Office of the Superintendent of Financial Institutions
We must all absorb and apply the lessons learned from the financial crisis. We must adjust to changing times. We need to take care, when designing new rules, to do no harm. And in resurging, we need to keep an eye on new risks.
Thank you -- And good morning, everyone.
Let me begin by congratulating the Canadian Reinsurance Conference on its 58th anniversary. Today, this conference is one of the premier events of its kind. I like the theme you have chosen for this year: Reflect. Rewire. Resurge. The words can be interpreted in different ways (like art), which is probably why they were chosen – it is always useful to have some debate! As a supervisor, what came to my mind was timing and whether the words implied that the crisis is over and we are back to normal and ready to resurge.
In reality, the current environment is far from normal. While we appear to be at the start of a normalization process, interest rates are still at historically low levels, the Federal Reserve must deal with its $4 trillion balance sheet and unwind Quantitative Easing (a few other central banks have similar challenges), growth in several advanced economies is still not at pre-crisis levels and, while the base case is for improvement, tail risks remain.
That being said, a whole lot of reflection has been going on regarding the global financial crisis, the huge impact it has had on global growth, whether we have re-wired enough in response, or too much, and lastly whether we are ready to resurge.
As you know, Canada fared better than many other countries in the crisis. As we at OSFI reflect on that, we continue to say that past success does not guarantee future success. OSFI and Canadian banks and insurance companies need to avoid complacency. We were recently subject to an IMF financial sector assessment (i.e. FSAP). The FSAP process determines a country’s compliance with international standards and provides an overview of the economic health of a country as well as regulatory effectiveness. The assessors were asked to look for any signs of complacency at OSFI. I am happy to say that they did not find any. They have concluded that we continue to be effective with a high level of compliance with international standards.Footnote 1
The FSAP report commented on some of the factors that helped Canada withstand the crisis well, including OSFI’s close touch supervision, our clear and straightforward mandate, and our ability to attract and retain financial sector specialists. The FSAP team also noted that stress tests recently conducted show that major financial institutions would continue to be resilient to credit, liquidity, and contagion risks arising from a severe stress scenario.
I think it is very important, however, not to rest on laurels because the bar is constantly rising. So, we continue to seek information on what others are doing and how we compare.
OSFI tends to strongly support global standards and practices, versus entering into endless debates about whether we need them.
While consulting and ensuring we understand impacts is important, we need to keep an eye on endless debate. In this regard, I was very happy to see the December 2013 report of the U.S. Department of Treasury, on modernizing insurance regulation. It did not mince words in advocating group capital adequacy and consolidated supervision in the U.S., something that has been debated for a long, long time.Footnote 2 The International Association of Insurance Supervisors (IAIS) is also on the verge of ending this debate.
In the area of standards, OSFI is often asked whether our goal is always to have the highest standards or the toughest rules in the world.
Let me be clear: OSFI’s approach is to look at international standards (which, remember, are minimums) and ask whether, in our judgment, they are sufficiently conservative. Sometimes we think they are, sometimes we do not.
Prior to the financial crisis, for example, we looked at international minimum capital rules for banks and expressed our view that they were not high enough - and so we set our standards above them. This turned out to be an important decision and is one reason why the Canadian system held up well.
We do not automatically set higher standards than what are agreed upon internationally. We are not ideological when it comes to regulation. Our philosophy is to look at the international standards, and then make up our own mind about whether they are appropriate or need to be strengthened in Canada.
In terms of re-wiring, I can offer a few comments on some of the things we are seeing.
Obviously, as a result of the global financial crisis, we are seeing continuing focus on safety and soundness in the financial sector.
We are also seeing re-wiring of a different sort: the work on risk culture, which the Financial Stability Board and many supervisors and many institutions are focused on, is to some degree about re-wiring how supervisors supervise and how financial institutions operate their businesses. Supervisors are being called on to focus on the attitudes and behaviours they are seeing at financial institutions regarding risk, and to discuss their observations with senior management and boards. Prior to the crisis, supervisors would have focused largely on objective matters, such as whether reserves were adequate.
Many institutions have already begun such re-wiring, by taking steps to delve more deeply into their culture and how it affects the balance between risk-taking and controls.
While not directly related to risk culture, the Own Risk and Solvency Assessment (ORSA) process, which the Canadian insurance industry is putting in place this year, will be very useful for them in forcing determination of the risks they are facing, as well as the valuation of the amount the risks represent in both normal and stressed environments.
Another sign of re-wiring is in evidence globally as we see supervisors being far more proactive, especially in the case of large, complex institutions. For example, most major supervisors now engage routinely with boards (including receiving notice of board and senior management changes, so that there is an opportunity to discuss any concerns in advance). The latter has become an international expectation, and is endorsed by private sector groups such as the G-30.Footnote 3
Proactivity in the area of stress testing is also evident. For its part, OSFI issued Guideline E-18 to provide guidance to federally regulated financial institutions in the area of stress testing. It notes that OSFI may ask institutions, “…from time to time, to carry out standardized scenario tests for use by OSFI to assess system-wide vulnerabilities.” In the life insurance sector, we have carried out industry-wide stress tests each year since 2010.Footnote 4
When designing stress tests, OSFI’s key goals are to:
Our stress tests in past years have captured exposures to insurance and market/economic risks; our 2014 stress test focuses solely on economic risk factors (including policyholder behaviour) and is framed as a global economic slowdown.
