OSFI head cautions insurers on alternative investments

Indeed, Canadian insurers may be more likely to search harder for yield, compared with foreign insurers, because Canadian accounting and actuarial standards require stringent mark-to-market financial reporting, she said. “The result is that low rates have a far more significant impact on the earnings of Canadian insurers than they do on their peers in other countries, notably in the United States,” she noted.

This impact is not necessarily all bad, she added, nor is it necessarily permanent. “The regime means that Canadian insurance companies have considerable funds set aside for rainy days. If it continues to rain, they will need these funds. If the clouds disappear, they will be able to bring some of this money back into earnings,” she said.

Nevertheless, she also noted that the Actuarial Standards Board has indicated that it intends to review the appropriateness of standards related to low interest rates. “It makes sense to do this,” she said, “we need to determine whether the current standards are overly punitive and the ASB review should help in this regard.”

Reviewing the standards is also important as the search for yield requires added risk, by taking on larger exposures to alternative investments such as equity, real estate, and other investments. “But caution should be exercised by financial institutions in moving too far into alternative investments given the nature of company liabilities. Further, any such move needs to be supported by enhanced controls and solid expertise in these alternative investment classes, and lots of discussion with boards,” she stressed.

While riskier investments may make sense for longer-term obligations, “OSFI would expect that as payments on policyholder obligations near maturity, these obligations would be backed by promise-to-pay instruments like bonds,” she said. “In other words, the closer the obligation is to maturity, the more reliable the instrument backing that obligation should be.”

Notwithstanding the current focus on low rates, Dickson also notes that much higher rates could yet emerge in the future. “You are in very long-term businesses, which poses unique risks. Unlike banks, life insurers do not get to turn over their balance sheets every one to five years. The business that you write today will be with you for a long, long time. Successfully managing these obligations takes considerable expertise,” she said.

Dickson also expressed her continued support for the new capital adequacy regime for banks, known as Basel III. “Lately, I have seen a number of articles suggesting that Basel III is too complex and that Basel III capital calculations cannot be relied upon. I think such thinking is misguided,” she said, adding that it believes Basel III can be relied upon, “if proper risk management and governance at financial institutions is in place, and if supervisors are active and diligent in their work of overseeing Basel III implementation.”

“Combined with a leverage ratio, Basel III, properly implemented, will fundamentally enhance financial stability,” she said. “It might be better for people to focus more on the quality of supervision, and focus less on Basel III complexity.”

The quality of supervision is even more variable in the insurance sector than it is for banking, Dickson suggested, adding that this is something that is being worked on at the Financial Stability Board (FSB), and among global insurance regulators.

“We encourage life insurers to recognize that their operating environment is still quite uncertain, that scenarios we would have considered to be unimaginable five years ago – continuing low interest rates, increased volatility, continued inter-connected and correlated financial markets – remain with us,” she concluded.