Insurance regulation plays an essential role in protecting policyholders from risks of many varieties. Due to the complex nature of insurance and its importance in society, regulators around the world impose guidelines for insurance companies to follow to ensure that insurers can fulfil the needs of customers.
In Canada, our national regulator, the Office of the Superintendent of Financial Institutions (OSFI), typically focuses on the solvency of insurers. Provincial regulators are more concerned with fairness and transparency of ratemaking and underwriting. Other countries may have more or less regulatory oversight in comparison to Canada.
For example, the difference between the intensity of the global financial crisis of 2007-2008 in the US and in Canada is arguably due to our regulatory restrictions. Many US financial institutions and individuals experienced financial collapse due in part to the rapid development of predatory financial products which targeted low-income home buyers.
US financial regulators did not impose limits to prevent these catastrophic outcomes. While Canada was not entirely spared, the regulatory regime that oversees financial institutions prevented the “Big Six” chartered banks from engaging in the kind of risky behaviour of their US counterparts. Partly because of this stronger regulatory environment, Canada’s banks were not in danger of insolvency in the crisis.
An important part of the regulators’ policy toolkit is to mandate how much capital insurance companies need to set aside to weather potential financial turbulences.
Some capital regulation regimes are more rule-based, with a set of pre-defined capital charges aimed at the industry overall. Others are more principle-based, allowing insurers a certain degree of flexibility to consider a company-specific risk profile, such as business strategy, risk appetite, risk mitigation and portfolio mix.
To illustrate the difference between Canadian and UK regulatory capital requirements, we use a manufacturing plant with a total insured value (property damage and business interruption).
In this example, the limit provided by the property policy of USD $100,000,000 with an annual premium of is $500,000. The insurer is aiming to achieve a 12% return on capital and, for simplicity, we keep expense factors and investment income the same for all countries, though they differ as well.
No claims / no CAT exposure |
Canada – MCT |
UK – Solvency II |
Statutory capital (initial capital) |
$200,000 |
$80,000 |
Operating profit before tax |
$25,000 |
$13,000 |
Undiscounted combined operating ratio |
97.3% |
99.3% |
Discounted combined operating ratio |
96.0% |
98.0% |
Premium to surplus ratio |
3.6 |
6.2 |
Capital required |
$138,899 |
$80,645 |
Note: this is for illustration purpose only. In reality, capital requirement is dynamic and depends on many factors beyond the scope of this simple example.
As the example demonstrates, the overall capital requirement for a Canadian insurer is higher under Canadian regulation, reflecting a relatively prudent view of the Canadian regulator compared to the UK. The Canadian requirements are also higher than most other jurisdictions.
Under the UK regulation, the insurer’s own risk profile is considered in determining the capital requirement, offering an advantage given our bigger, more diversified commercial book and better risk management than average players in the Canadian market.
What are the overall differences?
The Canadian regulatory capital requirement is more cautious, providing a higher level of confidence for policyholders and the stability of society overall. However, the opportunity cost of this prudence is that insurers can’t use as much capital to invest in their business.
What are some of the OSFI regulations?
Another OSFI guideline related to capital requirement is on Internal Capital Targets, which allows insurance companies to determine the amount of capital to hold on top of a pre-determined minimum target reflecting their own view of the risk profile.
In addition to capital regulations, regulators like OSFI also impose a set of risk management guidance for the insurance industry. For example, OSFI provides guidance on:
- Insurance and investment concentration risk (B-2)
- Sound reinsurance practices
- Third-party risk management, including insurance brokers
More recently, it has added climate risk management and model risk management (E-23).
What limits do provincial regulators impose?
Provincial regulators set regulations regarding issues such as auto insurance rates and fair treatment of insurance customers.
While these regulations are intended to improve insurers’ financial soundness and resilience and protect the policyholders, some can add to the “frictional cost” for insurers and potentially create barriers for new entrants thus harming the competitiveness of the insurance market.
Insurance regulations play a crucial role in safeguarding policyholders and ensuring the stability of the financial system. It’s crucial to explore the regulatory costs vs. benefits when developing relationships with insurers around the world.
Looking for more information about Insurance regulators?
Aviva's Global Corporate & Specialty team would be happy to answer your questions. Contact us at gcs.ca@aviva.com
