Increasing catastrophes the new reality for P&C insurers, says OSFI head

“The industry’s response to these catastrophic events has been admirable, but they will cause a negative impact on company bottom lines,” she said.

“Given the catastrophes that have occurred so far this year and the potential for others to occur, many Canadians have come to realize just how important P&C companies are – and P&C companies have been reminded of how important it is to manage the myriad risks that they face,” she added.

Moreover, Dickson said that the increased frequency and severity of catastrophe losses are “part of the new reality” for insurance companies. She reports that within the last five years, there’s been a change in insurer losses to around $1 billion or more annually. “A number of reasons have been cited for this increase including: changing weather patterns and climate conditions; aging infrastructures in municipalities across the country; increasing urbanization; and even an increase in finished basements,” she said.

And, as a result, “Insurers need to be increasingly focused on climate risk and stress testing, pricing, quality of risk modeling and ‘non-modeled’ risks, such as flooding,” she said. Indeed, she notes that while there are catastrophe models available for Canada for earthquakes, and limited modeling of winter storms, tornados, wind and hail, “There are no commercially available Canadian models that cover flooding, bush or forest fires or hurricanes.”

This is an issue that British regulators are also looking at, and that work will be interesting to Canadian firms and regulators too, she said.

In the meantime, she said, this year’s events have highlighted the growing need for firms to be able to deploy claims teams in the occurrence of multiple events; for insurers to actively manage their capital; and to reconsider their reinsurance arrangements. Additionally, “OSFI will be looking at whether companies are moving toward more comprehensive catastrophe risk management approaches,” she said.

“Risk assessment continues to be important. Establishing tolerance limits for each risk, assessing risk exposure using your own methodologies, establishing internal targets and documenting the process all contribute to strengthening the enterprise wide risk management process,” she noted.

And, she suggested that there may be growing demand for risk transfer mechanisms, such as catastrophe bonds, which can be used to help companies reduce exposure to certain risks, including earthquakes. “While issuance of catastrophe bonds may be a good addition to a company’s risk management tools, investments in catastrophe bonds could present risks to investors, particularly if the investments are being made in a search for yield, without regard to an understanding of the risks involved,” she cautioned.

She also warned about the risk of too much capital from institutional investors (such as pension funds) entering the insurance system in search of yield. ” Such excess funding or capital can put downward pressure on premium rates, and assuming those rates were properly reflective of risk, this is not what should be happening,” she said. While this hasn’t been observed in Canada yet, “it is important to continue to be on the lookout for any evidence of a search for yield and unintended consequences,” she said.

In terms of insurers’ capital requirements, OSFI has been consulting on the Minimum Capital Test (MCT). Back in May, it released a discussion paper setting out proposed changes for the MCT capital framework in 2015. It has also since carried out a quantitative impact (QIS) study.

The results of that work have shown that the industry, in aggregate, is generally well capitalized. Moreover, she said that OSFI has identified improvements to the framework that will likely mean little change to overall capital requirements. “This should not be interpreted as ‘no change’ on a company-by-company basis,” she noted. “Some will see requirements going up and some will see them going down.”

OSFI expects to have a draft version of the revised capital rules out for comment by the end of the year, and the final version of the guideline “will be issued well in advance of the 2015 implementation date” she said; adding that it also plans to review certain governance guidelines, and to consider possible changes, sometime next year.

“In OSFI’s view, those companies that have top-notch risk management and governance regimes in place will be ahead of the curve and better able than their peers to deal with challenges as they arise,” she concluded. “In other words, even a bad year can turn into an annus mirabilis (wonderful year), knowing that effective risk management kicked in, losses were lower than what they might have been, and lessons were learned.”