Office of the Superintendent of Financial Institutions
Neil Parkinson: Good morning everyone. Welcome to all of you. I’d particularly like to welcome our new Superintendent of Financial Institutions, Jeremy Rudin.
Jeremy, thank you very much. We greatly appreciate you being here. We’ve been fortunate enough to have your predecessor here on a number of occasions, but I know with you being new to the job, not to the industry exactly, you have lots of opportunities, and so we’re very glad indeed you were able to join us here this morning.
Jeremy Rudin: Thank you very much.
Neil Parkinson: As the new Superintendent, you attract a great deal of interest as to your attitudes, observations and thoughts. We’d like to ask you a little bit about whether, in your first few months on the job, you’ve had any particular observations or thoughts about the Canadian insurance industry or the the insurance industry in general.
Jeremy Rudin: Sure, I’d be glad to. I have a good familiarity with the industry based on my responsibilities in my previous position. Through the financial crisis I learned about some particular aspects of the industry. I would say the thing that has really been reinforced since becoming Superintendent is just how diverse the industry is. So it’s all insurance, but it’s very different in a lot of ways.
So if we look at the liability side, life companies, very long-dated liabilities are complex to value, and they pose some interesting challenges for matching the assets with the liabilities. Underlying risks of the long-dated liabilities probably change gradually over time, but there can be exceptions.
Now contrast that to P&C: typically, liabilities are much shorter dated, although there are exceptions and people have to be aware of that.
And then, mortgage. Mortgage insurance is an important part of what we supervise as well, and that’s something that’s in between the two — long-dated liabilities, but where the exposure tends to diminish over time, certainly if all goes well. So that’s on the liability side.
The structure of the industry is also very different. Life insurance is quite concentrated, but with an appreciable number of either smaller companies or large foreign companies with smaller Canadian footprints. In P&C, there is a much greater role for a larger number of companies. Consolidation has been occurring, so it’ll be interesting to see how that progresses. And in mortgage, we have a grand total of two mortgage insurers, three if you count the Crown corporation. So these are all very different industries. It’s all insurance, but it’s all different.
Neil Parkinson: Now I think you know that we’re going to talk a lot today about disruptive technologies, disruptive competitors, and how they have the potential to swiftly change the landscape for us in insurance and financial services generally. I suppose, in ways that may even affect the survivability of some companies and some business models. I wondered if you have any thoughts on those trends, whether they’re real, a bit overblown, if there are any issues that we’re perhaps under emphasizing.
Jeremy Rudin: In the regulator’s point of view, what’s most important is not what’s likely to happen, but what could happen. In particular, among the things we focus on, and we ask companies to focus on, are things that could happen that could have a major impact, positive or negative, on the industry. This means I don’t spend a lot of time forecasting what will happen in terms of technological change in financial services, but rather thinking about what impacts can they have and what do we expect the institutions to be able to manage.
This area, like many areas, is extremely difficult to predict. Like the industry, I am aware of the possibility that technological change could have a big impact on the industry as a whole and on individual players. It could do so at a pace that’s also very difficult to predict.
By way of example, I’m old enough that when I was in school, our teacher taught me the times tables but said I wasn’t going to need to know them because everyone would have handheld calculators in the future. At that time, the handheld calculator didn’t exist - this was the stuff of science fiction. She expected them in a couple of years, and they took quite a lot longer to arrive. They became ubiquitous. People give them away because they are so cheap and available. Yet, I’m still teaching my daughter the times tables. So it’s very difficult to know when technological innovations will become pervasive and what impact that they’re going to have.
So when I look at insurance, there’s a lot of ways this can have an impact. All of the additional data that’s available or can be deliberately collected can have a big impact on how risks are assessed, priced, monitored. That could be a very significant thing for the industry.
In other industries, we’ve seen technology change the sales model and in insurance the sales model is a very important aspect of the business. There’s a lot of reliance on individual brokers, or on a captive sales force that’s actively selling, as opposed to the consumer presenting itself at a website. That’s starting to gain a bit of traction in insurance but it hasn’t yet become pervasive. I don’t know if it will ever be, but it’s certainly a possibility.
