OSFI sticks to its principles

Canada’s solvency regulator is channeling its internal Frank Sinatra. It has a plan and is sticking to it, forging its own way in the wake of the global market meltdown.

Based on a number of speeches and the latest version of its reinsurance paper, the Office of the Superintendent of Financial Institutions (OSFI) is clearly sticking to its principles –or more specifically, sticking to its principles-based approach to regulation.

Why? Well, because it can. OSFI is operating from a position of strength now that the worst global financial crisis since The Great Depression is beginning to be mopped up. Canada has thus far seen its property and casualty insurers get by with nary an insolvency to show for it. Regulatory systems around the world are taking a second look to see what OSFI’s “secret sauce” for solvency might be. Thus, there is no reason for OSFI to deviate from its game plan — and it doesn’t look like the regulator will.

True to its public pronouncements over the past several years, OSFI is continuing its march down the path of a principles- based approach to regulation. International observers were witness to this determination to stay the course when OSFI superintendent Julie Dickson addressed the Heyman Center on Corporate Governance in New York on Mar. 16, 2010.

“A financial sector with strong regulatory rules, but with weak supervisory oversight, is not a safe and sound financial sector,” Dickson said. She likened “supervisory oversight” to the role of a referee — a ref not only calls penalties for rule infractions, but also controls the flow of the game. Referees “talk to players and coaches about what is expected, what is acceptable and not acceptable, and what situations they will be watching given past experience,” Dickson said. “They know the personalities of the players in the game, they use carrots and sticks, give some players the benefit of the doubt, and give others no room at all. The rules are important, but ultimately it is the referees that control the flow of the game.”

Sounds like a risk-based approach to us.

Lest anyone think Dickson was just trying to provoke her U.S. regulatory counterparts, OSFI’s latest reinsurance paper basically proves her point.

OSFI, for example, is proposing to drop its longstanding rule that caps the amount of unregistered reinsurance a company can buy at 25%. In tandem, it is proposing to drop its ceding limit of 75%, meaning insurers no longer have any limits on the amount of risk they can cede to reinsurers. These rules were established after reinsurer failures in the 1980s, and it is interesting that they are potentially going to be dropped at the tail end of a massive market failure.

They are also going to be dropped in the midst of an already- competitive Canadian reinsurance marketplace, where licensed insurers may soon have to contend with increasing competition for premium with unlicensed insurers. Sounds like a recipe for a financial disaster if pricing starts to drop as a result.

But even though OSFI is dropping its limits, it is not dropping its caution either. It will be keeping its requirement that unregistered (re)insurers maintain enough collateral to cover 100% of ceded liabilities and to post collateral in Canada.

OSFI assistant superintendent Mark E. White told the 2010 IBC Financial Affairs Symposium in Toronto that maintaining Canada’s collateral regime is all the more important now that OSFI is proposing to eliminate its 25% limit on unregistered cessions. In this context, “protecting ceding companies and their policyholders from weak unregistered reinsurers becomes even more important,” he said.

And that means no mutual recognition of potentially inferior solvency regimes. The international community of insurance regulators is “a very long way from harmonizing global insurance regulatory and supervisory standards, and realistically, this is a precondition for effective mutual recognition,” White said. “Countries like Canada are not likely to accept a lower or unknown standard due to mutual recognition.”

So there you have it: this is one of those rare times when Canada is able to duck the pressure to adopt international standards and channel its inner Frank Sinatra, doing things ‘Our Way.’

You can do this from a position of strength. And clearly OSFI feels it has most of the international financial aces in its hand.