Meeting regulatory requirements: Sometimes size matters

As insurers face the challenges of legislative and regulatory compliance, there is an argument to be made that large insurers will be in a better position to meet these challenges. As a means of meeting the regulatory requirements they face and of reducing the relative cost of adhering to those requirements, smaller insurers, especially those with a large proportion of Ontario automobile, may decide to consolidate.

Earlier this month, A.M. Best issued a briefing that pointed out that smaller companies may feel the impact of recent reforms and pricing targets to a greater extent than larger insurers. The Ontario government has mandated a 15% reduction in automobile insurance rates by August 2015 compared to the rates filed in August 2013. The target was for an 8% reduction by August 2014. In fact, rates were down by only 6%. As noted in its report, A.M. Best expects smaller companies having limited business profiles and resources will find the ‘choppy waters of the Ontario auto market difficult to navigate’ which could, in turn, ‘lead to changes in strategic direction and, possibly, more consolidation within the industry.’

It is not only legislative changes concerning Ontario automobile insurance that are impacting insurers. There are also increased regulatory requirements emanating from the Office of the Superintendent of Financial Institutions (OSFI). In a guideline issued last month, OSFI communicated its expectations with respect to the management of regulatory compliance risk by federally regulated financial institutions (FRFIs). In its guideline, OSFI defined regulatory compliance risk as the risk of an FRFI’s potential non-conformance with laws, rules, regulations and prescribed practice in any jurisdiction in which it operates, worldwide. Under the terms of the guideline, the overall responsibility for the assessment and management of regulatory risk compliance will be assigned to a designated Chief Compliance Officer (CCO), someone who is independent from operational management and who has sufficient stature and authority within the FRFI to influence the FRFI’s activities. OSFI’s guideline recognizes that for small, less complex FRFIs, the CCO may have other responsibilities beyond activities specifically related to regulatory compliance risk. In addition, OSFI will administer its supervisory program in ‘a manner appropriate to the circumstances of each FRFI’. Nevertheless, the costs of meeting the requirements of this guideline will be relatively larger for small insurers than for insurers with significant scale.

As of this year, insurers are also expected to complete an Own Risk and Solvency Assessment (ORSA). In a speech at the 2012 National Insurance Conference of Canada, Superintendent Julie Dickson commented that ORSA was being introduced because ‘it is not enough for companies to determine their capital needs based solely on OSFI’s capital requirements. Our capital rules are standardized and represent the minimum requirement. They are not tailored to address the specific risks to which each individual company is exposed, so companies cannot assume that using only OSFI’s capital rules will give them the appropriate risk valuation.’ The Superintendent went on to say that an insurer’s board of directors will be expected to understand how the company’s management is managing the risks identified through the ORSA process.

Whether wholly or partly due to changes in legislative and regulatory requirements, we have already seen consolidation within the mutual insurance community in Ontario. Just over a year ago, The Commonwell Mutual Insurance Group was formed by the amalgamation of Farmers’ Mutual Insurance Company (Lindsay), Glengarry Mutual Insurance Company and Lanark Mutual Insurance Company. Earlier this year, the proposed amalgamation of Kent & Essex Mutual Insurance with North Kent Mutual Insurance Company and West Elgin Mutual Insurance Company fell through when the policyholders of one of the mutuals failed to pass a motion that would have approved the amalgamation. Even though the proposed deal collapsed on the way to the finish line, the fact that the amalgamation was proposed in the first place is evidence that the boards of the three companies felt there was merit in joining forces.

There is no reason to think that the level of regulatory oversight will lessen in the future. Nor is there reason to think that the cost and effort of compliance will be felt equally by the small and the large. As noted in the A.M. Best briefing, insurers with ‘significant scale, robust segmentation capabilities and/or a niche focus are expected to be better-positioned to absorb the impacts of the challenges from recent reforms’.