The other risk that we’re pointing out to companies across financial services is cyber risk. This has many dimensions, whether it’s an inability to use the website to reach customers or a loss of data integrity. In principle, insurance companies are less vulnerable to this than banks — insurers are probably a less tempting target — but it’s no less important because inability to reach customers or data integrity issues can very much damage the brand. So we’ve got a self-assessment guide for cyber risk for insurance companies, and it’s well worth paying attention to.
Neil Parkinson: Do you think any of these trends potentially represent a threat to the safety and security of the financial products or the promises our insurance companies make to customers? Is that a new sort of an elevated concern for you as a regulator?
Jeremy Rudin: Well, we expect the companies to do their own risk assessment. They need to measure their risks. They need to monitor the risk. They need to manage the risks. And they need to be capitalized so that if their predictions go awry and they experience losses, they can survive through plausible but severe losses and still serve their customers. That’s our main line of defence.
In the case of technological change, I think it’s more likely to have an impact on individual companies rather than the industry as a whole, but the future’s uncertain. That’s why we have regulators.
Neil Parkinson: Well, speaking of uncertainties, I gather you’re an economist by background and there have been lots of economic uncertainties that may impact the profitability of the industry. I’m wondering if you have any thoughts on what the economic environment means for insurers. For example, do you think they have been able to adapt to protracted low interest rates?
Jeremy Rudin: Well, so I’m glad you mentioned the interest rates. In my view, the low and protracted period of low interest rates is the most significant economic change affecting the insurance industry at the moment. We have no less an authority than the Governor of the Bank of Canada telling us to expect rates that are lower for longer than we were thinking only a few months ago.
In life insurance, this is very significant because of the long-dated nature of the liabilities. Overall, the Canadian life industry has adjusted well. The accounting model has been good at causing a realization of the low interest rates to show up on the balance sheet, which is important. And we also recognize the recently-adopted changes to actuarial standards are going to further improve the recognition of low interest rates and create more comparability across the industry. Those are very positive developments, and we welcome them.
On the P&C side, low interest rates have also had an impact. The narrowing of investment margins has created an additional focus on underwriting. From a regulator’s point of view, the focus on underwriting is always a good thing. You always want emphasis on strong underwriting and not to neglect risk on the liability side by saying that we’ll just make it up on asset returns.
Neil Parkinson: The other headline story this year has been the decline in the Canadian dollar over the last few months, and I suppose more recently the steep decline in oil prices is not disconnected. Any thoughts on what that means for us in the economy generally and for the insurance industry?
Jeremy Rudin: If we’re talking about what’s likely to happen, I will defer to no less of an authority than the Governor of the Bank of Canada. The Governor has said that declines in oil prices can have a measurable, although not a material effect on economic growth. The Governor sketched out his views about that recently, and since then, oil prices have declined even further. As a regulator, I tend to focus on not what is likely to happen, but what could happen.
The recent change in oil prices is an object lesson in why we expect institutions to have a good risk management capability, to understand their risks enterprise-wide, and to be very well capitalized against severe but plausible losses because the range of macroeconomic uncertainty is very wide. I think it’s a natural human tendency to forget over time and in periods of stability that the macroeconomic environment has become more predictable. When we have some gyrations in commodity prices or you have movement in the Canadian dollar, it reminds people in a very useful way that things can change and they can change rapidly. This week it’s oil prices that everybody’s talking about, and that is significant, but next week, next month, next year, it could be something else.
Neil Parkinson: You did touch the dread subject of accounting and insurance accounting has been a real particular area of concern for the Canadian insurance industry, particularly life insurers. We’re finally getting close to a final standard. There’s been a lot of quite spirited debate at times about the IFRS proposals and whether they finally have it right. There are a lot of people in the room who probably think that that’s not really subject to debate, that it’s not anywhere near to getting it right, but are you concerned about the usability of the basic financial reporting in that new environment for supervisory purposes?
Jeremy Rudin: This is another case where I’m not spending a lot of time thinking about what will happen, but what might happen. It’s certainly possible that the final standard will be one that’s relatively easy for us to work with as regulators and supervisors, but we need to be prepared for the possibility that it’s not.
And I should point out that accounting standards are used for a variety of purposes, in particular for publicly-traded companies for reporting to investors and analysts, and that’s an important function of accounting standards. What we like to do at OSFI differs from some other regulators — we prefer to have a good link between the capital requirements and the public accounting. It’s a good idea because it reduces compliance burden. It also simplifies understanding for the companies, for us, for analysts in general.
