FORUM MAGAZINE
INSURANCE
Strength, Solvency & Stability
The global financial crisis spurred some media speculation about the long-term stability of life insurance companies. One advisor, Paul Goldstein, decided to do some digging of his own to provide due diligence for his clients. He shares the results of his research with advisors across Canada.
The idea for this report came to me in the wake of the widespread concerns caused by the recent economic crisis. The press was having a field day reporting the beatings some major life insurance company shares were taking in the market. Questions were raised about life insurance companies’ ability to fulfill their obligations to their policyholders. My clients wanted to know whether their policies were still safe and secure.
During my 43 years as a financial advisor, I have always prided myself on exercising the utmost due diligence on behalf of my clients. I felt that they, as well as consumers at large, deserved more than offerings of glib, reassuring platitudes. This called for a professional and realistic response.
It is important to note that because a life insurance company’s shares are down, it doesn’t follow that its insurance policies are in jeopardy. When individuals buy the shares of an insurance company, they look forward to participating in the growth of the value of those shares, but they have no protection against any drop in value.
Ironically, in certain circumstances, a drop in the share value of a life insurer may be due to its actions to secure the safety of its policyholders. The protection of policyholders is paramount to an insurer’s priorities. To maintain adequate capital, a company may take actions that will temporarily reduce its reported earnings, such as moving more assets to its reserves, issuing more shares or cutting dividends to shareholders. The shareholders may lose in the short run, but the policyholders gain security.
Rating Agencies
In response to their clients expressing “safety worries,” the first inclination for many financial advisors was to turn to the rating agencies. Throughout the years these ratings, such as those from Standard & Poor’s, Moody’s, A.M. Best, Fitch Rating and Dominion Bond Rating Service, had been heavily used by insurance companies to promote their competitive advantage.
In the wake of the collapse of Confederation Life (on Aug 11, 1994), the Globe and Mail on September 13, 1994, admonished that “even people who follow the often repeated advice to buy policies from a top rated company need to keep abreast because companies’ ratings can change drastically.” It should be noted that Confederation Life received top ratings from the major rating agencies until two years prior to its demise.
In fact, whereas the policies purchased by the consumers are mostly of a permanent nature, the ratings themselves can change drastically in a short period of time. This diminishes the value of these ratings as the basis for selecting a company for one’s life insurance needs.
Safety of policies is not provided by the rating agencies. Rating agencies provide an evaluation of the current financial condition of a company. When that condition worsens, so does the rating. Revised ratings, out of necessity, are always lagging behind the changes that trigger them. The role of rating agencies is not to try and save a company, only to record its financial position.
The safety of policies is achieved through the cooperative efforts of two organizations that are charged with the responsibility of safeguarding the interest of Canadian policyholders: the Office of the Superintendent of Financial Institutions (OSFI) and Assuris. While working closely together, these two agencies have different but complementary mandates and responsibilities.
OSFI
OSFI is an independent government agency that reports to Parliament through the Minister of Finance and has responsibility for regulating and supervising federally regulated life insurance companies. OSFI conducts risk-based assessments of the safety and soundness of these companies. The Insurance Companies Act of Canada provides a wide range of discretionary intervention powers allowing OSFI to address concerns that may arise with life insurers.
The principal measure used by OSFI to assess the soundness of a life insurer’s current financial position is a risk-based capital requirement known as the Minimum Continuing Capital and Surplus Requirement (MCCSR). The MCCSR ratio compares capital available to capital required as calculated by applying factors for specified risks. A life insurer’s minimum capital requirement is the sum of the capital requirements for each of five risk components:
- the asset default risk, both from on-balance sheet asset default and in respect of off-balance sheet exposure; and the loss of market value of equities;
- the mortality/morbidity/lapse risks, resulting from wrong assumptions;
- the changes in interest rate environment risk, associated with asset depreciation arising from interest rate shifts;
- the segregated funds risk, the guaranteed values at payout time may be in excess of the account values;
- the foreign exchange risk, resulting from fluctuations in currency exchange rates.
The ratio is set at 120 per cent rather than 100 per cent because the calculation does not explicitly address other risks, such as systems, data, strategic, management, fraud, legal and other operational and business risks.
