Regulators, insurers must focus on risks: OSFI

International regulators should narrow the focus of their mandates, while insurers must re-evaluate their use of modeling, according to the head of the Office of the Superintendent of Financial Institutions (OSFI).

Speaking at the National Insurance Conference of Canada (NICC) in Ottawa, Superintendent Julie Dickson told a ballroom of C-suite professionals in the P&C space that new risk transfer solutions need to be considered, given the frequency and severity of weather-related losses.

Capital market solutions have already been implemented in other countries — such as the U.S., Europe and Japan — explained an audience member, during a question and answer period after Dickson’s speech. The primary reason why Canada has not implemented this tool is a lack of “critical mass” according to an OSFI staff member, who was present during Dickson’s address

The frequency and severity of weather losses is what has prompted the national solvency regulator to consider and discuss risk transfer techniques using capital market solutions.

“There is a disproportionate level of losses,” caused by catastrophic, weather-related events, said Dickson. As such, the industry must consider product innovation, including new forms of risk transference and methods of handling weather-related losses.

Despite introducing the possibility of new products and innovative solutions, Dickson emphasized the need for these new tools to continue passing regulator tests, including compatibility and capital tests.

She encouraged insurers to bring forth their ideas, but not before making “sure that it not only meets your needs, but it meets our needs, too.”

International Focus Needed During the question and answer period, Dickson also answered questions on what needs to happen internationally to strengthen the global financial services sector.

Her main concern was the lack of focus on how supervisory agencies operate globally and the potential over-reliance on international standards, such as the European-based Basel II accord.

“There is a lot of discussion on low hanging fruit — such as Basil’s capital standards, or [the determination of] compensation, but not much discussion on regulatory independence,” said Dickson. She credits OSFI, and subsequently the four pillars of Canada’s financial sector, with being able to withstand the last 18 months of financial turmoil because the regulator’s mandate was focused. “We focused on one thing: solvency.” She believes regulators worldwide also need to consider their mandates and remove the “bells and whistles” that detract from achieving those mandates.

Dickson also expressed concern over the “short timeframes” many regulators and governments are now working under.

“There is a view that you have to take advantage of a crisis, because it’s the only time to get things done,” said Dickson. “But there is a high price to be paid; people should slow down.”

Reliance On Modeling Since the credit crunch hit the market 18 months ago, critics have targeted the practice of predictive modeling. However, when asked whether or not she agreed with the insurance industry’s reliance on modeling, Dickson stated: “It shouldn’t be thrown out.”

She, like others, noted that the failure of modeling to predict the underlying potentials for the sub-prime fallout were due to the controls, or lack thereof, of the modeling process.

“If you look at the alternative to modeling, you are going back to something pretty static,” said Dickson. “From our point of view, the lesson learned is that you have to spend a lot more time looking at the data and the controls. The models need to be checked and back tested. She added that all models should be designed to bring new information to the table and not be used to justify the replacement of knowledge and experience from “gray hair,” industry professionals.

(10/02/09)