So that would be our preference after the accounting standard is finalized, to use the accounting valuation basis in the capital requirement calculation. That’s always our first choice, but the most important thing is the capital requirement has got to work. Once the final standard is set and if there’s too much volatility in the capital requirement, then the capital requirement isn’t going to work as intended. We’ll have to do something to adapt our process, our capital requirements, so that we don’t have to take that much volatility into the capital requirement. Because for capital set aside against long-dated exposures, volatility will undermine the purpose of the capital requirement.
We won’t make a decision until we’ve had an opportunity to test drive what comes out as a final standard.
Neil Parkinson: Let’s shift subjects again over to risk management and ORSAs. Many of us in this room have been involved in either drafting them, reviewing them, in some cases approving them. There’s quite a number of external directors here. And this has really brought a renewed focus on the industry’s risk management practices. Can you tell us what you hope will be achieved by insurers as they implement ORSAs — Own Risk and Solvency Assessments – and how you would hope that they’re developed in the future?
Jeremy Rudin: You’re telling me that ORSAs have created a new focus on risk management in the industry, so that’s great. That’s very much the goal. The thing I’d emphasize about ORSAs is that “Own Risk and Solvency Assessments” is slightly confusing as a term, so “own” modifies “assessment”. That’s what the “own” is doing there. So, the whole point of it is for management and boards, or chief agents in the case of branches, to come to their own assessment of the risks that are facing the company or the branch and to do a very thorough and wide-ranging job with that.
That’s really the main purpose and it’s important that these assessments really be owned by boards and management, that they not be the assessment of an external consultant, an external auditor or the appointed actuary. As much as these people can contribute, it needs to be the board and management’s own view of the possible risks to the institution or the branch. If it is renewing the emphasis on risk management and a broad assessment of the risks, then it’s doing what it’s supposed to do.
We ask institutions to share them with us, even though they are the company’s assessment, not the regulator’s assessment. We’ll be looking to see what are the most effective practices and we’ll be providing some feedback to the extent that we can share with the industry. That’ll help as ORSAs continue to evolve and implant themselves in our regime.
Neil Parkinson: Overall, when you think about these things, are there particular areas where you think insurers need to make progress in order to get more out of the whole ORSA exercise?
Jeremy Rudin: It’s to be expected that the first time through, some companies will make more progress than others. Certainly those that have access to a foreign parent who’s already done an ORSA have a bit of a head start. I’m going to wait and see what the overall strengths and weaknesses are before we provide very specific feedback. And as I said, I think we’ll be well-positioned, as we are in a lot of other areas, to share the best practices that we’ve seen with the rest of the industry, and that’ll be very helpful.
Neil Parkinson: Another sort of recurring theme related to risk management is identifying and managing emerging risks, the proverbial black swans in some cases too. Are there best practices that you’re seeing for identifying and managing emerging risks in financial institutions more generally?
Jeremy Rudin: Emerging risk is a very difficult area. It’s a difficult area for good reason. We use the term emerging risks to mean the things that we are most dimly aware of or are the hardest to quantify or the hardest to assess. So by definition, emerging risks will always be the most challenging part of the puzzle because that’s really what we’re calling it.
What I do in my own work and what we do in general at OSFI in this area is two things. One is I assume every time we sit down to talk about risks that I’m missing something and no matter how good a job we’ve done in looking at the risk landscape, that there’s something I haven’t seen. And I think this is because if you read the narrative about any financial crisis or any failure of a major financial institution, they pretty much all – I mean I would assert they all have the characteristic that, looked at ex-post, whoever writes the story will say there were lots of warning signs, it was an accident waiting to happen, and they didn’t see it. Either they wilfully ignored the warning signs or they weren’t able for some reason to recognize them.
So I always assume that, and I drive my colleagues crazy at OSFI and around the other financial sector agencies in Canada by always asking, you know, what are we missing? What about this? Isn’t that a warning sign? I think you have to do that and that’s certainly the approach I take from an emerging risk point of view.
