Having proved resilient during the financial crisis,
Canadian life insurers will be hoping the outcome of current stress
tests do not lead to imposition of tougher capital requirements.
Adding to their concerns are pending accounting changes threatening
to disrupt their business models. Charles Davis
reports.
Go deeper with GlobalData
Canada’s financial regulators are
widely credited with helping the nation emerge relatively unscathed
from the global financial crisis. With the political wind at his
back, Ottawa’s head financial regulator is now conducting a new
round of stress tests on the country’s largest life insurers to
ensure they can withstand another stock market crash, a natural
disaster of epic proportions or a pandemic disease.
Canada’s Office of the
Superintendent of Financial Institutions (OSFI) is now reportedly
analysing the results of those stress tests, which are widely
acknowledged by the nation’s life insurers even if no one is
talking about them publicly for fear of rattling the markets. And
if the past is any indication, the OSFI will not hesitate to demand
that insurers hold more capital.
This sort of cautious, yet firm,
regulation is widely credited for helping Canada miss the worst of
the North American contagion that so badly damaged a number of US
insurers.
Although Canada was hit by the
worldwide recession, the Canadian financial system weathered the
global financial crisis comparatively well. Canadian financial
institutions were not unscathed by the crisis, but none were
excessively affected by toxic assets, no public funds were injected
into financial institutions, Canadian banks remained profitable and
they continue to lend money at healthy levels.
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By GlobalDataNot that all is rosy for Canadian
insurers. Sputtering stock markets and low interest rates are
slowing growth, and the industry is nervously awaiting new
accounting standards that could further hamper the sector.
Unusually
thorough
OSFI has asked 20 life insurers to
run through three scenarios and assess the impact on their
operations. Under one scenario, insurers are asked to run
mathematical models of what would happen if a pandemic wiped out
many thousands of people. Stress tests are commonplace in Canada,
but the depth and reach of this round is unusual.
In a recent note to clients,
Desjardins Securities analyst Michael Goldberg highlighted the
severity of the ongoing slowdown in life insurance in Canada,
noting that the lingering impact of the crisis has driven the stock
market’s valuation of life insurers below that of Canadian banks,
which have begun to climb out of the recession. Sun Life Financial
Corp and Manulife Financial Corp, which have traditionally held
price-to-book ratios above two, now have multiples around one, he
noted.
The markets are serving as an
anchor for Canadian insurers, Canadian Imperial Bank of Commerce
analyst Robert Sedran pointed out in a research note.
“Low interest rates and volatile
equity markets are essentially the opposite of an optimal operating
environment, since they affect not only the in-force block, but
also the outlook for sales and customer behaviour,” wrote
Sedran.
Accounting rule
threat
Then there are the
soon-to-be-released amended rules from the International Accounting
Standards Board (IASB).
The International Financial
Reporting Standards apply to publicly listed companies around the
world, but Canadian insurers are more worried than most because
some of the new rules could negatively impact the treatment of
certain long-term liabilities popular in the nation’s insurance
market.
Canada’s finance minister Jim
Flaherty and the financial regulator have written to the IASB
urging it to keep the potential impact on insurers here in
mind.
For example, Canadian financial
institutions currently ensure that the time horizon of their assets
matches their liabilities. For instance, if an insurer sells a
30-year annuity, it will match that with a similar term bond. The
new rules threaten to separate the two sides of the balance sheet,
so that assets and liabilities move separately, increasing
volatility.
The changes would impact how the
companies calculate their long-term commitments, forcing them to
use different interest rate assumptions that they say would be
detrimental.
Proposed rules would also make it
less attractive for insurers to buy as many long-term bonds, either
public or corporate, executives say. The industry has ensured that
that fact has not been lost on Canada’s policy-makers.
The life insurance sector holds
$C75bn ($73bn), or 14% of all Canadian and provincial government
bonds; C$77-billion, or 13% of all Canadian corporate bonds; and
C$82-billion, or 13% of all mutual fund assets in the country,
according to the Canadian Life and Health Insurance
Association.
That association sent a letter to
the IASB asking it to take more time to consider the issue and to
delay the release of its draft rules. It deemed rules that are
under consideration about interest rate assumptions to be
“fundamentally flawed”.
The cost of
capital
The changes could impact the cost
of capital for insurers in North America, forcing them to raise
prices on their products, and there would be consequences for the
capital markets, the industry association said.
“We are not suggesting the new
standard be equal to the existing Canadian standard, but instead
the concepts that are the strength of the Canadian model be
considered,” the letter said.
Ottawa is also in the process of
drafting legislation to stop Canadian banks from using their
websites to promote insurance that cannot be sold through regular
branch offices.
Flaherty is moving forward with
legislation that would make it illegal for federally-regulated
Canadian banks and trust companies to use their websites to promote
so-called non-authorised insurance products including life,
property and casualty insurance.
Ottawa intends “to adopt specific
policy measures to ensure that banks [including trust and loan
companies] do not do indirectly what they are not allowed to do
directly with respect to their insurance business activities”,
Flaherty wrote in separate letters to the heads of Canada’s
banking, insurance and trust and loan associations.
“These measures were made necessary by evolving use of
technology by banks.”