Even if the minimum ratio is 120 per cent, each life insurance company is expected to establish a target capital level that provides a cushion above minimum requirements to cope with volatility in economic conditions, innovations in the industry, consolidation trends and international developments. An adequate target capital level provides additional capacity to absorb unexpected losses beyond those covered by the minimum MCCSR and to address capital needs through ongoing market access. OSFI requires each institution to establish a target total MCCSR ratio, at no less than the supervisory target of 150 per cent and expects that insurers have their own target ratio of over 180 to 200 per cent.
If OSFI sees an MCCSR ratio decreasing, a number of steps are taken to increase the monitoring of a life insurer and OSFI requires the company in question to provide plans to correct the situation, and thus improve its ratio. OSFI does not wait until a ratio is at 150 per cent to take these steps, and it can take control of the company before capital reduction is too significant.
The system aims at ensuring that if OSFI needs to take over control of a company, there are sufficient assets still in place to transfer of the remaining obligations to another insurer or run-off the remaining obligations. All federally regulated life insurers must file the MCCSR return every calendar quarter (of note: on September 30, 2009, the combined MCCSR ratio for life insurers in Canada stood at 223.66 per cent).
Equally important as the capital surplus target levels is the quality of the assets earmarked for inclusion in the calculations. The OSFI Guidelines devote a 25-page chapter to their definition of capital for this purpose. The three primary considerations for defining the capital of a company for purposes of measuring capital adequacy are:
- its permanence;
- its being free of mandatory fixed charges against earnings;
and - its subordinated legal position to the rights of policyholders and other creditors of the institution.
The MCCSR returns submitted to OSFI must be verified by life insurer auditors and appointed actuaries, who must sign an opinion stating that they followed these rules. These professionals are responsible under the professional code of conduct of the Canadian Institute of Chartered Accountants and the Canadian Institute of Actuaries, and OSFI may inform those institutes of any false declarations.
These supervisory activities can, if necessary, lead OSFI to becoming progressively more directly involved in the company’s affairs, depending on how successfully the company responds to OSFIs requirements. At the earliest sign of potential problems, OSFI establishes a 4 stage progressive warning system.
Stage 1 — Early warning.
If a company is categorized as Stage 1, OSFI has identified deficiencies in the company’s financial condition, policies or procedures or the existence of other practices, conditions and circumstances that could lead to the development of problems at Stage 2 if they are not promptly addressed.
The following conditions could lead to OSFI categorizing a company as Stage 1:
- the combination of the company’s overall net risk and its capital and earnings compromises the company’s resilience.
- the company has issues in its risk management or control deficiencies, although not serious enough to present a threat to financial viability or solvency which could deteriorate into more serious problems if not addressed.
Stage 2 — Risk to financial viability or solvency.
At Stage 2, the company poses material safety and soundness concerns and is vulnerable to adverse business and economic conditions.
One or both of the following conditions would likely lead OSFI to classify a company as Stage 2:
- The combination of the company’s overall net risk and its capital and earnings may pose a serious threat to its financial viability or solvency unless effective corrective action is implemented.
- OSFI has identified issues in the company’s risk management that, although not serious enough to present an immediate threat to financial viability or solvency, could deteriorate into more serious problems if not addressed promptly.
Stage 3 — Future financial viability in serious doubt.
If a company is categorized as Stage 3, OSFI has identified that the company has failed to remedy the problems that were identified at Stage 2 and the situation is worsening. One or both of the following conditions pose a serious threat to the company’s financial viability or solvency unless effective correction action is promptly undertaken.
The combination of the company’s overall net risk and its capital and earnings makes it vulnerable to adverse business and economic conditions.
The company has serious issues in risk management or control deficiencies.
Stage 4 — Non-viability/insolvency imminent.
If a company is categorized as Stage 4, OSFI has determined that it is experiencing severe financial difficulties and has deteriorated to such an extent that the statutory conditions for taking control have been met. Once the Superintendent has taken control of the company, it can request that the Attorney General of Canada apply for a winding-up order in respect of the company.
If, after 30 days of having taken control the Superintendent has not made a request to the Attorney General of Canada to apply for a winding-up order, the board of directors of the company can request the Superintendent to relinquish control.
The Superintendent must, not later than twelve days after receipt of this request,
- comply with the request, if the Superintendent is of the opinion that the circumstances leading to the taking of control by the Superintendent have been substantially rectified and that the company can resume control of its business and affairs; or
- request the Attorney General of Canada to apply for a winding-up order in respect of the company where the assets of the company or the company itself is under the control of the Superintendent.