The other thing I do is I assume that – not only do I ask, you know, are we missing something – I always assume that there is something and we have missed it. And no matter how reassured I am at the end of the meeting or even if we add something, I always assume well, there’s something else, and we’ll have to come back to it. But in the meantime, we need a risk management and capital regime that is robust to our inability — demonstrated inability across the whole world, in any event — to necessarily recognize every risk. So it’s got to be something that as much as we try to look over the horizon, we’ve got to be sure that even if there’s something that we – or have a high level of assurance, to be more accurate, that even if there’s something we missed, we’ll be able to manage through it. And that’s why capital is so important.
Neil Parkinson: You may well have your own sort of list, or maybe not list but inventory of emerging risks or risks that are of particular concern to you at OSFI or you personally. Are there any you’d be prepared to share with us that are particularly relevant to the insurance industry?
Jeremy Rudin: Well, I keep coming back to the task at hand. The thing that keeps me up at night is the idea, the possibility that we’re missing something. And so I’m very interested to see the ORSAs as they come in and see what the companies have identified. And I’d be reluctant — I think reluctant is too strong a word — for me to put out what I think are the most neglected risks at this point because these ORSAs need to be the assessment of the companies rather than the assessment of the regulator. And we’ll do a better job working on this collectively.
Neil Parkinson: We’ve got lots of different sorts of people in the room today: management, actuaries, accountants, external directors, all sorts of different occupational and subject matter backgrounds. And all of us have roles to play in maintaining a strong, sound insurance industry. So I guess I just have the general question where you as a regulator would like to see us do a better job or even it’s not a matter of saying what’s a better job, what we’ll have to do more of or do better in future just because, you know, this is the sort of thing where you have to run just in order to stand in place sometimes.
So let’s start with company management. Any particular areas of focus where you think management’s going to have to step up a little bit over the next few years?
Jeremy Rudin: I’d like to talk about management and directors at the same time. And the reason is I think that this relationship between management and directors is one that is evolving. If I’ve got something on my list for each of them, it’s working through this particular evolution.
So we at OSFI have raised our expectations about the role of boards and directors in oversight of the companies, and this is a part of a larger phenomenon, so it’s not just OSFI in Canada who’s raised expectations for financial institution boards, it’s regulators across the globe. And it’s not just happening in financial services. Even in unregulated industries, the perception and responsibilities of boards of directors for oversight have gone up materially over time and that’s very positive. I do think that it can be a struggle sometimes for boards and management to figure out what their new roles are because this is principles-based as opposed to a rules-based set of guidance. And it’s asking boards and management to set aside their previous division of labour, and have an enhanced relationship.
I recognize this is a work in progress and I think that not all companies, but in many companies it’s worth paying more attention to this. I certainly get feedback indirectly or directly, that risk committees receive voluminous reports, hundreds of pages, many thousands of numbers. That’s really worth thinking about. Oversight by the risk committee, by the board, needs to be based on the right side of information, and if a company is having that kind of interaction between management and the risk committee or management and the board, that’s something that I think can certainly be improved. If management is providing these voluminous reports and the risk committee is not getting anything out of them, well, why is that? Is it because that’s what management thinks the board or the risk committee is expecting? If this is the case, the risk committee needs to provide clearer guidance. If that’s what the risk committee thinks they really need – does the risk committee really feel equipped to go through information in all that detail? And if neither of them are happy and they think they’re doing it because that’s what the regulator wants, well, I’m here to tell you that’s not what we mean by enhanced oversight.
So that’s an area that boards and management can work on in. It’s a journey, and we’ll be as helpful as we can in that journey.
Neil Parkinson: Any thoughts on the actuarial profession? Clearly critical to all the really complicated judgments and estimates that are made, both in terms of building products, measuring them in the accounting, key role in risk management. Where do you think the actuarial profession needs to go?
Jeremy Rudin: One of the most significant developments is the updating of actuarial standards related to life insurance liabilities. That’s been very positive, and we really welcome that. Looking ahead, I would mention a couple of things.
One is actuaries aren’t accountants, but actuarial standards and accounting standards have to work together, so I do hope and expect that the actuarial profession will keep up with the evolution of accounting standards and the evolution of accounting practice, so that these things can continue to work together.
