Avoiding ‘Death by Best Practices’

As the Financial Services Com- mission of Ontario (FSCO) moves towards a risk-based regulatory model, insurers must maintain clear lines of communication with regulators to make sure the implementation of the model works as advertised, panelists told an audience attending the IBC’s Regulatory Affairs Symposium in Toronto.

“I’m very much in favour of risk-based regulation as an approach, but my comment is very much of a warning about it,” said symposium panelist Paul Belanger, a partner in the Toronto office of Blake Cassels & Graydon LLP.

The risk-based regulation model relies heavily on the insurance industry to develop and conform to standards and best practices. Belanger says it’s important for this model to reflect individual company circumstances once it is implemented. To this end, it is important for the industry to keep in touch with regulators and make sure everyone involved is agreed on how to interpret the standards, he said.

REGULATORS’ TOYS

“You’ve got to remember that regulators are not like little children,” Belanger said. “With little children, if you give them a new toy, some of them don’t like the new toy. Some of them will like it for awhile and then it gets left in the toy box. Some of them will only play with the toy once or twice and then leave them alone.

“Regulators like all of their toys and they like them for a long time. If the risk-based regulation becomes a toy … then there’s a [risk of] ‘Death by Best Practices.’…

“You’ve got to have [best practices] that fit your business strategies, your organizational structure, what you’re doing. But at the working level, there are times when you find there’s never really a best practice that particular people [in regulatory bodies] wouldn’t like to see applied by every company, no matter what they’re doing and what business they’re in. You get inundated with these things. At the margins, it’s always easy to go along and implement a best practice, but overall you’re hampering governance and compliance and making it less efficient and effective.

“With risk-based regulation, I think people have to work hard and honestly at not letting it devolve into where we have [one set of] best practice[s], and [regulators are] trying to make sure that everyone is doing them…People have to be very careful to get good, honest interpretations of what the rules are and what the goals are and what those goals mean. You have to have a common understanding as to what that means. Absent that, you can find that what you think the goal is on one side of the table isn’t what that other person thinks it means. Again, communication is critical.”

In its published June 2005 statement of priorities, the Ontario Financial Services Commission (FSCO), the provincial regulator of the insurance industry, said it intended to develop and implement risk-based examination processes for pension plans, mortgage brokers and insurance companies.

“The objective of this initiative is to evaluate the safety and soundness of companies through a separate assessment of inherent risks and risk management processes,” FSCO announced in its statement. “This approach is a more cost-effective use of resources as it works through a sharper focus on risk.”

The risk-based approach is a departure from the provincial regulators’ rules-based approach to regulation. The IBC has enthusiastically endorsed the risk-based approach, saying the risk-based model “is breaking new ground in how the Canadian industry is regulated.”

IBC President Stanley Griffin told symposium participants the new regulatory approach is “more efficient” and “less intrusive” to the insurance industry than the rules-based model. He said the new model would focus regulators’ attention more specifically on the industry members that are truly at risk of unethical or illegal activities.

LOOKING FOR FIRES

The rules-based model, on the other hand, forced all industry members – regardless of whether they represent a true risk to markets and consumers – to keep pace with and conform to the sum total of regulators’ rules and regulations.

“I like to use the example of imagining you are in a forest of B.C. or Alberta, trying to look for forest fires,” Griffin said, comparing the two models. “You could try and wander around in the forest trying to find a fire, or you could take a plane and fly over the forest and look for smoke. And where there is smoke, there is fire.

“I think we’re agreed the latter approach would be much more efficient – especially if we don’t know whether there is a forest fire out there in the forest. Risk-based regulation is like the plane. It monitors the system from a high level and only moves in when there is evidence of a problem. It’s more efficient, it’s less intrusive and it’s less costly for both the industry and the regulators.”

Belanger said he liked Griffin’s plane analogy. “If that’s the way risk-based regulation is implemented, then that would be a good thing,” he said. “The warning is that you’ve got to remember that implementation is critical and there’s going to have to be a lot of communication and interaction to make sure everyone is living up to that ideal on both sides of the table.”

Griffin said the successful implementation of the risk-based model depends on regulators feeling confident about the trustworthiness and public credibility of the insurance industry. “To build trust [with regulators and the consumers], one needs to be trustworthy,” he said. “Standards can be used as a means to address supervisory concerns.”

To this end, IBC approved Standards of Sound Marketplace Practice in January 2006. The standards call for:

* competitive products meeting the unique needs of customers;

* informed and transparent sales transactions;

* competent and professional insurance representatives that conform to a specified code of ethics;

* fair claims settlement and claims handling; and

* timely, accessible and responsive claims handling.

Griffin said regulators appear most interested in the standards relating to transparency and timely and responsive claims handling. He said the next step is for insurers to adopt the standards and to work with regulators to promote risk-based responses to specific provincial concerns.

IBC will be reviewing companies’ adoption of the standards in January 2007, and FSCO will follow up with a review of its own in April 2007.

FSCO CEO and superintendent Bob Christie called the IBC’s development of the standards “a major market conduct initiative” that “represented a positive direction for the industry.” He said regulators “would be very interested to see how they develop and how they are applied in practice.”

Christie noted the IBC’s standards have a “strong connection” to the principle-based standards on disclosure adopted recently by the industry practices review committee of CCIR/CISRO. “This is not surprising, because they have the same objectives, which is enhancing consumer confidence in the industry,” he said.

Christie noted that by developing their standards in terms of principles or desired outcomes, “regulators are expressing confidence in the ability of market participants to determine how best to achieve these desired outcomes in ways that best reflect their circumstances and their own business models.”

The risk-based approach obviously offers some benefit to regulators as well, Christie said. “It doesn’t require the complexity of a new regulatory code. Standards are relatively easy to monitor and it leaves regulators with options if problems are discovered. Using Stan’s analogy, if there is smoke, regulators have a number of options to determine how to deal with it, including involving the industry efforts to make sure that no substantive fires break out.”

COMMUNICATION

“You have to keep up to speed because obviously you don’t want to be doing something that you find out later is now out of favour,” Belanger said. “You [don’t want to] take a step that is wise under one particular legislative scheme, and then find out that scheme is changing in a way that might have changed what you were implementing.

“Also, probably you will want to have input into the way that regulatory policies are evolving in order to make sure that you are best protecting your interests. When you are dealing with regulators, we are now in an age where it’s important to do this in writing, just so there is a clear line of communication back and forth and everyone is on the same page in terms of what you’re discussing.”