Canadian Context

Solvency II continues to be a hot topic in the global insurance regulatory space. But if you think Solvency II does not apply to Canadian insurers, think again.

Canada continues to outperform its peers on the international stage. As key global players, it has become increasingly important for us as Canadian insurers to become more acquainted with regulatory practices around the world. Why? Because doing so allows us to see the big picture and to identify best practices that are gaining support and recognition. Solvency II has gained quite a bit of recognition with its suggested practices, and there are a few key reasons for this.

In its Canada Insurance Market Report 2013, Marsh notes that the Canadian p&c market has continued to outperform the global and North American marketplace, allowing Canadian insurance costs to remain below the average benchmark in other areas of the world. Canada is primed to continue as a global insurance leader despite the current global economic environment.

These significant advantages and the desire to play in global markets increase the need for Canadian insurers to keep abreast of best practices encouraging strategic growth. Solvency II plays an important role in this.

THE PRIORITY LIST

For most Canadian insurers, Solvency II is not something hitting the list of key priorities. This is mainly because the Solvency II Directive and its requirements apply to legal entities in countries – those considered European Economic Areas, Bermuda and Japan – that have adopted this regulation. Canada is not one of these countries, so Canadian legal entities are not in scope.

Ah, yes. We can rest at ease. But should we? A few questions need to be asked: What can insurers gain from the directive being proposed? Should insurers bother to read it at all? Why should we pay attention?

First, any regulation – whether in draft or final form – can drum up quite a bit of negative noise, especially where the requirements are seen as cumbersome and unnecessary. No doubt, there is quite a bit of negative noise out there. Some of that noise is warranted; another portion is successfully hiding complacency.

Superintendent of the Office of the Superintendent of Financial Institutions (OSFI), Julie Dickson, highlighted this risk of complacency at KPMG’s 21st Annual Insurance Issues Conference this past December. When asked about a wish list for the insurance industry, Dickson responded: “I still get people saying to me, ‘Why is OSFI doing this or that? Why are you picking up this rule that someone else has globally? We didn’t cause the crisis; we perform well; we don’t think that we need to change.’ And so I would pay very close attention to that risk [of complacency] and nip it in the bud if you ever see it.”

Second, change is happening. Much consideration should be placed on the fact that many financial services organizations are global businesses – at least, if they are not yet, they are likely working on expansion. Regulation developed in key markets is commonly applicable to global players in those markets, thus piquing interest in its objectives. As such, where Canadian insurers hold their place on the world stage, keeping abreast of global regulatory developments is not just good practice, it is common sense.

Finally, the Solvency II Directive incorporates a number of excellent ideas for enhancing governance at insurance enterprises. As part of its mandate, OSFI continues to monitor the global regulatory space and where appropriate, adopts global best practices within Canada.

So it comes as no surprise that OSFI’s Guideline E-19 on Own Risk and Solvency Assessment (ORSA), released in draft form in December, offers the following as one of its objectives: consider international developments and standards, including advancements in risk and capital management techniques.

The practice of conducting regular ORSAs (a concept developed to address the International Association of Insurance Supervisors’ Insurance Core Principle 16) is one of the good ideas highlighted in the Solvency II Directive.

Therefore, while Solvency II regulation does not apply directly to insurers in Canada, consideration of its suggested practices should not be regarded as out of the question. In this case, it is an excellent indicator of what is likely to be coming down the pipeline.

And while OSFI maintains a keen focus on a “made-in-Canada” approach, it is wise to ensure the country’s regulation is best-in-class. For insurers aiming to be industry leaders, adopting a more globalized view on best practices will drive more efficient, and more resilient, governance frameworks.

FOREIGN CONNECTION

The Canadian p&c market is home to numerous foreign players. In fact, several Canadian insurers are subsidiaries of Solvency II-regulated parent companies. For these insurers, Solvency II compliance might be required, especially where Canadian operations are proportionally material to the global business.

For other Canadian insurers, some of the governance practices offered through Solvency II simply make good business sense. Those seeking to optimize local and global business operations and employ relevant, effective risk management will not tune out.

So which best practices are likely to “catch on” over time?

EMERGING TRENDS AND BEST PRACTICES

Alongside ORSA, there are a few other themes within the Solvency II Directive that might make sense for Canadian insurers:

1) Increased Focus on Effective Capital Management: 

The primary purpose of the Solvency II Directive is to protect policyholders and hold insurers accountable for paying out on contractual obligations. The regulation calls on insurers to further buttress systems supporting the effective employment of capital and evolve measures for calculating the capital required to manage each significant risk.

Employing analysis on risk-adjusted return on capital allocated to support capital assessments, as well as for use as reliable methods of evaluating economic performance, is a natural fit. The use of better capital analytics will prove insightful, especially given tough market conditions, where effective capital management is crucial.

It may require further investment in management information systems to extract necessary data sets needed to conduct such analysis. Regardless, a better analysis of risk and required capital will help to support sound business decision-making and, ultimately, provide an enhanced view on an insurer’s capital adequacy and financial position. Where this analysis is conducted, boards and senior management will be eager to use it to better understand factors affecting capital efficiency.

2) Engaged Corporate Governance – Serving the Board with Better Information:

Effective corporate governance over an evolving industry demands evolving information. As insurers grow and gain complexity, so too do the responsibilities and accountabilities of their respective boards. Greater board responsibility is outlined throughout the Solvency II Directive. In particular, the business strategy and risk appetite, as well as their supporting frameworks, are key areas where the ability to demonstrate board acknowledgement and approval are explicitly required.

In Canada, the insurance ecosystem is also evolving and expanding. Both internal and external influencing factors and risks will continue to increase in their interaction and intricacy. As such, the need to offer better information and insight to boards will continue. Reliance on tick-box-type information packs and rolled-forward presentations will be a death sentence. Timely and forward-thinking information with a focus on offering insight will be in high demand. Boards will need multi-faceted, objective information and analysis to employ effective governance and support the business in making sound decisions.

All the while, the focus remains the same: maximizi ng shareholder value. As such, information that focuses on key risks and on capital management will prevail. The ability to extract better management information and showcase capital efficiency across lines of business will solidify the company’s focus on maximizing shareholder value and this information, undoubtedly, will be coveted by boards.

3) Silo Busting, Building on Capabilities and Knowledge Sharing:

The Solvency II Directive calls for the installation of greater knowledge-sharing and collaboration across an insurance organization as a means for improving the internal system of governance. Fostering cross-functional knowledge-sharing is a powerful way to build good governance practices and a culture that embraces a holistic view of the business. Thus, increased interaction across key functions and business operations will be a determinant of sound governance.

Increased capabilities within risk functions and interaction with capital management teams will promote a better understanding of the relationship between insurance business risks and related capital management issues.

Capital management teams will also stand to benefit from increased interaction with business operations, and gaining better assurance over the underlying data used to develop internal models, capital adequacy calculations and reserves.

Better understanding of the underlying data can lead to increased capital efficiency. Knowledge-sharing across key functions will also address other strategic business initiatives, such as building internal information capital and succession planning. 

LOOKING FORWARD

Regulators across the globe are facing the challenge of ensuring their governance remains relevant to the markets and economies they serve. The European Solvency II Directive, while subject to difficulties in its resolution, has developed guidelines that seek to install sound governance practices. OSFI acknowledges global insurance best practices and adopts them where they fit for the Canadian marketplace.

Canada’s focus on high-quality management information and governance has brought us global recognition and success. It has served us well through the recent challenging market conditions.

As we continue to make waves in the global insurance marketplace, it will be our drive towards employing effective information and embedding sound business practices that will keep us solvent, relevant and successful.