And the other thing that I would point out is with the role of ORSA, which needs to be the management and board management’s own assessment. We now have these somewhat parallel or interrelated processes of the ORSA and the DCAT, the Dynamic Capital Adequacy Test which needs to belong to the appointed actuary. It’ll be interesting to see how these evolve. They’re related exercises, but they serve different functions, and they have different owners. We’ll be interested in further information that we get through more experience in ORSA. It will help to understand – both from boards and management but also from actuaries – what the right relationship is between these two.
Neil Parkinson: Okay. Well, how about auditors? I guess I’m one of those and there’s a few of them in the room. Auditors as a group have come in for some criticism, not just in financial services, but for some of the events in the last few years. So any thoughts about the auditing profession?
Jeremy Rudin: In our system here in Canada, we rely a great deal on the information that’s provided to us by firms. This is a system that really can only work effectively if we’ve got a high level of confidence in the accuracy of that information. While internal audit and external audit are very important for investors in the company, whether it’s private or publicly traded, from a regulator’s point of view, effective audit is absolutely essential to getting a high-enough level of assurance to be able to rely on the information that we receive. So anything that the profession can do to raise that level of assurance and to learn from evolving practice will be very supportive to the principles-based approach used here in Canada.
Neil Parkinson: To what degree are we going to continue to do things on a domestic level distinctly from international trends? And of course there are international standard models in Europe. There are standard models in a variety of jurisdictions, all of which have a characteristic of having higher capital requirements if you invest in equities than you do in the presumably-less-volatile or safer bonds, gilts and so on. I suppose that the question will be to what degree we need to align ourselves more and more closely to those kinds of global approaches, considering how interconnected the business is.
Jeremy Rudin: There’s a big push internationally to come up with a capital standard for insurance companies that will do for insurance companies what the Basel Committee on Banking Supervision has done for banks. This is work that is on a fairly accelerated timetable. The first targets of this work are the globally systemically important insurers, and we don’t have a Canadian company on that list at the moment. But coming right behind that and seeking to overtake it is a standard for all internationally active insurance groups.
We’re certainly very active in the discussions at the IAIS about this. We want to make sure that to the extent this moves forward as it’s expected to, that it will work with the particular features of the Canadian industry. The features of the Canadian insurance industry are not entirely unique, but they’re certainly not represented in as great a measure all the way around the world.
Overall, it would be useful to have an international standard for a variety of reasons. One, it would simply allow us more easily to benchmark what we’re doing relative to other countries. And also the experience certainly that we’ve had in banking, which is relevant, although not a hundred per cent in insurance, is that if you want to have strong capital requirements for your internationally active institutions, and if you can have a minimum baseline agreement across the globe, it helps to minimize the level playing field issues. It makes it easier to have strong prudential regulation without handicapping your own industry. So all of those benefits are potentially there.
That said, we’re a ways away from seeing the final version of the insurance capital requirement. We’re contributing very actively in its development and we’ll have to see where it ends up before we decide how to implement it in Canada. One thing I have said a few times, and I don’t mind repeating, is that if we feel the international capital agreement sets a capital requirement that’s lower than is really needed for prudential regulation in Canada, we’ll certainly set a standard that is higher. This is what some of my predecessors did in banking, and I’m grateful to them for that now.
Neil Parkinson: I just had one last question, and it is one I’ve asked your predecessor in previous years. What’s on the Christmas wish list if you would have one for the industry?
Jeremy Rudin: What I’ve stepped into at OSFI is a principles-based approach to regulation that is effective in large part because we have a very good working relationship with the industry as a whole and with the individual members of the industry. When the regulator has a good working relationship with the industry, when it can have confidence in the information that is received from the industry, when it can be confident that the industry will adopt and embrace changes to regulation that are principles based and will approach them with the idea that these are things that need to be implanted in the firm, rather than simply adopted in a compliance-based checklist approach, that’s the most effective way to regulate. It’s the most effective way in terms of being able to have appropriate prudential standards, and it’s also less costly and less burdensome for the industry. That’s a win/win.
We’re very fortunate in Canada to have the conditions that allow us to regulate in this way and my wish for the industry, for the whole financial services industry, is that we maintain that ability to have a principles-based approach.
Neil Parkinson: Thank you for being with us today. I would certainly second what you said about the value for the full financial-service industry of having a very good working relationship with the regulators and so thank you for that. We appreciate all of your answers, and we look forward to working with you. So thank you. (Applause.)
Jeremy Rudin: Thanks very much.