach gives more freedom to investors but also places significant responsibility on both insurers and regulators to ensure that funds are prudently invested. Management controls in place ensure investment policies are followed.

OSFI applies limitations on real estate and equity holdings to encourage the purchase of safer, more stable products such as guaranteed investment certificates (GICs) and bonds. These more conservative investments provide lower returns to insurers, and this may affect investment returns that insurers might realize. This, in turn, can affect an insurer’s ability to make a profit to offset underwriting losses that may occur, especially in a soft market.5-17

Financial Regulatory Tests

A risk-based capital standard is used to rate the adequacy of an insurer’s capital. OSFI applies tests to the balance sheet, with emphasis on the insurer’s assets, liabilities, and capital to make its assessments.

Managing capacity is critical to a company’s success. A company can enhance its solvency and capacity by adding capital through retained earnings or the sale of shares, or it can make strategic use of reinsurance. Reinsurance is used to reduce an insurer’s liabilities by bringing net premiums written to a level that can be supported by the insurance company’s equity (capital and surplus) position.

Measuring Capacity

Regulators impose minimum capital requirements on insurers, and that limits their capacity to write business. Capacity is the function of both capital available and extent of exposure that insurers are prepared to accept.

The level of capital and surplus must be sufficient to cover expenses, commissions, premium taxes, and claims that are incurred prior to policy premiums becoming earned. The insurer must be capable of weathering bad cycles in which premium income and investment income are insufficient to cover the cost of claims and expenses.

The guidelines regulators use to measure the capacity of insurers include the following:

• The ratio of net premiums to equity (capital and surplus) is measured. For an average mixed portfolio of business, the premium-to-equity ratio might be 2.5:1. If the ratio went as high as 3:1, the regulator would be concerned.

• The maximum single exposure, being a maximum percentage of equity that can be put at risk on a single exposure, is assessed. For example, an insurer might be restricted to a net retention on a single risk of not more than 2 percent of its equity.

The percentage of reinsurance ceded on an insurer’s total portfolio business is limited by OSFI guidelines to ensure that the insurer retains a significant financial interest in the outcome of its underwriting decisions and will, therefore, operate in a responsible way.

Measuring Solvency

OSFI uses the minimum capital test ratio or MCT Ratio (formerly known as merely the minimum capital test) to measure solvency. A single harmonized asset test applies to all Canadian insurers operating in Canada, whether they are licensed federally or provincially/territorially. A similar test using MCT Ratio principles applies to branches of foreign P&C insurers. The MCT Ratio framework more closely relates capital requirements to the degree of risk that an insurance company assumes, similar to risk-based requirements for deposit-taking institutions and life insurers. This test is intended to give regulators early warning of an insurer’s potential solvency problems.

OSFI communicated with insurers to determine the amount of capital required to support insurers’ premium volumes. It discussed business risks with them and asked them to conduct “stress tests” of their financial positions in different hypothetical scenarios. That involved assessing their solvency at different premium volumes and proportions of exposure from various5-18lines of insurance, among other variables. It was ultimately up to each insurer to determine the level of capital it needed to offset the credit, market, legal, regulatory, operational, strategic, compliance, and insurance risks in its business.

The MCT Ratio requires that an insurer’s assets exceed its liabilities by a specified ratio; that ratio may be higher for some insurers than for others. Over time, as insurers’ portfolios grow or shrink and the proportions vary among different lines of insurance, some insurers may find themselves to be overcapitalized and others undercapitalized. Overcapitalized insurers have a business problem: They will want to increase their premium volume to take full advantage of the capital at their disposal. Undercapitalized insurers must restore an acceptable balance between their premium volume and the capital they have to support it. Such insurers can

• reduce their premium writings;

• take a different strategic direction on the type of business they write;

• cede more to registered reinsurers;

• reduce the capacity they provide in certain lines of business; or

• restructure their balance sheet to free up more capital.