We are also seeing a lot of re-wiring of things like capital. The IAIS is developing backstop capital requirements, as well as higher loss absorbency requirements for designated Global Systemically Important Insurers (G-SIIs), as well as global Insurance Capital Standards for all internationally active insurance groups (or IAIGs).
Harmonization of insurance capital requirements globally is an important development. It is premature to determine the impact these will have on Canadian capital requirements. Therefore, as expected, OSFI intends to continue development of our internal set of rules, given the international global standard might initially act as only a minimum requirement until sufficient time has been allowed to develop and test a robust enough capital test.
Even more rewiring is being done via a major overhaul of global accounting rules that apply to insurance companies, that is, International Financial Reporting Standards (IFRS). While this rewiring is not being done as a result of concerns arising from the global financial crisis, it is of incredible importance. Unfortunately it is not being done in a harmonized fashion globally, as the U.S. is going its own separate way.
In Canada, we are very concerned about where IFRS may end up. Our view is that re-wiring must be done in such a way that the insurance industry will still work. The IAIS has weighed in, as has OSFI with our own proposals to the International Accounting Standards Board (IASB). Our primary concern is over the impact on long-duration insurance contracts and the presentation of insurers’ asset-liability management.
An additional and particular concern for Canada is trying to ensure that new standards apply to all IFRS companies at the same time. Past experience with a brand new accounting standard, where Canada was first to adopt, caused Canadian insurers and their auditors to lead the work at the global level. It would be far better if all global companies and auditors are working on a new standard at the same time, so that global agreement on interpretations can be reached.
More broadly, we have called on the IASB to consider issues of complexity and to keep the standard as simple and as principle–based as possible, in order to give insurers and other stakeholders the necessary flexibility in adopting it. We are hopeful that the IASB will give favourable consideration to our suggestions.
What about resurging? Let me turn for just few moments to a few issues of particular concern to reinsurers, which may be relevant to the concept of “resurging”.
First, longevity risk – something I know that there is healthy debate about and that you will be addressing later in the breakout sessions.
The nub of the debate is whether it is prudent to assume that recent mortality improvements can serve as the basis for long-term projections. In other words, can we simply continue to extend the line projecting ever-longer lives into the future?
While it is certainly true that huge improvements have been seen in the past two decades, future improvements may depend on our understanding of things like the biology of aging and regenerative medicine – areas that remain new frontiers.
As we explore these frontiers, with their potential for transformative medical breakthroughs, forecasting mortality rates will become increasingly uncertain.
In the meantime, there can be surprises, such as we’ve seen in the United Kingdom, where mortality rates improved two to three percent every year over the past decade only to slow down in the last two years. Whether this was just a statistical blip or the beginning of a tapering of the rate of improvement remains to be seen.
The point is that pension actuaries - and companies selling longevity insurance - need to be prudent as they make projections that can have significant financial impacts.
Second, the reinsurance industry, like many others, faces ongoing cyber threats, including challenges with data administration and other technology issues. This has become a big focus for banks, as well as insurers, and significant attention must be paid to it.
OSFI released Cyber Security Self-Assessment Guidance last October. It has proven to be a valuable tool for institutions to self-assess their own cyber risk and preparedness and has resulted in productive discussions between institutions and OSFI. Cyber threats and data losses are reported in the news every day and in nearly every industry and the number, sources and sophistication of attacks are increasing. Cyber risk is an ever evolving risk, that in our connected world, touches nearly all business consumer relationships and potentially the safety and soundness of the institutions OSFI regulates and the policyholders interests that we are charged to protect. Adequately addressing and mitigating these risks requires an active and dynamic approach that many institutions have already adopted or are planning to in the near future.
Let me close, as I began, by referring to the theme of the conference: reflect, rewire and resurge. We must all absorb and apply the lessons learned from the financial crisis. We must adjust to changing times. We need to take care, when designing new rules, to do no harm. And in resurging, we need to keep an eye on new risks.
If we all take these steps, the future for reinsurance, and indeed the insurance industry in general, will be very bright indeed.
I wish you all a very successful conference.
The results of the International Monetary Fund Financial Sector Assessment Program for Canada were released earlier this year and are available online at: http://www.imf.org/external/country/CAN/index.htm
Return to footnote 1 referrer
The Federal Insurance Office of the U.S. Department of the Treasury released the report titled “How To Modernize And Improve The System Of Insurance Regulation In The United States” in December 2013. Available online at: http://www.treasury.gov/initiatives/fio/reports-and-notices/Pages/default.aspx
Return to footnote 2 referrer
See “A New Paradigm: Financial Institution Boards and Supervisors” Group of Thirty, Washington, 2013. Available online at: http://www.group30.org/images/PDF/Banking_Supervision_CG.pdf
Return to footnote 3 referrer
Excluding 2013, when major life conglomerates, as well as the large banks and CMHC, participated in the International Monetary Fund’s Macro Stress Test.
Return to footnote 4 referrer