At this point, OSFI will have completed its regulatory and supervisory duties and will hand the responsibility of protecting policyholders to Assuris.
Assuris
Assuris, formally known as Comcorp, was founded in 1989. It is a not for profit organization, funded by the life insurance industry and endorsed by the government of Canada. Its mission is to mitigate the impact on Canadian policyholders of the financial failure of a member life insurance company. Its role is to protect policyholders by minimizing loss of benefits and ensuring quick transfer of their policies to a solvent company.
In May 2009, at a convention of financial brokers in Toronto, Josée Rheault, an Assuris vice-president of communications, confirmed that Assuris has access to an immediate liquidity fund of $120,000,000 to fund insolvency claims and it has the legal authority to collect $4.5 billion from its members to deal with insolvency claims.
She went on to explain that in a worst-case scenario, Canadian policyholders would have 85 per cent coverage for guaranteed values in excess of prescribed minimum amounts.
Confederation Life, policyholders will usually get 100 per cent of their value returned to them, since it is Assuris’ mandate to ensure that the solvent insurer can acquire the policies of a failed competitor and continue coverage.
Although there are no regular supervisory interactions between Assuris and member companies, Assuris will closely follow any concerns that come to light through OSFI’s supervisory activities. Should a situation reach the point where a company has become insolvent, Assuris will step in to carry out its consumer protection mandate, once the company has been placed under the control of OSFI.
Assuris works hand in hand with OSFI in keeping track of the financial condition and operating performance of the company.
When a company is classified as Stage 2, Assuris may:
- Request and analyze information from OSFI including:
- Business plan obtained from the company reflecting its remedial measures;
- Reports and results of OSFI regulatory and special examinations;
- Mandate, scope and results of work done by auditors; and
- Mandate, scope and results of work completed by actuaries.
- Hire consultants to provide in-depth analysis of critical areas.
Note - OSFI will treat these consultants in the same manner as senior Assuris management so long as appropriate confidentiality agreements are in place. - Develop a preliminary restructuring plan.
When a company is categorized as Stage 3, Assuris’ responsibilities may involve:
- Declare the company to be a “troubled member;”
- Develop a detailed restructuring plan;
- Estimate its coverage exposure;
- Evaluate whether to make a financial commitment to support the restructuring in order to reduce its potential exposure;
- Formulate a detailed contingency plan for managing liquidation and funding its coverage commitments.
At Stage 4, OSFI has determined that the company will become non-viable on an imminent basis. When a company is categorized as Stage 4, Assuris’ activities may involve:
- Obtaining board commitment to provide coverage in the event of liquidation;
- Proceeding with planning an assessment to raise funds required to meet coverage obligations in anticipation of the Winding-up Order being issued;
- Where appropriate, planning for an orderly commencement to liquidation with the assistance of the appointed liquidator, including:
- preparing a closure manual designed to assist with issues and procedures arising immediately upon liquidation;
- training information officers to handle public inquiries;
- establishing funding and reporting arrangements during liquidation; and
- developing strategies with the liquidator for operating the company in liquidation.
Conclusion
Shortly after Assuris came into being in 1990 they were called upon to deal with the only three insolvencies in the life insurance industry in Canada — Les Coopérants, (Jan 3, 1992), Sovereign Life, (Jan 18, 1993), and Confederation Life, (August 11, 1994). In addition to financial support, Assuris quickly developed expertise to resolve the unique and largely unprecedented issues in a life insurance company insolvency affecting Canadian policyholders. In all three cases, all the Canadian policies were ultimately transferred to solvent life insurance companies.
When Confederation Life Insurance Company was seized by regulators on August 11, 1994, it was the single largest life insurance company to fail in North America. What led to its demise makes a compelling narrative in Rod McQueen’s extensively researched book — Who Killed Confederation Life? The Inside Story, published in 1996.
In the wake of the Confederation Life experience, OSFI has been tightening its regulatory and supervisory practices to the point that it is highly unlikely that a federally regulated life insurer will ever again be allowed to deteriorate to the level that Confederation Life did.
No one truly knows how well a system works, until it is tested. Through the great trial Confederation Life presented to our regulators, we have had, here in Canada, the opportunity to develop one of the most rigorously regulated financial service industries in the world.
I am confident that the OSFI rules and processes combined with the protective role played by Assuris are appropriate to safeguard Canadian policyholders from the possibility of losing any guaranteed benefits from a federally regulated life insurance company.