Withdrawal from a province might be the right business choice for an organization, but insurance companies must also comply with government notice requirements for such action or perhaps face a significant fine. Even if the number of policies being issued by the insurer does not change, rate increases that increase an insurer’s premium volume affect the amount of capital the insurer needs to comply with the MCT Ratio.

When capital is scarce, it is more difficult for the insurer to accommodate certain lines of coverage. For example, an underwriter who provided high excess limits for directors and officers liability coverage may find on renewal that capacity has been cut and that underwriters are unable to offer as much coverage as before. The variation in margins the MCT Ratio requires for loss reserves might guide an insurer to pursue lines of insurance for which lower margins and less capital are required. Writing riskier business requires more capital, while writing less risky business requires less capital.

It is sound for a business to aim at a capital level that provides a cushion above minimum requirements to cope with volatility in markets and economic conditions, innovations in the industry, consolidation trends, and international development, and to provide for risks not explicitly addressed in the calculation of policy liability or the MCT Ratio. The MCT Ratio does not provide the optimum capital requirement. The insurance company, its board of directors, and the regulators decide what an individual company’s optimum capital condition should be.

Loss reserves and unearned premium reserves (known as liability for incurred claims and liability for remaining coverage under the International Financial Reporting Standard, IFRS 17) are examples of the liabilities for which such calculations are performed. The margin required to be added for loss reserves varies for different lines of insurance; it tends to be higher for lines such as liability insurance and lower for lines such as property insurance.

The variation in margins required for loss reserves might suggest that an insurer focus its marketing efforts on lines of insurance for which lower margins and less capital are required. However, other considerations affect the choice of target market: the insurer’s expertise in the line of insurance, an appropriate distribution network, and whether it is licensed to underwrite the line of business.

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Reinsurance Recoverables and Solvency

A margin is added to the MCT Ratio for the risk that the insurer may be unable to recover on purchased reinsurance. Reinsurance recoverables would be in jeopardy if the reinsurer failed or the insurer’s actuaries miscalculated loss development and the corresponding ultimate losses so that the amount of reinsurance purchased was insufficient to cover liabilities.

Insurers who use registered reinsurers have a smaller margin to add to their assets than what would be required for using an unregistered reinsurer. Thus, the difference in margin requirements between registered and unregistered reinsurers is a consideration for insurers in making their arrangements for reinsurance because it means a difference in the amount of capital an insurer must set aside to cover the risk of non-recoverable reinsurance. That difference in capital affects how much premium the insurer’s capital supports.

Financial Consumer Agency of Canada

The performance of the insurance industry is also judged according to how it treats consumers. The Financial Consumer Agency of Canada (FCAC) is an independent body established by the federal government to oversee consumer issues and expand consumer education in the financial sector. The FCAC promotes a greater awareness of the financial system and the rights and responsibilities of consumers. It helps consumers become more informed about financial products and services. It operates on a risk-based compliance framework.

The FCAC performs the following activities:

• Supervises financial institutions to determine whether they are in compliance with the consumer provisions applicable to them

• Promotes the adoption by financial institutions of policies and procedures to implement consumer provisions applicable to them

• Monitors financial institutions’ publicly available voluntary codes of conduct designed to protect the interests of customers and any public commitments made by financial institutions to protect customer interests

• Promotes consumer awareness about the obligations of financial institutions under the consumer provisions applicable to them

• Fosters understanding of financial services in cooperation with any other relevant organization

The FCAC’s mission is to improve Canada’s financial marketplace by doing the following:

• Supervising financial institutions efficiently and effectively with respect to fulfilling their obligations to consumers

• Providing information to consumers to enable them to understand their rights and to make informed financial decisions

The FCAC is funded by the financial institutions it regulates. It cooperates with other organizations, creates information programs, and operates a consumer help line to achieve its ends.

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Privacy Regulation

All businesses are subject to the federal privacy law—the Personal Information Protection and Electronic Documents Act (PIPEDA)
. Some provinces and territories have enacted their own privacy laws that also affect how information is gathered and released.

