Being Ready

Over the course of its 15 years in existence, the Property and Casualty Insurance Compensation Corp. (PACICC) has paid out about $100 million to policyholders relating to 12 insurer failures. Now, as the insurance industry nears the outer edge of what has been described as the most challenging and protracted “down” and “up” of its long history of business price cycles, attention from regulators and even companies themselves has turned to question how effective PACICC is in the current risk environment. Notably, the financial vulnerability of insurers in Canada by the end of 2002 was at a high level not seen since PACICC was first established, says Paul Kovacs who was recently appointed as the new president of the corporation. “Industry conditions for 2003 have improved, but we’re [the insurance industry] still not out of the woods.”

Working in conjunction with Alex Kennedy, the former president of PACICC who is regarded as the “life force” that got the corporation onto its feet, Kovacs says he is ready to move ahead with organizational reform proposals. Earlier this year PACICC released a “white paper” for discussion detailing the main issues which it believes need to be addressed by members to ensure that the corporation’s role remains effective in today’s marketplace. Subsequently, PACICC has brought out a three year “direction report” which members will vote on at a corporation meeting set for mid-November this year. “The fact that the industry was willing to invest in reform sparked my interest in the PACICC position,” Kovacs notes.

Part of the urgency to “update PACICC” did relate to concerns expressed by the federal regulator, the Office of the Superintendent of Financial Institutions (OSFI), toward the end of last year regarding the industry’s deteriorating financial health, Kovacs observes. In this respect, the insolvency risk was not limited to small companies, but included some major players in the industry, he notes. Furthermore, he points out that the “worst period” for increased insurer insolvencies is a year or two after the industry has overcome its financial low. “There is a lag, or a delay, after the low financial point of the industry [when insolvency risk is at its greatest]. There is definitely a two to three lag before the insolvency risk is reduced. The weak [industry] numbers for last year were the trigger.”

Provincial regulators also began questioning PACICC’s compensation limits on payment of unearned premiums (a heated debate remains ongoing between east-coast regulator Winston Morris and PACICC over the latter’s limited 70% payment of unearned premiums up to $1000 a policy, which the regulator believes compensation should be 100%) and the ceiling value on claims. All of the issues above have to be seen against a backdrop of significant growth in the premium base of the industry, which in just a few short years has jumped by 50% in value.

“It became evident that PACICC couldn’t continue as it had [in the past] based on the [increased] vulnerability factor in the industry. A different industry mindset toward PACICC was needed,” Kovacs emphasizes. PACICC’s three year reform plan consists of three groupings: operational, governance and research, he explains.

Operational issues

The operational mandate of PACICC will receive the most attention in the year ahead, assuming the three-year plan is voted in favor, Kovacs observes. The key factors involved are the corporation’s “pre-fund reserve”, a re-evaluation of “reasonable compensation” in terms of both maximum claim payments and refunds of unearned premiums in the event of an insolvency, and whether large commercial claims should be covered.

PACICC currently operates on a “pre-fund” of $30 million for purposes of dealing with claims and refunding of unearned premiums. However, with the size of the marketplace having grown by 50% to reach $30 billion, the size of the pre-fund has to be looked at, Kovacs says. PACICC’s commitment to the public is to provide “reasonable compensation” to policyholders in terms of a failure, he notes, which with the rapid growth in value of premiums, this definition needs to be examined. “We need to review what ‘reasonable compensation’ is. At the moment, we give back 70% of the unearned premium up to $1000 per policy. With premiums having risen, is this adequate?”

The other issue is PACICC’s level of compensation on claims. At present, the corporation pays up to $200,000 a claim in the event of failure of the underwriting company. While there are not many claims that have fallen into PACICC’s lap of this magnitude, those that do tend to be large commercial risks. The idea behind the establishment of PACICC was to provide a final resort of coverage to personal and small business policyholders, Kovacs notes, and whether large commercial coverages should fall under the corporation’s protection needs to be clarified. Furthermore, one of the more significant reasons for PACICC’s existence is to provide policyholders with some form of immediate compensation. Company windups can take years in going through the courts, Kovacs points out, which in many cases the full value of the premium or claim is achieved. In this respect, PACICC’s role is to provide some immediate relief, he adds, and not to provide 100% compensation upfront to policyholders, as has been argued by some in regulatory circles.

Independent governance

Kovacs says some pressure has come down on PACICC to adopt independent board members outside of the insurance industry. This is fairly common practice with similar insolvency compensation bodies for other financial services sectors such as investment funds, banking and life insurance. However, after much consideration, PACICC’s members felt that the business of p&c insurance was significantly unique to maintain control of the corporation by the industry, he notes.

Lack of independent board members has created some concern for OSFI, Kovacs admits, in that the federal regulator had always maintained a close company information sharing relationship with PACICC before real concerns of insurer(s) failure became a high priority concern. Subsequently, OSFI has been reluctant to provide some of its company data to the corporation on grounds that the board is not sufficiently independent of the industry. As a result, PACICC is now looking to increase the makeup of independent members sitting on its board, he adds.

Research muscle

One of the biggest challenges having faced PACICC in the past is lack of research resources, Kovacs says. The corporation relied heavily on data and information supplied by outside bodies such as the Insurance Bureau of Canada (IBC) and regulators. While these avenues of research information remain important, PACICC has to have its own research staff to achieve accurate assessment of the state of the market and its various players, he adds.

As a result, Kovacs has asked for a dedicated research team to be assigned to him. This will mean a bigger operating budget for PACICC, he says, although the outlay will be minor relative to the end benefits. Kovacs plans on providing the PACICC board with an annual review of the financial position of insurers in order for the corporation to better prepare itself relative to market conditions.

Relationship building

Having come from a relatively “abstract” analytical role at the IBC, Kovacs says the most interesting change for him in moving to PACICC is the “hands-on” relationships involved with the job. There are only three liquidators that have handled p&c company insolvencies, and maintaining a close relationship with these organizations is critical, he notes. “Unlike many other countries, we [PACICC] talk [with the liquidators] instead of argue. Keeping that positive relationship is crucial.” Then there is also the relationship with the federal and the provincial regulators, he observes, all of which involves hands-on work at keeping the communication lines open and friendly.

From a personal perspective, Kovacs says one of the more appealing aspects of taking over the helm of an organiz ation like PACICC is it fits into his broader interest of “risk mitigation”. He adds, “all my work at the IBC concerned issues where the industry may have been vulnerable. The situation at PACICC is similar. The point is to take mitigation steps to avert the risk. In other words, being ready as an industry.”

With 11 years of experience at the IBC in the role of chief economist and vice president, Kovacs expects to be around in the industry for some time. He will continue to hold the position of executive director of the Institute for Catastrophic Loss Reduction (ICLR), which being a relatively new industry body, has received tremendous support from companies. “PACICC is not necessarily enough to keep me interested all the time. I love the ICLR work, so when I need to be [focused] on PACICC I will be. It is a nice mix,” Kovacs says.