The full effect of privacy legislation is still not known in the claims and underwriting environments with respect to access to insurers’ files and what information can be exchanged between insurers. Concerns and questions have been raised regarding access to an adjuster’s notes in a claims file. Do notes constitute personal information? Are file management strategies confidential commercial information, and are opinions expressed in claims files considered work product (or information that can be prepared for litigation) to be protected? Traditionally such information in a claims file has been considered to be privileged information and subject to the benefits of privilege bestowed by the courts.

There is no doubt that competing interests are at play, and it is important that balanced judgments be made with respect to privacy. The mechanics of what constitutes access have also been questioned. Can an insured be told what is in a file, or must copies of documents be made available? Files with a substantial volume of materials could create significant expense for insurers who are required to copy everything. Consumers have raised privacy complaints against insurers, brokers, and other players within the industry, voicing the following issues:

• Requests for access

• Use and disclosure of information

• Collection without consent

• Wording of companies’ consents

One area of contention involves access to statements taken from third parties during the course of a claims investigation. Should the insured have access to these statements? If the statements are provided to the insured, then adjusters should advise people from whom they take statements that the information in their statements could be the subject of an access request.

Privacy consent forms should include sufficient information about disclosure to industry databases. Other issues that have been raised include various definitions of what constitutes personal information, work product, access, and agents, and whether the transfer of information is as a user or as disclosure. Access requests during the claims process, including during litigation, have raised some concern that PIPEDA is being used by plaintiff lawyers to exploit the vulnerability of insurers during litigation. Other issues that have been broached include retention periods for information, implied consent, and withdrawal of consent by third parties.

1 www.ccir-ccrra.org/, accessed October 6, 2023.

Summary

The insurance industry must comply with government legislation and practise good corporate governance. Certain regulations have created arduous processes for insurers. Regulators must seek a balance between principles and rules. A regulator that must enforce too many rules may lose sight of concerns that really matter and negatively impact the ability of their territory to attract insurance capital.

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The effects of globalization are also felt at the regulatory level and so it is prudent to understand how regulation is handled internationally. The insurance industry can better position itself if it understands how legislation may be influenced by international initiatives.

Changing the communication model between regulator and insurance company is a focus of risk-based supervision. Governments must clearly state their goals and key policy objectives to the insurance industry.

Regulators develop information about the insurance business and its business practices to understand what would create difficulty for companies. Regulators consider a company’s significant activities such as the lines of business written, the risks inherent to such business, and the risks involved with the use of AI, big data analytics, and inadequate pricing. Inadequate premium rates inevitably affect profitability. Eventually regulatory capital requirements will falter if rates are not corrected.

The responsibilities of the federal government include monitoring the solvency of federally incorporated insurers, as well as Canadian branches of foreign-owned insurers. Insurers can choose to register with either the provincial, territorial, or federal government. Either level of government may grant a licence to an insurer, but the level of government the insurer chooses to register with affects how it can operate.

Insurance issues are becoming increasingly complicated and increasingly cross-jurisdictional due to factors like globalization and technological change. The Canadian Council of Insurance Regulators (CCIR) is an association composed of regulators (officials and not ministers) from each province and territory and the federal level.

The Office of the Superintendent of Financial Institutions (OSFI) uses the MCT Ratio to measure solvency. A single harmonized asset test applies to all Canadian insurers operating in Canada, whether they are licensed federally or provincially/territorially. The MCT Ratio requires that insurers have assets worth at least a certain multiple of the amount of their liabilities, as well as a margin of additional assets.

The Financial Consumer Agency of Canada (FCAC) is an independent body established by the federal government to oversee consumer issues and expand consumer education in the financial sector. The FCAC promotes a greater awareness of the financial system and the rights and responsibilities of consumers.

All businesses are subject to the federal privacy law—the Personal Information Protection and Electronic Documents Act (PIPEDA). Some provinces and territories have enacted their own privacy laws that also affect how information is gathered and released. The full effect of privacy legislation in the claims and underwriting environments is still not known with respect to access to insurers’ files and to what information can be exchanged between insurers.5-22